METRO TO BUY A&P CANADA

Jon Springer

MONTVALE, N.J. -- A&P is leaving Canada with a pocketful of cash, no debt and a plan to reinvest in its stateside stores.

The retailer based here agreed last week to sell its 236-store Canadian division to Montreal-based Metro Inc. in a deal valued at about $1.475 billion -- a price that exceeded most analyst expectations and was "the best possible outcome" of A&P's previously announced plan to sell the division, said Christian Haub, chairman and chief executive officer of A&P.

The deal calls for Metro to pay $982 million in cash and $409 million in stock and to assume $83 million in net debt consisting of capital lease and benefit obligations. The stock portion provides A&P with a 15.8% equity stake in Metro, making it Metro's largest shareholder and, according to A&P officials, positioning it to benefit from the $50 million in annual synergies Metro hopes to achieve as it combines its operations, as well as dividend payments that could generate $6 million a year -- not to mention a last vestige of a profitable retail operation. A&P also gains two seats on Metro's board and will receive around $16 million for technology services over the next two years as Metro aligns its systems with A&P Canada. The deal is expected to close next month.

Proceeds will allow A&P to retire its outstanding debt and leave around $500 million in cash, which it intends to use to update its remaining stores in the Northeast, Haub said.

"It's a fantastic deal all around," Perry Caicco, an analyst for CIBC World Markets, Toronto, told SN. "It worked out well for A&P, that's for sure."

After the sale announcement, A&P said Eric Claus, former president of A&P Canada, was named president and chief executive officer of A&P, and Haub would become executive chairman, responsible for long-range strategic direction and public aspects of the company. A&P also said Brian Piwek, president and chief operating officer of A&P, will retire effective July 31.

"A&P got the full price for it," Bill Chisholm, vice president of research for Dundee Securities, Toronto, told SN, noting the purchase price is roughly 11 times operating earnings -- a huge multiple by U.S. standards but a fair price given A&P's lucrative business and strong market position in Ontario and greater Toronto.

Metro operates 343 stores in Canada but had just 3% market share in Ontario. The addition of A&P banners vaults it to the No. 2 position in the province behind Loblaw. Reports last week said Sobeys, based in Stellarton, Nova Scotia, offered more -- about $1.5 billion in cash -- but analysts said Metro's offer of equity swung the deal in its favor. Executives of both A&P and Metro highlighted cultural and operational similarities between the new partners, noting that both companies operate fresh and discount stores and stand to benefit each other through the exchange of best practices.

"I think it's a very compelling, strategic fit," said Pierre Lessard, chairman of Metro, in a conference call. "With the continued presence of A&P as an important shareholder of Metro, I am confident that together we will continue to innovate, grow and deliver value to our customers and shareholders."

For A&P, the transaction provides more than enough to retire its debt and feed a cash-hungry U.S. store base. Bryan Hunt, a debt analyst for Wachovia Securities, Charlotte, N.C., said A&P's debt load is approximately $1.1 billion, including lease obligations and payments on dark stores. Mitch Goldstein, A&P's chief financial officer, said the company intends to tender $460 million in notes due in 2007 and 2011.

Hunt noted that the bonds due in 2007 essentially became the spark that set off a dizzying series of moves over the last year for A&P. These included corporate downsizing in December, the announcement that it would sell divisions in the Midwest and Canada and concentrate in the Northeast this spring, and the recent announcement to outsource distribution to C&S Wholesale Grocers, Keene, N.H.

"If you go back a year ago and look at the company's cash-flow generation and analyze its markets, the question was: How are they going to retire this debt in 2007? It was the huge question overhanging this company," Hunt told SN. "They weren't generating enough cash to do it, and it would have been difficult for them to refinance that debt. One way to do it was to sell its profitable stores in Canada."

Goldstein said the company hopes to have a deal in place to sell its Michigan-based Farmer Jack division by the end of its fiscal year in February. After that, A&P will be challenged to make a profitable business of its remaining stores while attempting to support a stock price that skyrocketed on speculation of a financial windfall from the sale of assets, analysts said. The company said it intends to reach profitability by 2007.

In a conference call last week, Haub pledged to use caution while investing the company's newfound riches: "The experience of the last year made us very disciplined on every dollar we're investing, and that shouldn't change just because we're debt-free and have cash available."

He emphasized that the company's first priority will be converting all of its remaining stores to either the Fresh Market perishable or discount Food Basics models, a process that could take up to three years. Haub played down speculation that the company could also use a portion of the proceeds to fund acquisitions.

"We will pay attention to what's going on in the marketplace," Haub said. "And if there are opportunities that we become knowledgeable about, we will take a look at them, but at the moment we are not proposing to become proactive in the [merger and acquisition] marketplace."

Observers believe consolidation is a possibility in the East. Karen Miller, an analyst for Bear Stearns, New York, noted that new private equity investors in Bi-Lo and Pathmark, and their respective distribution deals with C&S, make the Eastern Seaboard "ripe for consolidation," although she stressed she didn't think any combinations were imminent.

"They're debt-free now, so they can start investing correctly in their business, and they have more than enough cash to fix it," Caicco said. "But I wouldn't doubt there are more moves to come. There are other companies out there, like Pathmark, which might work well in combination with A&P."

Stock in A&P and Metro shot to new 52-week highs on the news in heavy trading. Stock in Sobeys fell $3, reflecting its failed bid.

In a statement, Haub complimented Piwek and Claus for their efforts in building the profitable and ultimately lucrative business at A&P Canada.