ALBERTSONS MULLS 'ENDGAME' PLAN

Elliot Zwiebach

BOISE, Idaho -- Albertsons here said last week it is moving "even more aggressively" to divest underperforming, non-core assets -- just days after announcing it was exploring strategic alternatives to increase shareholder value, including a possible sale of the company.

In a conference call with analysts last week, Larry Johnston, chairman, president and chief executive officer, said, "We are at the point in our turnaround where we are clarifying our endgame, preparing to exit even more underperforming markets in order to monetize their embedded real estate and business value for shareowners [and] driving even harder for operational excellence [that] will enable us to focus on a strong and growing set of core assets that will form a smaller yet more profitable best-in-class company with leading market positions and a very exciting future."

Johnston did not say which operations the company considers to be core or non-core.

Selling the company outright remains an option, Johnston said. But he added, "At the same time, I want to be clear that while we are going through this process, we will also be aggressively running this company and continuing to execute on the same strategy that we unveiled over four years ago. We don't plan to slow down or take any time off."

Johnston said Albertsons plans to cut capital spending by 30% this year to focus on core assets, including increased spending on its Osco and Sav-on drug stores -- a move analysts said would seem to indicate the company considers drug stores a core asset.

Johnston also said he believes Albertsons has a powerful investor advantage in its real-estate holdings -- a fact he said is not reflected in the chain's share price. The company owns approximately 70 million square feet of real estate nationwide, or more than 60% of all its real-estate holdings, he noted, "and this real estate has tremendous value in today's market. So moving forward, as we sell underperforming assets or markets, we will also work to monetize this valuable real-estate for shareowners."

Despite Johnston's clarifications, several analysts told SN they believe Albertsons still intends to sell the entire company, most likely to a private investment group that would break the company into pieces.

Jonathan Ziegler, an analyst with J.M. Dutton & Co., El Dorado, Calif., said Albertsons could be taken private by an investment group that would then break it up "in a sort of replay of the dismemberment of Safeway by Kohlberg Kravis Roberts in the late 1980s."

Bryan Hunt, a high-yield analyst with Wachovia Securities, Charlotte, N.C., suggested a similar scenario in which a consortium of private equity investors could buy the entire chain and sell off smaller assets -- "the quickest and most desirable way to exit markets and generate value," he noted -- to pay down debt and generate profits while strengthening the chain's financial structure. After selling off the weakest assets -- potentially including stores in Texas, Florida, Denver, Salt Lake and Phoenix -- the company could decide what to do with stronger assets, including Jewel and Shaw's, before getting the company down to a core of stores along the West Coast, Idaho and surrounding states that could be sold to strategic buyers, the analyst said.

Another analyst said, "I think Albertsons' goal to divide stores into core and non-core is actually a fallback plan. Ideally, Albertsons would like to sell the whole thing to a private equity player and let them start divesting it."

Mark Husson, New York-based managing director and global head of consumer research for HSBC Securities, London, said an investment group would probably force buyers interested in stronger markets into taking weaker markets in any deal -- "for example, someone interested in Phoenix might have to take Denver or Salt Lake City to get what it wanted," he explained.

Gary Giblen, senior vice president and director of research for Brean Murray & Co., New York, said he doubts Albertsons has any buyers lined up. "Making the announcement the way it did probably means it's not sure what it can get and it's trying to create an open auction environment," he noted. "However, that's going to wreak havoc on employees and store productivity because everyone is now worried about his job, and clearly, the longer the process takes, the more the value diminishes as store results decline."

With Albertsons in play, the chain's business could suffer, Husson said. "One thing that's likely is a disruption in the channel for awhile as some Albertsons stores may go dark, market share may be lost and rivals Kroger, Safeway and Supervalu may all end up bigger and stronger in their core markets," he said.

Andrew Wolf, an analyst with BB&T Capital Markets, Richmond, Va., said he believes Albertsons signalled its decision to divide the company into core and non-core assets months ago "by letting shares in some markets go down while boosting shares in others. In essence, it's been operating its assets on a portfolio basis -- running markets with strong shares better to maintain those shares while running markets where it couldn't get to that point to maximize cash flow rather than sales."

Albertsons is the nation's second-largest conventional retailer, with sales of $40 billion and more than 2,500 supermarkets and drug stores. It revealed just before Labor Day weekend that it has retained Goldman Sachs & Co., New York, and The Blackstone Group as its financial advisers to assist in the process of exploring strategic alternatives, including a possible sale of the company. Albertsons said at the time it does not expect to disclose developments in its exploration "unless and until the board has approved a definitive transaction."

Talks with a variety of industry observers last week elicited the following opinions:

- The decision to explore alternatives may have stemmed from a frustration by Albertsons management over its inability to raise its stock price despite generally positive efforts to improve productivity and supply chain logistics.

- Besides selling the chain outright, Albertsons' strategic alternatives could include selling off selected regions to get down to a core group of stores, possibly limited to the West -- the strategy the company spoke about last week.

- If the entire chain is sold, potential buyers include a European operator like Delhaize Group, Brussels, or London-based Tesco, though a more likely scenario is for the company -- or an investment group that takes over -- to sell off assets on a piecemeal basis to various regional operators, investment groups or national rivals Kroger or Safeway.

- While it's possible the exploration process could be completed by year's end, it could be a year from now before all the smoke clears and the transition to new ownership has been completed.

- The selling price for Albertsons could range from $18 to $31 a share, or $6.7 billion to $11.1 billion.

Hunt told SN he believes Albertsons' decision to explore a potential sale is a recent one, given its acquisitions in 2004 of Shaw's in New England and Bristol Farms in Southern California. "Though companies often make acquisitions prior to a sale to build critical mass, that was not the intent of those acquisitions, so the timing of the chain's announcement is peculiar, particularly coming right before the release of quarterly results. I believe word of Albertsons' decision may have begun to leak out, and this was one way to defray questions or avoid discussing lackluster results."

Another analyst, who asked not to be named, told SN he believes a deal may already be in the works. "Typically the catalyst in a situation like this is a minority shareholder stepping up and rattling management's cages, but that didn't seem to happen here. That means it's possible they've already been approached by a private equity player."

Wolf said he expects the breakup value of Albertsons to be approximately $27 per share, compared with its current market price of around $24 per share. Any transaction by a single buyer would have to cost approximately $15 billion or more -- $9 billion in equity and another $6 billion to $6.5 billion in debt, he added.

Meredith Adler, an analyst with Lehman Brothers, New York, said she sees a potentially broad valuation range of $18 to $30 per share, with the likelihood the chain would sell for between $20 and $24 a share -- a multiple 6 to 6.5 times cash flow. While the company as a whole might not command a high valuation, "individual pieces, especially Jewel-Osco and Sav-on, could command healthy multiples," she noted.

Husson said he believes the overall food business could be valued at $22 to $31 a share, or 6 to 8 times cash flow, while the stand-alone drug stores could go for 7.5 to 8.5 times cash flow.

Observers offered a variety of selling scenarios because, as Giblen noted, given its size and the diversity of its operations, "Albertsons offers a very flexible opportunity."

Most said they doubt a single strategic buyer is likely to emerge, unless a European company like Tesco or Delhaize were interested.

Husson said he doubted Tesco would be interested in acquiring all of Albertsons "because no one comes into America to buy the second-largest supermarket chain that isn't able to run its own business -- though it could be interested in exploring the possibilities in one or two markets.

Ziegler said Delhaize, which operates Food Lion in the Southeast, Kash n' Karry in Florida and Hannaford in New England, "has some natural market adjacencies" for some Albertsons divisions in the East.

Most of those questioned by SN said they believe Albertsons would be more valuable if sold in pieces.

"We do not see one buyer for the company," Adler said. "We do not see any other operator being able to come in and manage the current group of Albertsons' assets any better than the current management, and the logical step is to break the company into its component pieces and try to find the best buyer for those pieces."

Within hours of Albertsons' announcement, Standard & Poor's Ratings Services put Albertsons on "credit watch with negative implications."

"Although the ultimate outcome of this process is uncertain, these strategic alternatives could potentially weaken bondholder protection measures," S&P said.

What Went Wrong?

Industry analysts generally give Albertsons' management high marks for what it has tried to do but attributed its frustrations to problems endemic to the industry itself.

"Even with the productivity Albertsons has been able to generate, it hasn't helped [the stock price] because the company has had to pass those savings through in lower prices to keep the doors open," said Jonathan Ziegler, an analyst with J.M. Dutton & Co., El Dorado, Calif. "Larry Johnston must have found it frustrating to be in a commodity business with narrowing margins. He came to Albertsons from General Electric on a white horse to revitalize the chain but has been confounded by the challenges confronting the supermarket industry, where top-line growth is difficult and operational matters are insidious.

"Johnston and the board must be very bearish on supermarket stocks because of that frustration, and the announcement to explore alternatives up to and including the sale of the company could be seen as a wake-up call for the industry to do something about its standing on Wall Street," Ziegler said.

According to Gary Giblen, senior vice president and director of research for Brean Murray & Co., New York, "For Albertsons, it isn't so much a matter that things went awry as that they didn't go right enough. Albertsons made intelligent acquisitions and divestitures but not enough to cope with the stiff headwinds in the industry, including exponentially intensifying competition from alternative formats -- Wal-Mart at the low end and Whole Foods at the high end -- plus escalating labor costs, while failing to come up with anything that produced traction.

"Since Johnston joined Albertsons, he's promised to produce a major turnaround, but it was always next year, so I have to interpret Albertsons' announcement as an admission that an operational and strategic turnaround has been frustrating, and that doesn't bode a lot of promise going forward because you don't sell a company when you're about to do well," Giblen said. "It's the white flag of capitulation to the challenges the industry faces."

Giblen also said Albertsons has been hurt by inconsistency in its consumer message. "At a time Kroger has been consistent on price and Safeway has become more consistently upscale, Albertsons never found a consistent position," he said. "For four years, it's gone back and forth -- sometimes stressing price, other times perishables, other times its formats -- and that inconsistency has hurt."

According to Bryan Hunt, a high-yield analyst with Wachovia Securities, Charlotte, N.C., although Albertsons has managed to eliminate more than $1 billion in costs, "its stock has done nothing for five years and its market shares are running third, fourth and fifth in more markets than either Kroger's or Safeway's."

For Mark Husson, New York-based managing director and global head of consumer research for HSBC Securities, London, Albertsons' difficulties come down to the fact that "it was dealt a weak hand in strategic market share, with strong shares in weak markets like Dallas and weak shares in strong markets like the Intermountain region. It's also possible a resurgence by Safeway and Kroger may have pressured Albertsons' sales to the point that only a gross-margin collapse could get it going again."

According to Meredith Adler, an analyst with Lehman Brothers, New York, "Albertsons has had some success with its initiatives to take significant costs out of its business -- primarily by improving procurement and making its supply chain more efficient -- but the benefits have mostly been offset by price investments and poor sales leverage in weaker markets. Clearly, the decision to sell the company or increase shareholder value some other way recognizes the tough reality facing the company and the difficulty of achieving an operational turnaround.

"Albertsons brought in a new management team four years ago, and they have worked hard and diligently to take out unnecessary costs, upgrade operations at the store level, exit some of the most underperforming markets and conserve cash flow in weak markets while directing capital only to the best markets.

"Execution of these strategies has not been perfect, and the external environment has been very tough," Adler said. "The end result has been a failed turnaround, with value now being destroyed at the best parts of the business because of the problems at the weak parts."

Andrew Wolf, an analyst with BB&T Capital Markets, Richmond, Va., said Albertsons tried to change the supply chain "in a major way to maximize its efficiencies -- by getting closer to the demand side and getting the purchase side down to dead net cost -- but its decision to explore strategic alternatives suggests the core execution strategy was not delivering."

1939: Joe Albertson opens his first supermarket in Boise, Idaho.

1957: Albertsons introduces food center formats that incorporate drug stores with food.

1969: Albertsons is listed on the New York Stock Exchange.

1970: Joe Albertson and Sam Skaggs form partnership to operate Skaggs-Albertsons combination food-and-drug stores across the Sunbelt.

1974: Warren E. McCain is named president and chief executive officer.

1991: Gary Michael succeeds McCain as president and CEO.

1993: Joe Albertson dies. Gary Michael is named chairman, and John B. Carley is named president and chief operating officer.

1996: Carley retires and is succeeded by Richard L. King.

1998: Albertsons acquires Seessel's, Nashville; Buttrey Food & Drug, Great Falls, Mont.; and certain Bruno's stores in Alabama.

June 1999: Albertsons acquires American Stores Co. for $11.7 billion after complying with Federal Trade Commission order to divest 143 stores. Company launches Albertsons.com. King leaves Albertsons.

November 1999: Albertsons converts 508 Lucky Stores in California to the Albertsons banner.

March 2000: Peter Lynch is named president and COO.

April 2001: Larry Johnston, a 28-year veteran of General Electric Co., is named chairman and CEO after Gary Michael steps down.

February-March 2002: Albertsons exits 95 stores in Nashville and Memphis, Tenn., and Houston and San Antonio, Texas, and closes 157 underperforming stores in other parts of the U.S.

August 2002: Albertsons opens first of three Hispanic-format stores, called SuperSaver Foods, in Southern California.

July 2003: Peter Lynch leaves abruptly as president and COO in what company calls a streamlining move.

September 2003: Albertsons signs agreement for Office Depot to operate "store within a store" at Albertsons units.

October 2003-February 2004: Albertsons and Kroger stores in Southern California lock out members of United Food and Commercial Workers Union striking Safeway-owned Vons. Albertsons acknowledges loss of $800 million in sales during 17-week labor dispute.

February 2004: Albertsons consolidates 11 retail divisions down to seven to make organization more responsive to market needs.

March 2004: Albertsons pays nearly $2.5 billion to acquire 202 units of Shaw's Supermarkets, West Bridgewater, Mass., and Star Markets, Boston, from Sainsbury, adding a volume base of approximately $4.6 billion.

May 2004: Albertsons completes first three national promotions.

July 2004: Albertsons introduces Check the Price program, which lowers everyday pricing on products consumers buy most frequently and those with the highest index of sensitivity to price.

September 2004: Albertsons opens first Super Saver price-impact store in Duncanville, Texas, a Dallas suburb.

September 2004: Albertsons acquires Bristol Farms, an 11-store gourmet and specialty chain in Southern California.

October 2004: Albertsons moves a majority of employees in its Dallas-Fort Worth division from full-time to part-time status to cut costs and improve customer service.

May 2005: Clarence "Gabe" Gabriel, executive vice president of supply chain and asset management, abruptly leaves Albertsons.

June 2005: Albertsons sells seven stores to exit Jacksonville, Fla., market.

September 2005: Albertsons says it is exploring strategic alternatives, including a possible sale of the company.