FOOD LION READY TO ROAR

ELLIOT ZWIEBACH

SALISBURY, N.C. -- Food Lion is on the prowl.

After years of largely tending its own den, the $10.2 billion company is aggressively hunting for acquisition candidates to increase shareholder value.

The company was a runnerup earlier this year to Ahold, based in the Netherlands, in seeking to buy Pathmark Stores, Carteret, N.J. -- a strong indicator that Food Lion, along with its parent, Delhaize "Le Lion" Group, based in Brussels, is serious about becoming a major player in industry consolidation in the U.S.

Details of Food Lion's new strategies were disclosed during SN interviews here with Bill McCanless, Food Lion's president and chief executive officer, and Pierre-Olivier Beckers, chairman of Food Lion and CEO of Delhaize. McCanless became Food Lion's chief officer in April after the unexpected resignation of Tom E. Smith, chairman, president and CEO. Smith had a 29-year career with Food Lion. Beckers became chairman of Food Lion at the same time. He assumed his titles with Delhaize in January.

In the interview, McCanless asserted, "We must be aggressive in growing our company, both through acquisitions that will cement our position as an industry leader and organic growth that will keep us strong in our expanding markets. And we must be open to opportunities wherever they may lie."

Expanding its holdings through Food Lion and on its own worldwide would give Delhaize more clout on the global stage, Beckers told SN.

"For years Delhaize was an association of independent companies, but our thinking has evolved over the last few years," he said. "Now we see how fast the world of retailing is becoming global in order to gain a competitive advantage, so we've decided to move more aggressively to transform our association of companies into a more integrated group."

As Food Lion looks ahead, its faces some challenges:

To seek growth through acquisitions while strengthening its existing markets in the Southeast and Mid-Atlantic areas.

To take advantage of global synergies through more coordinated strategies with Delhaize.

To take its first steps overseas in a joint venture with Delhaize in Thailand.

To boost its stock price.

Food Lion operates 1,234 supermarkets -- 1,141 under the Food Lion banner in 11 Southeastern and Mid-Atlantic states (North Carolina, South Carolina, Virginia, West Virginia, Georgia, Florida, Tennessee, Maryland, Kentucky, Delaware and Pennsylvania)

and 93 Kash n' Karry Food Stores in west-central Florida, which it acquired at the end of 1996.

Delhaize has 1,904 stores and sales of $13.9 billion, and operating companies in Belgium, Greece, the Czech and Slovak Republics, France, Indonesia, Singapore, Thailand and the U.S. In the U.S., besides Food Lion, Delhaize owns 38 Cub Food Stores in Atlanta in a joint venture with Supervalu, Minneapolis.

Delhaize acquired Food Lion in 1974 and owns 45% of the chain's total stock and 52% of its voting stock, and Food Lion accounts for the lion's share of its business -- 65% of its store base and 73% of its sales volume.

"We believe the U.S. is a great market to be in," Beckers told SN. "Gross domestic product is growing at more than 3% a year, which is more than we see in Western Europe; the U.S. dollar is a strong currency, and there's more room here to grow organically and through acquisitions."

Delhaize's stronger role in Food Lion is a result of the emergence of a global food industry, Beckers said.

"Every company has different stages in its history, and there was a stronger attitude for Delhaize in the past to let its companies operate totally independently," he explained. "But this is no longer acceptable from a competitive point of view.

"So Delhaize has decided to be more active in integrating its companies through synergies and economies of scale."

According to McCanless, "This is a new era of consolidation, and Food Lion can no longer function as a fully autonomous division operating under its own strategies. Instead, it must become part of a more integrated global organization under Delhaize's direction.

"We began discussions three or four years ago with Delhaize, seeking ways to lever the two companies and its other operating units, and we see clear advantages to being a member of the Delhaize group, which allows us to participate in global information exchanges, sharing of best practices and the common pursuit of mutually beneficial opportunities."

The ultimate goal, observers told SN, is more global sourcing, which could prove particularly useful to Food Lion in nonfoods, making it possible for the chain to offer more in-and-out seasonal and direct-import goods throughout the year. And as more suppliers operate on a global basis, procuring products for a worldwide operation makes sense, observers added.

A spokesperson said the two companies were still working on global procurement strategies, but was unsure when those strategies would be implemented.

Jonathan Ziegler, a San Francisco securities analyst for Salomon Smith Barney, New York, said he saw Delhaize's new global strategy -- and its decision to buy back 3.5 million additional Food Lion shares in the last few weeks -- as a way of enhancing the value of Food Lion stock, which has bounced back to double digits after dropping into single digits for most of the 1990s following a 1992 high of $18.25.

"The stock hasn't done much for years, and as an asset base, it hasn't been making money for Delhaize or other shareholders," Ziegler said.

He said the stock's relatively low multiple could make growth through acquisition difficult. "The stock lacks liquidity because, with foreign ownership, it doesn't trade a lot, and that would constrain Food Lion in financing any acquisition," he said.

"Most acquisitions today involve trading equity for equity in a pooling of interests, whereas using cash to do a deal creates goodwill, whose amortization hits earnings. However, buying back shares creates additional shareholder value and makes it easier to do an acquisition for stock. And Food Lion is willing to make an acquisition that is dilutive in the first year, as long as it can grow earnings in the second year and thereafter."

According to Chuck Cerankosky, an analyst with McDonald & Co., Cleveland, the problem with Food Lion's stock is Wall Street's misperception of the company.

"Food Lion is not an upscale operator, and while its merchandising strategy is very focussed, it's misunderstood and therefore underappreciated by investors.

"Everyone likes an upscale retailer, but Food Lion is no-scale -- not upscale or downscale. It's a full-service conventional supermarket geared to a budget-conscious shopper, and while others talk about supercenters, combination stores or fresh markets, Food Lion is more low key, but it has a huge product variety and low price points," Cerankosky said.

As Food Lion pursues acquisitions, cash will not be a limiting factor, McCanless noted. "We've gone through several scenarios about our borrowing capacity, and Delhaize has said it would consider an additional infusion of funds if the right target is there."

Industry sources put Food Lion's debt at $800 million, "and it can probably carry up to $2 billion," one observer said.

According to McCanless, "We have a strong balance sheet, tremendous debt capacity and an A-minus credit rating, and we're only one of two or three supermarket chains that are in the A range, so we've not yet tapped all our financial resources."

Food Lion was an unsuccessful bidder earlier this year for Pathmark, a $3.7-billion chain of 132 stores in the Northeast. "We were very serious about Pathmark," Beckers told SN. "It is a good example of what Food Lion is looking for in an acquisition -- a company in the eastern part of the U.S., with strong management, geographical expansion possibilities, synergies going both ways, a strong concept and economies of scale."

According to Gary Giblen, New York managing director for NationsBanc Montgomery Securities, San Francisco, "Pathmark represented very new ground for Food Lion, in contrast to its prior, more modest acquisitions. Pathmark was far bigger, as well as being unionized and in a region that's more urban and more densely populated than most of Food Lion's regions."

McCanless declined to pinpoint any acquisition targets that were currently being pursued. "We have been active in evaluating acquisition opportunities, and we will continue to do that," he told SN. "But I can't comment on what level of activity we have with any one company."

Looking at Food Lion's organic growth prospects, McCanless noted Food Lion operates in 11 states, "but our real concentration is in less than half those states, so there's still room to grow in our core markets and many opportunities for growth contiguous to our current operating areas. "We believe there is still room for the ink-blot strategy of past years where we grow out from existing distribution centers. So this year we will fill in stores in our core markets and expand our presence in states where there are still opportunities."

Food Lion plans to open 59 stores this year, most of them in North Carolina and Virginia, where most of its stores operate, and expand considerably in South Carolina, Maryland, Tennessee and Florida; more limited growth is planned in Georgia, Delaware and Kentucky, McCanless said.

Although its Florida stores operate under the banners of both Food Lion and Kash n' Karry, the company plans to convert an unspecified number of Florida Food Lions to Kash n' Karry this year, McCanless said; observers say up to 35 units could be renamed.

"We believe, at least in west-central Florida, we should operate under one banner, Kash n' Karry, to avoid duplication of advertising and other operating costs associated with two banners in a single market," McCanless explained.

Giblen said Food Lion's success in operating Kash n' Karry -- a promotions and service-oriented format, compared with the everyday-low-price strategy at its core stores -- "bodes well for future acquisition integration."

Besides pursuing large acquisitions, Food Lion is also looking at smaller domestic opportunities "for the real estate," McCanless said, noting that in the past five years Food Lion had acquired 64 real estate locations, including 28 leases from A&P in the Richmond and Tidewater areas of Virginia earlier this year, 11 A&P stores in North and South Carolina last year and 10 units of Food Fair in Winston-Salem, N.C., in 1996, plus individual locations from Kroger Co., Harris Teeter and Bruno's.

Food Lion is also looking overseas, and is part of an existing joint venture with Delhaize that runs a 10-store food operation in Thailand known as Food Lion. Observers told SN they believed other international investments could follow.

Food Lion's directors voted in late May to invest $10 million in the Thailand project, following a unanimous recommendation by the company's independent directors _ those unaffiliated with Delhaize.

"Our initial investment there is the equivalent of investing in two-and-a-half new stores in the U.S. and gives us a foothold in a country with 60.6 million inhabitants," McCanless explained. "In the present Asian economy, the price is very attractive and there are few competitors.

"While Thailand has faced challenges to its economy, the Bangkok market has soared to its highest level in more than a year, and the economic situation is improving with a strong trade surplus."

The Thailand investment is being questioned by some shareholders, including Ralph Ketner, co-founder of Food Lion, who wrote to the company in early May asking, "If this is such a good investment opportunity, why is Delhaize offering to share with Food Lion? I was in Thailand in January [1999], and the economy was in very bad shape."

Beckers said the investment provides both companies with an opportunity to gain a foothold and expand in Thailand, "where opportunities [for expansion] are available."

Analysts said Delhaize wanted majority control of the Thailand operation, but was forbidden by Thai law to seek a larger interest; however, bringing Food Lion in as a partner allowed it to skirt that restriction, they said.

Beckers told SN Delhaize wanted to control the Thai investment but brought Food Lion in for strategic reasons. "Food Lion brings financial means and management expertise that can be combined with the expertise of Delhaize."

Asked about the possibility that Food Lion itself could become an acquisition target, Beckers told SN, "Food Lion is an integral part of the strategy of Delhaize, and we are happy with that investment, which is offering us high profitability and important growth, thanks to the fast-developing American economy."

He did not comment on the possibility that Wal-Mart might be interested in buying Food Lion or Delhaize.

According to Ziegler, "Both Wal-Mart's Neighborhood Stores and Food Lion operate everyday-low-pricing formats offering basic assortments, and they appeal to the same customers. And Wal-Mart wants to be in food retailing with smaller, convenient stores, and Food Lion operates smaller, convenient stores.

"Wal-Mart will find it difficult expanding its Neighborhood Store operation fast enough because of limited real estate and labor opportunities, and opening four or five of those stores a year isn't going to do it. And Delhaize is already in Europe, where Wal-Mart wants to be."

Giblen expressed similar thoughts. "While Wal-Mart is not normally acquisition-oriented, Food Lion offers a special fit in light of leaner store formats that are akin to the food offerings of a supercenter and Wal-Mart's new Neighborhood Stores.

"Food Lion also shares with Wal-Mart an absolute dedication to low operating cost and nonunion status. And Food Lion's neighborhood location strategy meshes well with Wal-Mart's Neighborhood Stores.

"As for Delhaize, it appears to need more critical mass to compete long-term versus larger and more consolidated European players."

Cerankosky told SN he saw Food Lion as "a very definite acquirer in the near term. But over the long term, when you consider the industry from a global perspective, Delhaize could be acquired by someone who wants to develop its global retail reach, and in that case, Food Lion would be Delhaize's biggest asset."

In a significant change for Food Lion, the chain has flattened its organization and is delegating more authority -- a decision that apparently led to the elimination of the position of senior vice president of merchandising, and the resignation in April of Pamela Kohn, who held that position.

Category management and distribution now report to the director of operations, "which makes for a more seamless reporting process," the company spokesperson told SN.

According to McCanless, "Food Lion will be a customer-driven company. Everything we do in any department at the office is only half done -- we hand it to our store management team to execute the other 50%."

According to Giblen, Food Lion's willingness to delegate more authority should help its acquisition efforts "by offering more autonomy to retained acquired managements." Despite Delhaize's larger role, Food Lion management still retains considerable autonomy, Beckers told SN. "The local management team is still in charge of running Food Lion," he said. "There's no question about Delhaize managing the company. But we want to make sure Food Lion's business strategy meshes with the Delhaize strategy, which is to get all the synergies we can get in retailing for a global company."

A variety of industry analysts told SN they believed autonomy might have been the primary issue in the retirement in April of Food Lion's former principal officer, Smith, after 29 years with the company, 18 of them running it. Smith is said to have preferred the autonomy Delhaize was formerly willing to give.

Asked if Delhaize's increased involvement was the catalyst for Smith's resignation, Beckers replied, "There's no connection between the two events, and there was no resistance by Smith [to the new strategy]."

Observers noted that McCanless, previously chief administrative officer, had been groomed to succeed Smith for several years. "He is the quiet power behind many a decision," Giblen said, "and his understanding and handling of labor issues is particularly effective."

According to Ziegler,"He's a guy everyone respects, and he's a sound operator."