GOLDMAN SACHS GLOBAL RETAILING CONFERENCE 2005-09-19 (2)

Jon Springer

NEW YORK -- With speculation over the future of Albertsons providing a fresh backdrop, representatives from three prominent private-equity firms acknowledged that after years away from the table, private equity is reacquiring a taste for retail grocery chains.

"I think the environment today is much more attractive than it was seven or eight years ago," said Ron Burkle, managing partner of Yucaipa Cos., the Los Angeles-based private investment company that returned to the supermarket business this year with stakes in Wild Oats Markets and Pathmark Stores. Burkle, who is seen as a possible player in Albertsons' potential reorganization, made his remarks during a panel session at the Goldman Sachs Global Retailing Conference held here this month. Panelists Mike Calbert, a director at New York-based investment firm Kohlberg Kravis Roberts -- which, according to recent trade reports, may bid on Albertsons -- and John Roth, a partner with Los Angeles-based Freeman Spogli, agreed that private investors are reexamining retail.

In the 1990s, private investment groups such as Yucaipa and KKR led a wave of profitable supermarket buying and selling, but rising prices, fewer available assets and concern over the growth of Wal-Mart has cooled their interest in the years since. Burkle said the opportunities for profit may not be quite as good as they once were, but prices as a multiple of earnings have fallen, and new realities of the supermarket industry will require small companies to find wealthy investors or risk ruin.

"If they position themselves well, the 'big three' will be able to do fine, but most of the smaller guys will disappear," he said.

Engineering consolidation remains the "most exciting" opportunity for profit in retail investments, Burkle said, but he noted that improving operating performance first is critical. "You can't just go in and improve the capital structure of a company anymore," he said. "You have to go and improve earnings."

Opportunities to improve earnings tend to vary by company, he said. At Los Angeles-based Ralphs Supermarkets, which Yucaipa acquired 10 years ago, nearly all the improvement came as a result of more efficient logistics. Yucaipa's more recent investment in Pathmark offers a variety of areas to improve. "The stores aren't very well merchandised; they haven't kept up with capital expenditures; they have some systems issues; and they have one big supplier, and that's an issue," he said.

The panelists expressed different views on the effects of Bentonville, Ark.-based Wal-Mart Stores. "One of the things we like about food retail is that it's a long-term, viable format that has good cash-flow characteristics," said Calbert of KKR. "The question we have though is, when positioned against Wal-Mart, what does the upside look like?"

Burkle argued that limited upsides are partly the result of supermarket chains overreacting to the Wal-Mart threat, slashing prices and margins too aggressively. "Where people didn't pay enough attention to Wal-Mart years ago, now I think they overpay attention to it."

While Burkle predicted that EBITDA (earnings before interest, taxes, depreciation and amortization) margins of 10% "won't ever be seen again," he also said margins are at their worst and can improve if retailers, such as Safeway, continue to address aspects other than price.

The panelists acknowledged that internal rates of return -- a measure of cash flow relative to initial investment -- are closer to 18% to 25% among retail investments today than the 25% to 30% in years past. But according to Roth, uncertainty in the manufacturing and technology industries is helping make retail a more attractive investment.