STILL KING KROGER

ELLIOT ZWIEBACH

CINCINNATI -- Kroger Co. is and will remain No. 1. Last week's riveting announcement that Kroger here has signed a definitive agreement to acquire Fred Meyer Inc., Portland, Ore., demonstrated that in some cases the more things change, the more they stay the same. Kroger, already the nation's top-volume chain, stood to lose the top spot once the merger of Boise, Idaho-based Albertson's and American Stores Co., Salt Lake City, is completed early next year.

However, the combination of Kroger's $28 billion sales base and Fred Meyer's $15 billion would give the new Kroger volume of approximately $43 billion -- considerably ahead of the $36 billion Albertson's would control after its merger.

The Kroger deal, valued at $7.4 billion in stock plus assumption by Kroger of approximately $4.9 billion of Fred Meyer debt, is expected to close early next year, subject to approval by shareholders of both companies, antitrust clearance and customary closing conditions. The boards of both companies have already unanimously approved the merger.

Securities analysts contacted by SN last week were in agreement that the geography of the deal makes a lot of sense, noting that the two chains "fit like a glove." The only point of overlap is Arizona, where Kroger operates 57 Fry's Food Stores and Fred Meyer operates 56 units of Smith's Food & Drug Centers.

Analysts listed a variety of positives that would emerge from the merger, including the following:

* Strategic benefits. Debra Levin, an analyst with Morgan Stanley Dean Witter, said Kroger is likely to benefit from Fred Meyer's experience in operating various formats, including warehouse stores and supercenters (multidepartment stores, in Fred Meyer's lexicon).

Other benefits are likely to emanate from Fred Meyer's extensive nonfood-merchandising experience and in private label, particularly in the area of a premium private-label line, which Fred Meyer has but which Kroger does not offer, Levin pointed out.

According to another analyst, "What's good about this deal is that Kroger picks up an excellent, well-run property with geographic diversity that takes it to the West Coast, where Wal-Mart is unlikely to expand its food operations for at least the next five years." Mark Husson, an analyst with Merrill Lynch, New York, said the two companies have had a past affinity because of a share group between their managements over the past five years.

However, Husson questioned Fred Meyer's decision to seek an acquisition partner at this time. "Fred Meyer had a couple of strong-looking years ahead of it," he said. "But it may have wondered whether it could sustain growth in the high teens as a stand-alone company after two years and whether Kroger would be available for a merger at that later stage."

Other observers, who asked not to be named, told SN Kroger's decision to merge with Fred Meyer was "a poison pill" Kroger had to bite to head off an unwanted takeover, following nearly a year of speculation that Kroger might be an acquisition target of Safeway, Pleasanton, Calif.

* Procurement, with the new Kroger generating economies of scale from volume-based purchasing in food, health and beauty products, general merchandise and seasonal items, plus supplies, equipment and raw materials.

According to Gary Giblen, managing director of FAC Equities, New York, "The No. 1 driving force behind this deal is the changing procurement paradigm in food retailing. It used to be that supplier deals were offered on a regional basis, but Wal-Mart changed that, and the nature of national deals is the strategic impetus behind the creation of national, or quasi-national chains."

* Elimination of duplicate overhead, particularly in Arizona, where stores overlap, and at Fred Meyer, where various staff functions will become redundant, Levin said.

Both companies have solid experience realizing economies of scale, Levin said. "Kroger has benefited from numerous internal consolidation projects in procurement, distribution, administration and best practices, while Fred Meyer is benefiting from acquisitions" in the past year of Ralphs Grocery Co., Compton, Calif.; Hughes Family Markets, Irwindale, Calif.; Quality Food Centers, Bellevue, Wash.; and Smith's Food & Drug Centers, Salt Lake City.

Giblen said he wondered if the integration process might run into some problems because of Kroger's lack of merger experience. "It's less clear than it would be with a Safeway, for example, exactly what best practices, cross-fertilization and improvements can be made," he said, "although it's clear there are major opportunities in the area of private-label."

Another analyst said both chains are in "various stages of streamlining their own operating infrastructures, and that process will be advanced under the combined company. While the specific game plan to combine the operating infrastructures will unfold over time, it is clear that a combination of this magnitude will hold enormous savings."

* Manufacturing and distribution. Levin said Kroger will use Smith's dairy facility in Tolleson, Ariz., to serve its Arizona stores; it will also convert the former Hughes distribution center in Irwindale, Calif., to a facility for slow-moving items, which will benefit Fred Meyer and Kroger operations in Arizona. In addition, Kroger will make greater use of manufacturing facilities by serving both groups of stores, Levin said.

* Growth outlook. Management expects capital expenditures of $1.5 billion annually while growing square footage 4% to 5% a year, complemented by small in-market acquisitions, Levin said..

* Information systems. Kroger operates two information-systems platforms and Fred Meyer is consolidating four platforms into two by early next year, "so any broader combination of systems is likely to be a longer term project," Levin said.

Kroger operates 1,398 supermarkets and 802 convenience stores, plus 34 manufacturing facilities, in the Midwest and Southeast, while Fred Meyer has approximately 800 stores in 12 Western states ranging from Alaska to Texas.

The new Kroger would operate 3,000 stores, including nearly 2,200 supermarkets, and stretch from coast to coast across 30 states, with the industry's broadest geographic coverage and widest spectrum of formats, ranging from convenience stores to supercenters.

Kroger said last week the combination is expected to generate annual cost savings of approximately $225 million within three years -- including approximately $75 million the first year -- through combined procurement of goods and services, reduced corporate overhead, in-market synergies and consolidation of support services.

According to Levin, 50% to 55% of the synergies will come from purchasing and merchandising; 25% from in-market synergies, primarily in Arizona; and 25% from general and administrative savings, as well as streamlined distribution and economies of scale in manufacturing.

She said she does not expect Kroger's anticipated synergies to disrupt the $155 million that Fred Meyer expects to realize in 2001 from its own previous acquisitions.

According to Joseph A. Pichler, chairman and chief executive officer of Kroger, "This is a powerful strategic combination. Together we will have the No. 1 or No. 2 market share in 33 of the nation's largest markets. "Fred Meyer's strength in the fast-growing Western markets will complement Kroger's leading position in the Midwest and Southeast, and we will achieve economies of scale by leveraging purchasing, information technology, manufacturing and distribution across a much larger store base."

Kroger said its corporate headquarters will remain here, and Pichler will remain chairman and CEO of the combined company.

The company also said Ronald W. Burkle, Fred Meyer chairman, will become chairman of the executive committee of Kroger's board of directors, and Robert G. Miller, vice chairman and CEO of Fred Meyer, will become vice chairman and chief operating officer of Kroger, while David Dillon will continue as Kroger president.

Still open to question, observers said, is how the new company would be administered, and whether Miller would relocate to Cincinnati or direct the Western portion of the new Kroger operations from Portland while Pichler oversees the Eastern portion.

Burkle, Miller and four other Fred Meyer nominees would join the Kroger board, which would expand from 13 to 19 directors.

According to Burkle, "I have been a longtime believer in consolidation in the supermarket industry. Kroger and Fred Meyer represent the ultimate strategic combination, creating a truly national company."

Miller said both companies enter the merger from positions of strength, "having consistently achieved their growth targets while increasing efficiencies and improving margins.

"This is a win/win for both companies, our shareholders, customers and employees. Fred Meyer shareholders will receive Kroger stock on a tax-free basis and benefit from the upside potential of the combination, while Kroger shareholders will benefit from Fred Meyer's premier retail outlets.

Under terms of the definitive agreement, Fred Meyer shareholders would own approximately 38% of the combined company after receiving one newly issued share of Kroger common stock for each Fred Meyer common share. The transaction would be accounted for as a pooling of interests and is expected to be tax-free to shareholders, Kroger said. Kroger said the transaction should be neutral to earnings in fiscal 1999 and "significantly accretive" in subsequent years, excluding merger-related costs. On a cash-flow basis, the company said the transaction is expected to be immediately accretive.

Musical Chains

The last two weeks of merger news won't change the companies on the list of Top 5 supermarkets, but will alter the order. Last week Kroger Co. announced it will merge with Fred Meyer Inc., and the prior week Safeway said it will merge with Dominick's Supermarkets. In the new lineup, Kroger moves past Albertson's to regain the No. 1 spot and Safeway moves past Wal-Mart Supercenters as No. 3. Following is a list of the Top 5 chains in the U.S. supermarket industry, ranked by volume. Most of the volumes are pro forma because of pending deals, and in those cases the numbers are further broken out:

1. Kroger Co., Cincinnati, $43.2 billion pro forma (including projected 1998 volume of $28.2 billion from Kroger and $15 billion from Fred Meyer Inc., Portland, Ore.).

2. Albertson's, Boise, Idaho, $33.8 billion pro forma (including 1997 sales of $14.7 billion from Albertson's and $19.1 billion from American Stores Co., Salt Lake City).

3. Safeway, Pleasanton, Calif., $26.5 billion pro forma (including projected 1998 sales of $23.7 billion from Safeway; $2.4 billion from Dominick's Supermarkets, Northlake, Ill.; and an estimated $400 million from Carr Gottstein Foods, Anchorage, Alaska).

4. Wal-Mart Supercenters, Bentonville, Ark., $25.0 billion (1997 est.).

5. Ahold USA, Atlanta, $18.5 billion pro forma (including 1997 sales of $14.3 billion from existing operations and $4.2 billion from Giant Food, Landover, Md.).