Track the companies that matter to you. It's FREE! Click one of these fan favorites to get started: Apple; Google; Ford.



Safeway's Low-Ball Buyout Sets a Bad Precedent

Watch stocks you care about

The single, easiest way to keep track of all the stocks that matter...

Your own personalized stock watchlist!

It's a 100% FREE Motley Fool service...

Click Here Now

Recently, Safeway (NYSE: SWY  ) announced that it had entered into an agreement with Cerberus Capital to merge with its subsidiary Albertson's. Cerberus previously purchased Albertson's and a number of other brands from SUPERVALU (NYSE: SVU  ) last year, and under this new agreement it will acquire all outstanding shares of Safeway for a total value estimated at $40 per share.

Although Safeway has been looking for a buyer, shareholders are likely to be unhappy with this deal -- $40 per share offers essentially no premium over what the share price already was. Rumor has it that Kroger (NYSE: KR  ) is also interested in buying Safeway and may make a slightly higher offer, but the current one barely values Safeway at an enterprise value of 7 times EBITDA -- with an initial offer that low, Kroger is under no pressure to do much better.

This deal creates a number of problems for other players in the traditional grocery industry, especially SUPERVALU, which will face increased competition from the combined companies.

From Hell's heart I stab at thee
I'll admit it -- the deal hardly vindicates my CAPSpicks on the traditional grocery industry. In November 2012, I declared that Safeway's stock would underperform the market over the next few years, before it went on to outperform the market by more than 100 percentage points. But at the same time, the deal doesn't really vindicate Safeway bulls, either, who ignored its years of stagnating revenue and income, focusing instead on its rock-bottom valuation multiples. Well, the company is now being bought out at essentially the same EV/EBITDA as when I made my underperform call.

My underperform call on SUPERVALU has done about as well as the one for Safeway, but I continue to be bearish on the company. The same problems hold true for SUPERVALU, because it is fundamentally the same store as Safeway. Both are nondescript, mid-range grocers; both have watched revenues decline for years; and both have tried to hang on by selling off various segments for quick cash. These stores are in decline because of competition on all sides by premium retailers like Whole Foods, deep-discounters like Dollar Tree (NASDAQ: DLTR  ) , and one-stop-shops like Wal-Mart.

SVU Revenue (TTM) Chart

SVU Revenue (TTM) data by YCharts

In SUPERVALU's most recent quarter, the only two segments that saw any revenue growth were Save-A-Lot and Corporate. Admittedly, Save-A-Lot grew comparable store sales by 1.7%, which isn't much, but it beats the 1.2% that boosted Dollar Tree to a record quarter. Unfortunately, Save-A-Lot only accounts for a quarter of total sales, and it wasn't enough to offset declines in the company's wholesale distribution and traditional grocery segments.

Gross margin improved during the quarter, but management says that was "primarily driven by incremental fees earned under the TSA and the benefits of lower infrastructure costs." Lower infrastructure costs are a good sign of improvement, but the TSA fees are ephemeral. The company is simply collecting a temporary consulting fee as part of its deal with Cerberus, a fee that will phase out in a few years and isn't a sign of any real improvement in the company's business.

The shape of things to come
While it's unclear whether SUPERVALU is looking for a buyer currently or if it's content for now with last year's sale of five of its brands, the Safeway deal sets a bad precedent and should have SUPERVALU investors worried. The company is currently valued at around twice what Safeway is selling for, giving potential buyers a deep floor to consider.

Furthermore, a Safeway-Albertson's marriage will create a formidable team, with around 2,600 stores, compared with SUPERVALU's 2,400. The sheer size of the merger will give the combined companies significant negotiating power that SUPERVALU previously didn't need to worry as much about. Even if the Safeway deal doesn't immediately affect SUPERVALU's valuation, it will pose a competitive challenge in the years to come.

The future of retail
Wal-Mart is crushing traditional grocers like SUPERVALU, but even it can't hold its dominance forever. To learn about two retailers with especially good prospects, take a look at The Motley Fool's special free report: "The Death of Wal-Mart: The Real Cash Kings Changing the Face of Retail." In it, you'll see how these two cash kings are able to consistently outperform and how they're planning to ride the waves of retail's changing tide. You can access it by clicking here.

Read/Post Comments (3) | Recommend This Article (2)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 18, 2014, at 7:14 AM, djlresearch wrote:

    Safeway is selling at a huge premium considering when the stock was around $20 and the fact that business will only get worse for Safeway over time. Eventually Safeway would succumb to lost sales and debt. Lets face it, Safeway isn't very good at operating supermarkets based on their sales per square foot. Any current performance ratios are meaningless.

    Look for Albertsons to close or sell redundant locations in order to increase sales per sq. ft. at the remaining stores.

  • Report this Comment On March 20, 2014, at 1:34 PM, fbobw62 wrote:

    You do realize that Cerberus owns a significant piece of SUPERVALU right? So why would they do anything with the Safeway buyout to hurt SUPERVALU's business? If anything they should be able to eventually improve their business by taking the Safeway supply agreements away from SUPERVALU competitor C & S and awarding it to SUPERVALU along with closing any Safeway stores that could be re opened by an independent customer of SUPERVALU. Doesn't this make the most sense or am I missing something??

  • Report this Comment On March 20, 2014, at 8:17 PM, TMFTheDoctor wrote:


    You're right. Through a Cerberus-led investor consortium, Symphony Investors, Cerberus sort of indirectly owns about 20% of SUPERVALU. Despite this, I still believe both Safeway and SUPERVALU have poor prospects. The low-ball valuation Cerberus is offering for Safeway, coupled with their existing stake in SUPERVALU, makes it easier for them to make a low-ball offer for SUPERVALU if they choose to, and the mid-range grocery segment that both are operating in is wilting anyway. But thanks for pointing out Cerberus's stake in SUPERVALU.

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2877166, ~/Articles/ArticleHandler.aspx, 9/4/2015 6:30:41 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Jacob Roche

Jacob Roche is a California native and alumnus of UC Davis. His focus is mainly on agriculture stocks and anything tangentially related.

Today's Market

updated 9 hours ago Sponsored by:
DOW 16,374.76 23.38 0.14%
S&P 500 1,951.13 2.27 0.12%
NASD 4,733.50 -16.48 -0.35%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

9/3/2015 4:00 PM
KR $34.57 Down -0.08 -0.23%
The Kroger Co. CAPS Rating: ****
SVU $8.24 Down -0.01 -0.12%
Supervalu CAPS Rating: **
SWY $0.00 Down +0.00 +0.00%
Safeway, Inc. CAPS Rating: **