Regional grocery chain Safeway (UNKNOWN:SWY.DL) has been shaking up its business lately in a bid to appease increasingly impatient shareholders, most notably activist hedge fund Jana Partners. The company sold off its Canadian operations late last year, grossing 5.8 billion Canadian dollars in the process, a transaction that followed on the heels of the sale of its Genuardi's brand in 2012.
Those transactions, though, were just a prelude to Safeway's latest gambit, agreeing to sell itself in a complicated deal to investment powerhouse Cerberus for approximately $9.7 billion, or $40 per share. However, with the transaction valuing Safeway at a seemingly meager 5.5 times trailing-12-month adjusted EBITDA, should investors hold out for a better offer?
What's the value?
Despite its aforementioned downsizing activities, Safeway still has a formidable footprint, with a strong operating position in the high-population meccas of California and Texas. Like its competitors, the company has been adding fuel centers to its network of stores in spite of the notoriously low margins, hoping the heavy foot traffic will bring more customers into its adjacent stores. Safeway has also been focusing on increasing its product mix in the health and wellness space, an area in which it competes with its Open Nature and O Organics private-label brands.
In its latest fiscal year, Safeway generated decidedly mixed results, highlighted by flat top-line growth and lower operating profitability compared to the prior year. While the company's comparable-store sales growth recorded a positive performance, its operating profitability was negatively affected by higher marketing costs, including the ramp-up of its Just For U digital marketing initiative. The net result for Safeway was lower operating cash flow and fewer funds to invest in its growth initiatives.
Are there any potential takers?
While Safeway's size would make it a big nugget to swallow for most would-be acquirers, its essentially net debt-free financial profile, courtesy of the sale of its Canadian operations, would seem to make it an intriguing risk-reward play for larger competitors, like Kroger (NYSE:KR). The neighborhood-grocery kingpin has its plate full, having just closed its purchase of the Harris Teeter grocery chain, a $2.5 billion transaction that it is still integrating. However, Safeway would seem to fit well with Kroger's desire for a larger national footprint, as evidenced by its multiyear acquisition binge, and the combined store base of almost 4,000 supermarkets would put the company more on par with No. 1 domestic grocer Wal-Mart Stores.
In its latest fiscal year, Kroger posted decent financial results, highlighted by a 1.8% top-line gain that was aided by a solid comparable-store sales performance. More important, the company's adjusted operating profitability improved slightly, thanks to more productive stores and a focus on private-label offerings, including a larger presence in the natural and organic segment through its Simple Truth brand. The net result for Kroger was a jump in operating cash flow that is funding its organic growth strategy, as well as the acquisition of weaker competitors.
Also capable of swallowing Safeway "whole" is natural and organic grocery pioneer Whole Foods Market (NASDAQ:WFM). The company has already taken advantage of Safeway's downsizing moves, agreed to buy seven store leases in the Chicago metro area back in February, part of Whole Foods' expansion into the nation's urban markets. While high-profile acquisitions don't seem to be Whole Foods' style, its pursuit of Wild Oats Market in 2007 shows that it is not completely averse to big transactions that enhance shareholder value. With an operating margin far above that of Safeway because of a premium product mix that favors perishable goods, Whole Foods could conceivably create a profit windfall in the Safeway operation merely by recasting Safeway's stores in its own image.
The bottom line
Cerberus' bid for Safeway seemed to be a lowball offer, given Safeway's pristine financial profile and its valuable non-core assets, including major stakes in Mexican retailer Casa Ley and prepaid card distributor Blackhawk Network Holdings. However, the lack of a competing bid during the pending transaction's go-shop period indicates that other players, like Kroger and Whole Foods, didn't see the right fit for their franchises. As such, it looks like Safeway has no more room to run, and investors should probably make a beeline for the exits.