Will Safeway Use a Buyout to Avoid a Supermarket Sweep?

Safeway store

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Private equity firm Cerberus Capital Management, LP is considering a leveraged buyout (or, LBO) of  Safeway Inc. (NYSE: SWY), people familiar with the matter told Reuters. Other buyout firms are reportedly interested in Safeway, which is the second largest mainstream grocery store in the U.S., and may be worth $8 billion. The same sources told Reuters that even Safeway knew of the interst and was discussing matters with a Goldman Sachs Group, Inc. (NYSE: GS) advisor.

On its website, Safeway lists over 1,400 stores that it operates in the U.S. The company recently sold its Canadian Safeway stores to Canadian retailer Sobeys Inc., a subsidiary of Empire Company Limited. Any profit from the sale, the press release announcing third-quarter earnings on October 10 said, would be put towards $2 billion worth of debt, and to repurchase stock. The company projects post-tax sale profits of $4 billion.

The announcement also included news that Safeway was selling its Dominick stores in the Chicago area, and exiting that market entirely. The decision was made by Safeway at the end of the third-quarter. The company’s departure from Chicago and Canada ”is consistent with Safeway’s priority of maximizing shareholder value,” according to Safeway President and CEO Robert Edwards. These decisions allow the company  ”to focus on improving and strengthening our core grocery business.”

The announcements came close after Jana Partners LLC disclosed with the Securities and Exchange Commission that it has a 6.2 percent stake in Safeway. The filing reports that Jana purchased the shares because it believed Safeway stock was undervalued and presented a good chance for investment. The filing further reveals that Jana had discussed with Safeway management strategic opportunities, and that Jana expected talks to continue and “may take other steps seeking to bring about changes to increase shareholder value.”

When Safeway became aware, through the SEC filing, of Jana’s stake in the company, they implemented a stock repurchase plan, which they increased by $2 billion on October 18. Safeway’s actions are considered a “poison pill.” It is a common way to safeguard against shareholders gaining too much control of a company, then using their shareholder power to dictate the companies operations.

Safeway was previously part of a leveraged buyout to avoid a hostile takeover, then by Dart Group Corporation. The New York Times reported in 1988 on the success of the 1986 buyout by Kohlberg, Kravis, Roberts & Company. Safeway became a publicly traded company again in 1990.

The game has changed since the 1980s and so too have grocery stores. UBS analyst Jason Derise explained the situation in a note to investors, part of which was printed by the Financial PostDerise explained that, “Safeway was once one of the largest LBOs nearly 30 years ago, but grocery fundamentals have dramatically deteriorated over that time period.” Grocery retailers now face high end competition from retailers like Whole Foods, bulk selling competition from warehouse retailers, and also need to fight off encroachment from dollar stores. Given these conditions, Derise called an attempted LBO “brave.”

The largest mainstream grocery retailer operating in the U.S. is The Kroger Co. (NYSE: KR). Kroger recently acquired Harris Teeter stores. Kroger’s stock price reached a high for the year on October 22, at $42.81 per share. Safeway reached their 52 week high of 33.93 per share a few days earlier, on October 18.

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