A $25bn grocery deal takes fight to Walmart

It’s a deal which until recently was hard to imagine. Buying Albertsons Cos triggers major antitrust risks for any of its obvious industry suitors. But on Friday the US grocery chain agreed to be acquired by larger rival Kroger Co at a $25 billion enterprise value, with the duo outlining a seemingly cunning plan to assuage the competition authorities.
Albertsons announced a strategic review in February, raising hopes for a transaction of some form. If this was all playing out in 2020 or 2021, you’d have expected private equity to take a swipe. But the seizing up of the leveraged finance market has changed the game and given corporate buyers an advantage in M&A.
For Kroger, the idea is clearly to become more competitive against the likes of Walmart Inc., Amazon.com Inc. and Costco Wholesale Corp. The transaction broadens its footprint in US: Albertsons and Kroger have 5,000 stores between them.
Combining will enhance Kroger’s buying power with suppliers as well as generate the usual merger efficiencies from eliminating overlapping functions. Scale economies are especially valuable at a time when there’s inflationary pressure on the cost base, and customers are more focused on value for money. There could be revenue synergies from expanding the online offering.
The financial benefits of the transaction look considerable. Kroger envisages some $1 billion of annual cost savings within four years of closing – equivalent to 40% of Albertsons’ expected operating profit this financial year. That would ordinarily justify the premium being offered over Albertsons’ equity value before Bloomberg News revealed talks on Thursday.
But the acquisition is more expensive than it first appears. There’s a commitment to invest $1.3 billion in Albertsons stores. And, as ever, it’s unclear how many of the benefits will go to shareholders in the long term. Kroger is already allocating $500 million of the savings to funding price cuts (which admittedly may drive sales volumes higher). It’s also talking about investing in higher wages.
Moreover, Kroger’s leverage will rise sharply with the transaction. It’s also buying a company which has historically traded at a lower price-earnings ratio: The risk is that this dilutes Kroger’s own rating.
But the main problem here is uncertainty. It’s not clear what concessions will be necessary for this transaction to go through given the overlap in the store network. Trustbusters may be more worried about increased industry concentration than pleased with the creation of a bigger rival to Walmart.
If private equity’s woes have given Kroger a chance at the transaction to begin with, they also complicate the deal’s execution. Ideally, Kroger would package up the needed store divestitures into a separate company that would make a tasty leveraged buyout. Kroger can realistically only hope for piecemeal asset sales right now.
To get round this, the idea is to create a separate company spun off to Albertsons shareholders, housing the assets being jettisoned for regulatory approval. This is certainly creative. But the portfolio will need sufficient scale and quality to have a chance to be a desirable stock. The risk is that it’s perceived as a sub-scale collection of cast-offs.
It would have been better to have a package of disposals already agreed on today. As it is, we’re told anything from 100 to 375 stores will go into the spin-off. That seems low, says Bloomberg Intelligence analyst Jennifer Bartashus. Should more than 650 have to go, the deal could fall apart. If Kroger is lucky, the buyout market will return to health in coming months. That’s hardly something to bank on. Both sets of shareholders face considerable uncertainty.
—Bloomberg