Lure of the Aisles
The bag boy is back.
Billionaire Ronald Burkle returned to the grocery business last month, convinced he could work his magic on two struggling chains, Pathmark Stores Inc. and Wild Oats Markets Inc.
Viewed by many on Wall Street as something of a grocery oracle, Burkle’s private investment firm, Yucaipa Cos., has made investments in other industries over the years, including fashion and technology. But his first love was supermarkets.
In the 1990s, Burkle embarked on a series of increasingly bigger acquisitions, building both an empire and a fortune. He bought Alpha Beta, Ralphs Grocery Co. and Fred Meyer before selling them and other holdings to Kroger Co. for $12.6 billion in 1999. He acquired Dominick’s Supermarkets in Chicago, selling it to Safeway Inc. for $1.2 billion in 1998.
Burkle had been out of the aisles since the Kroger deal -- until last month. What brought him back was a sale he couldn’t resist: grocery chains are selling for a fraction of what they did in the late 1990s.
“When we sold them they were selling at 10 or 11 times” cash flow, Burkle, 52, said in an interview last week. “Now they are selling for five to seven” times cash flow.
Burkle, who started in the business as a teenager as a bag boy at Stater Bros. when his father was president, bristles at the idea that he had left the industry at all.
“We have looked at every supermarket deal for the last 20 years,” Burkle said. “I don’t feel like we have been out of the business at all.... When we find a good opportunity, we want to be a buyer.”
Burkle became just that last month, agreeing to pay $150 million for a 40% stake in Pathmark, a 142-store chain in the Northeast that was in bankruptcy protection a few years ago, and $25 million for a 9.2% stake in Wild Oats, which has 110 stores, including 25 in Southern California, and has struggled to turn a profit. Shares of both chains surged on the news.
Of the two deals, Wild Oats is the riskier bet, analysts say.
Although natural and organic food is one of the fastest-growing segments of the supermarket business, Boulder, Colo.-based Wild Oats has struggled after acquiring 19 grocery brands as it has tried to keep pace with bigger Whole Foods Markets Inc.
Wild Oats ended up selling more than 40 stores that were too small or poorly located, and last year it lost $7.1 million on $1.05 billion in sales.
By contrast, 169-unit Whole Foods has become a Wall Street darling by offering large stores with a mix of gourmet items and mainstream foods. Whole Foods made $216.6 million in profit in 2004 on $3.9 billion in sales.
“Wild Oats has a somewhat uncertain future, with or without Yucaipa,” said Burt P. Flickinger III, managing director of New York-based Strategic Resource Group, a consulting firm.
Wild Oats executives blame last year’s poor performance on changes in distributors, one-time charges from problems with its 401(k) plan and losses from over-stocked perishables in its new California warehouse. Wild Oats enjoyed a temporary pickup in business during the Southern California grocery strike, but its sales have since slackened.
Burkle bought into the chain because he believed in the growth potential of natural foods and because of his confidence in Wild Oats’ chairman, Robert Miller, who was named in December. The two worked together at Fred Meyer when Miller was chief executive.
“We really like the [natural foods] space and we think it has a lot of opportunities,” Burkle said. But “basically it was an endorsement” of Miller.
With Miller in place and the chain’s distribution problems behind it, the company is working on solving the identity problem. It has ditched most of its separate store names and is focusing only on the Wild Oats and Henry’s Marketplace brands.
Henry’s Marketplace, a San Diego company acquired in 1999, has slightly more mainstream stores and stocks a large selection of premium produce and natural foods as well as mainstream items such as Pepperidge Farm cookies and Entenmann’s pastries.
And although Wild Oats may lack the cash to open a flood of new stores, it is expanding with the help of other retailers, both bricks-and-mortar and on the Internet .
In the second quarter, Wild Oats will open five stores-within-a-store in Stop & Shop supermarkets in Massachusetts and Connecticut that will carry vitamins, supplements and other items. It also has begun working with online grocer Peapod to deliver about 500 Wild Oats-brand foods to home delivery customers in the Chicago area. A rollout in other Peapod markets is expected in the second quarter.
Longer-term, Burkle sees an opportunity for Wild Oats to grow, partly because of the availability of numerous, large retail sites.
“There are all of these boxes now available, whether it’s empty Toys R Us [stores] or Winn Dixie” supermarket locations, Burkle said. Winn-Dixie Stores Inc., a Southern grocery chain, filed for bankruptcy protection in February.
Some Wall Street analysts believe that Wild Oats may be beyond even Burkle’s turnaround talents.
“They have meaningfully cleared up a lot of things,” said analyst Jason Whitmer of FTN Midwest Securities Corp. “But they have yet to break out and have a sustainable growth period without some operation or financial stumble.”
Still, the stock has picked up since Burkle bought in. When Burkle announced his investment, Wild Oats was trading at $8.71; it closed Friday at $9.96, down 12 cents, on Nasdaq.
Burkle, though, said he would increase his stake in Wild Oats only if he saw an uptick in performance.
“An investor group with sharp elbows may be just what is needed to pull Wild Oats to the next level,” Prudential Equity Group analyst Robert Campagnino said.
Meanwhile, Burkle’s investment in Carteret, N.J.-based Pathmark looks more clear cut.
An operator of grocery stores in New Jersey, New York and parts of Pennsylvania, Pathmark lost $7 million on sales of $2.98 billion in the first nine months of its current fiscal year.
Still, the Northeast “is the only place in the U.S. where there hasn’t been that much consolidation” in the grocery business, Burkle said. “Pathmark is a big fish in a big pond.”
Burkle believes that if the company can raise its cash flow to $200 million a year from its current range of $140 million to $150 million, Pathmark would make a good acquisition candidate for one of the big three supermarket chains, such as Kroger, which lack stores in that area.
“[Pathmark] has the highest sales-per-square-foot of any supermarket company,” he said. “These are very busy, high-volume stores.”
Burkle has a five-year management agreement with Pathmark and plans to add five members to the company’s board of directors after this deal closes this summer.
Wall Street seems to like his plans. Pathmark shares rose 19 cents Friday to $6.21 on Nasdaq, up from $4.48 before Burkle announced his interest in the grocer.
Burkle hasn’t scored with all of his investments. He recently sued former Hollywood power broker Michael Ovitz, claiming that Ovitz reneged on a promise to share the financial risks in two ill-fated Internet companies that lost millions of dollars. Ovitz’s lawyer has denied the allegations. (Among his other investments: stakes in hip-hop impresario Sean “P. Diddy” Combs’ clothing brand, Sean John, and in Alliance Entertainment Corp., a recorded music distributor based in Coral Springs, Fla.)
Burkle said the years since his last grocery deal hadn’t cooled his passion for the industry. He plans to be “very involved” with strategy and capital structure at Pathmark, he said, where he has an option to increase his stake to 60%.
