Dramatic shifts in the retail grocery business continue to create opportunities for asset-based lenders and private-equity investors alike. But as a Tiger Group expert noted in a Sept. 12 panel discussion with colleagues from Nixon Peabody LLP and Deloitte, these deals tend to hinge on a host of practical and legal challenges that are unique to the fast-changing retail grocery sector.
“Traditional grocers are under the gun amid the economic downturn and the fierce competition posed by the likes of Walmart, Target, Amazon, Trader Joe’s and Whole Foods,” said Jason Rae, Director of Business Development for Tiger Group, which provides asset-valuation, advisory and disposition services to a broad range of retail, wholesale and industrial clients. “That makes this sector top-of-mind in the ABL and private-equity communities. It is important to carefully consider the potential impact of union-dominated workforces, perishable inventories, regulations, real estate values, the competitive landscape and many other factors. Maximizing returns in this space takes some finesse.”
Conducted at Nixon-Peabody’s New York City office, the panel discussion—“Cleanup on Aisle 9: Distressed M&A and Reorganization Opportunities and Challenges in the Retail Grocery Sector”—sought to help clarify the aforementioned dynamics. Joining Rae were Craig Boucher, Director of Deloitte’s Corporate Restructuring Group, and Nixon Peabody partners Richard C. Pedone and Lee Harrington.
The panelists began with a discussion of the current state of the retail grocery landscape and an overview of recent reorganization and M&A activity. “Traditional groceries tend to be low-margin, high-volume businesses, and so even a small drop in revenue can push a company or store into the red,” said Rae. “And today, trends such as unemployment and rising gas prices are driving cash-strapped shoppers away from traditional grocers and into the arms of mass-market discounters who are able to leverage their economies of scale to offer lower prices.”
This is all-important, Rae added, because market surveys consistently show that price is the top priority of today’s more value-conscious consumer. With their deeper pockets, meanwhile, giants like Walmart and Costco are better able to woo shoppers in other ways as well. “They can afford to adopt innovative private-label branding and technology strategies, for example, that struggling chains lack the capital to emulate,” Rae said. “When you look back at the growth in this segment since 2008, it has mostly been driven by the mass merchants. Traditional grocers’ revenues have stayed flat or contracted.”
Meanwhile, M&A activity is running high. “According to one analysis by Bloomberg,” Rae noted, “M&A activity in 2013 has already reached the highest level since 1999.” So far this year, notable M&As include Bi-Lo’s acquisition of three Delhaize Group nameplates; Spartan Stores, Inc.’s acquisition of Nash Finch Co.; and Kroger’s acquisition of Harris Teeter Supermarkets, Inc. “Growth has been occurring primarily through acquisitions for some time,” Rae said. “Over the past six years, for example, Tiger Group has been involved in the liquidation of more than 250 underperforming Albertson’s stores.” Tiger is a participant in the Cerberus Capital Mgt. LP-led group that invested in Supervalu, Inc. and acquired certain Supervalu brands for about $3.3 billion earlier this year.
During the discussion, Rae’s fellow panelists described multiple legal considerations that tend to affect restructuring, including specialized regulations and issues related to mechanics liens on store properties, reclamation and critical-vendor claims, and lease assumption/rejection decisions.
Rae rounded out the discussion by exploring some of the variables than can affect efforts to bolster returns on the closure of grocery chains and stores. In the course of a sale, for example, liquidators typically continue to replenish fresh milk, bread, eggs and other products in order to improve the return on slower moving general merchandise. “These continuity products are an important driver of traffic throughout the sale,” Rae explained. “They help keep your loyal customers coming in the door.”
In some cases, though, vendor relationships can complicate this process. “What happens when the store in question does 50 percent or more of its business with a single vendor and that relationship is fractured?” Rae said. “This presents a significant risk to the supply chain. In a downside scenario, it can lead to the degradation of your existing inventory mix and can dramatically hinder your ability to augment the existing inventory.” When the liquidator is involved early in the process, the firm can explore alternative payment terms and vendor relationships with a view toward keeping the supply chain intact, he advised.
Payroll considerations also tend to be more complex, he noted. “Oftentimes, you’ve got a highly unionized workforce, possibly with multiple unions,” he said. “Obviously, a work stoppage would be disastrous to the return on the assets because you’ve got a very short sale, typically about four weeks.” But with union rules, workforce decisions must be made carefully. “The lowest-tenured worker in a given store may not be the lowest tenured worker chainwide. Union rules may dictate that you cannot cut personnel store by store. This is a process that takes time to sort through.”
The same is true of the myriad state regulations that can apply regarding the discounting and sale of tobacco, beer and wine, lottery inventory and the like. Pharmacies, too, involve a subset of specific considerations. The pharmacy’s list of prescription customers is a potentially valuable asset, but its value can degrade with time, Rae noted. “The timely auction and migration of customer information is key to ensure that the integrity and value of the pharmacy script list is upheld,” Rae said. “If the neighborhood customers learn their grocery’s pharmacy is going out of business, they might just preemptively go down the street to the CVS or Walgreens. This is going to quickly impact the value of that list.”