Sunday, June 27, 2010

The Insider: Will Tesco Acquire Supervalu, Inc. and Change its 'Fresh & Easy' Game in America?

The Insider: Heard on the Street

I ended my last column - June 12, 2010: Will Phil Clarke Shake Things up at Fresh & Easy Neighborhood Market USA When He Becomes Tesco CEO in 2011? - with the question below:

"What follows then - the big question in this scenario should it play out - is: 'Who would replace Tim Mason, say in late 2011, as CEO (or whatever the title might be) of Fresh & Easy Neighborhood Market USA?' And: I'm going to leave that question to be addressed in part two of what is going to be a series of columns on this topic, which is: 'Will incoming Tesco CEO Philip Clarke shake things up at Fresh & Easy when he becomes CEO in March 2011.' But Here's a hint: The central premise of my follow-up next column can be summed up in this question: 'If my scenario does become reality, would Phil Clarke name a new chief for Fresh & Easy Neighborhood Market from Tesco's ranks, or would he name a veteran U.S. food and grocery retailing executive to head up Tesco's fledgling U.S. operations?' But that's only a part of the next column. Stay tuned."
In today's column I'm going to offer one answer to the question in part by harking back to my April 29, 2010 column - Heard on the Street: There's Something About Albertsons ... In Southern California - about Supervalu, Inc. You need to read the column to get the full background.

First, a little back story: For over two years Fresh & Easy Buzz has mentioned in various stories and analysis pieces that the real game-changer in the U.S. for Tesco would come were the United Kingdom-based global retailer acquire a major U.S. food and grocery retailer. We've even mentioned in the past a specific retailer - Minnesota-based Supervalu, Inc. - that in our analysis is (or should be) the prime candidate for such an acquisition by Tesco.

In fact, earlier this year The Insider suggested via an e-mail exchange to United Kingdom-based financial analyst Mike Dennis (as well as a few others), who currently works for the firm MF Global and has followed Tesco plc for many years, that an acquisition of Supervalu by Tesco has the potential to be a game-changer for the UK-based retailer, which continues to struggle with its small-format Fresh & Easy Neighborhood Market chain, which currently has 159 stores in California, Nevada and Arizona. Tesco has projected a loss of about $253 million for fiscal year 2010/11, which ends in February 2011. That loss is on top of a loss of $253 million for fiscal year 2009/10 (the year just ended) and $208 Million for its fiscal year 2008/09. In other words, daylight, in the form of break-even, is a long way away for Tesco with Fresh & Easy.

Dennis, who knows Tesco as well or better than most, didn't disagree with my premise. However his opinion was that Tesco won't acquire Supervalu or a chain of similar size - Supervalu is the second-largest U.S. supermarket chain (after Kroger) and the fourth largest retailer of food and groceries in America - because of the huge debt load it would have to take on in order to make such an acquisition, which is a good argument from a financial-stock analysis perspective. But as I suggested, there's the "grocer or merchant element" to always consider as well. We left the e-mail exchange there.

But here's a summary of my strategy and scenario for a Tesco acquisition of Supervalu, Inc., which is ripe for the pickings, based on its low level of performance but excellent asset value, at least excellent in my analysis and opinion. (Note: I am neither for nor against an acquisition by Tesco plc or any other party of Supervalu, Inc. Nor do I own any Tesco or Supervalu stock at present.)

My strategy and scenario for Tesco's acquiring Supervalue is primarily - but not exclusively - for its small-format, hard-discount Sav-A-Lot chain. There are about 1,200 Save-A-Lot stores currently in the U.S. Nearly all of the stores are east of the Rocky Mountains. Supervalu plans to double the Sav-A-Lot store-count over the next five years. There's only a handful of Sav-A-Lot stores in California, and just a small store-count in the Western U.S. in general. As such, there's plenty of room for growth out west, as well as elsewhere in the country.

Having Sav-A-Lot would make Tesco, along with Aldi USA, the leading operator of small-format discount grocery stores in the U.S. Sav-A-Lot would also give Tesco a dual small-format retail strategy - Sav-A-Lot and Fresh & Easy.

Fresh & Easy Buzz has long argued a major problem with Fresh & Easy is that it's a format muddle. It's one part discount format, another part prepared foods format, yet another part natural and specialty foods format, and still yet another part convenience store. As such we argue trying to be everything in one box has resulted in a format muddle. The most successful food retailing formats are well differentiated - Walmart (discount), Wegmans (hybrid-upscale), Aldi USA (hard discount) Whole Foods (natural-organic), and the like.

Having Sav-A-Lot then, Tesco could, as an example, turn Fresh & Easy into a more differentiated format, perhaps focusing primarily on fresh, prepared foods and natural and organic products, offered at discount prices. Sav-A-Lot could then be Tesco's primary discount grocery format. This is what I mean by gaining a dual format advantage for Tesco by having Sav-A-Lot.

Secondarily, but still important, Supervalu owns Albertsons in Southern California. Albertsons is the number three market share grocery chain in the region, behind number one Ralphs (Kroger-owned) and Vons (Safeway-owned). With ownership of Supervalu, and thus Albertsons, Tesco would go from having virtually no market share with Fresh & Easy in the Southern California market to being number three. That's a game-changer, at least in the market share numbers game. Supervalu also owns the upscale Bristol Farms chain in Southern California, 16 stores. I think this could be a good asset for Tesco. But it also could fetch a decent price if sold.

Perhaps Tesco could change up the Albertsons format, making it similar to its superstores in the UK, which in addition to offering fresh food and groceries also offer a strong selection of general merchandise, clothing, electronics and other non-food product lines. Tesco does this in UK stores no bigger than the average Southern California Albertsons. In fact, many are smaller. This format, unlike Fresh & Easy, also taps into Tesco's core retailing competence, supermarkets and superstores. It also, if executed well, might find a niche in Southern California, since there isn't anything currently similar. If you haven't seen them, think of the Tesco UK stores I'm talking about as much smaller versions of Walmart supercenters, for example. I put it out there more of as a thought experiment for now, rather than as a definitive suggesten.

Beyond Sav-A-Lot and Albertsons Southern California, Supervalu has some good retail grocery chain assets. These chains include, for example, Jewel-Osco, which is a major player in the Metropolitan Chicago, Illinois market. After California, Nevada and Arizona, Metro Chicago is the next U.S. market Tesco planned to enter with Fresh & Easy in its original strategic plan, and up to early 2009, when it halted the original strategy and postponed its launch into Northern California. In the original plan, Metro Chicago was supposed to happen in mid-to-late 2010 -to- early 2011.

Other key Supervalu-owned chains include Shaws on the east coast and others. (You can view all of Supervalu's chains here.) I'm not going to get into an analysis of each Supervalu chain here. That's not my focus. Perhaps in a future column?

My focus: Beyond keeping Sav-A-Lot and Albertsons Southern California, an acquisition of Supervalu gives Tesco the ability to play on a huge chessboard in terms of strategically deciding which U.S. markets it wants to be in and which formats it wants to keep. For example, if its wants to be in Metro Chicago (and other parts of the Midwest) and on the east coast with traditional supermarket formats, it can keep Jewel-Osco and Shaws but sell all of the other chains, using the cash to pay down the debt acquired in the acquisition.

This cut-and-paste scenario can be played out in a dozen different variations. It all depends on which formats - other than Sav-A-Lot, all of Supervalu's chains are traditional supermarkets or superstores, ranging from price-impact focused formats to mid-range and upscale - and which market regions Tesco wants to operate and be in. And remember, supermarkets and superstores are what Tesco operates best.

Supervalu also operates a wholesale grocery division, which sells to independent grocers. Tesco could - and I would - sell that off. It should fetch a decent price, and there are at least three or four wholesale grocery companies and cooperatives out there that would love to buy all of or pieces of Supervalu's wholesale division. This would provide additional cash for Tesco to use to pay down the Supervalu acquisition debt.

So, what I'm suggesting in summary is: Supervalu, Inc. is an excellent U.S. acquisition for Tesco. I also believe that if a decent offer were to be made, Supervalu's board would have to take it. Why? Because Supervalu, Inc. shareholders, particularly the institutional investors, would likely demand it. The company's stock is once again back near its 52-week low after seeing a pretty good run up earlier this year. Additionally, most analysts have fairly poor mid-term -to- longer-term outlooks on Supervalu, Inc. This combination of factors makes the company a hot potato for acquisition. In fact, one of the reasons the stock went up considerably earlier this year was because rumors of acquisition were strong. Tesco was never mentioned in those rumors.

Additionally, in summary, I'm suggesting acquiring Supervalu (at a decent cost) would be a good move for Tesco, if it's really serious about being a major player in U.S. food and grocery retailing. The fact is as I see it, the odds on Tesco ever becoming anything more than a minor, niche player in the U.S. with just Fresh & Easy aren't in the retailer's favor.

Conversely, an acquisition of Supervalu, Inc. would vault Tesco from a tiny start up with Fresh & Easy, with 159 stores and about $450 million in annual sales, to the fourth-largest retailer of food and groceries in America, just below Kroger (number three), Costco (number two) and number one Walmart. That's game changing folks.

Ask yourself this, which one of these two (above) positions do you think Tesco, which is the third-largest food and grocery retailer in the world, wants - and needs - to be in in America?

I've shared this scenario with a number of analysts and other people in, and observers of, the U.S. food and grocery industry. Many of them, unlike Mike Dennis who just said he didn't think it will happen, dismissed my suggestion that a Supervalu, Inc. acquisition would not only be a smart strategic move for Tesco, despite the cost, but actually if done well - the wholesale and retail chain asset sales aspect - a financially prudent one, right out of hand. Additionally, Tesco could bring in a private equity firm as a partner in the acquisition, which would spread the financial burden around a bit. Cerberus, for example, partnered with Supervalu in the acquisition of Albertsons Inc. a few years ago.

Until recently, a Tesco acquisition of Supervalu Inc. has merely been a concept I've shared via e-mail exchanges with various analysts like MF Global's Mike Dennis and others in order to test my proposition and get feedback.

However, two recent developments lead me to conclude that Tesco could actually be considering acquiring Supervalu.

The first recent development is that sources tell me Tesco executives have met with Supervalu executives to discuss such a deal. And that there's been more than one such meeting.

The second development is that Fresh & Easy Buzz has learned from more than one source Tesco plans to make a couple big and important announcements in the next couple weeks, starting as soon as at its July 2 shareholders' meeting, regarding Fresh & Easy Neighborhood Market and the UK-based retailer's plans in the U.S.

Additionally, a San Francisco City Supervisor confirmed the information at a meeting on Thursday, June 24, of the Lincoln Park Neighborhood Association, which was held in the Richmond District of San Francisco, California. [June 26, 2010: Tesco Planning to Announce in July When First Northern California Fresh & Easy Neighborhood Market Stores to Open] The purpose of the meeting was a presentation by representatives of the CVS drug chain and its local developer, Landmark Retail Group, about a new CVS store coming to the neighborhood.

Earlier this year, Tesco's Fresh & Easy Neighborhood Market sub-leased 40% of a vacant Albertsons building at 3132 Clement Street in San Francisco's Richmond District to CVS. Tesco has a 25 year lease on building, which has remained vacant since Fresh & Easy Buzz reported on its acquisition of the building in April 2009. [April 13, 2009: Despite Postponing its Northern California Launch Again Earlier This Year Tesco's Fresh & Easy Planning Third San Francisco Store; First Stockton Unit] Tesco's Fresh & Easy has never publicly confirmed it has the lease. The about 32,000 square-foot building is in addition to the two store locations in San Francisco the grocer has confirmed. Those two store locations are: Third Street & Carroll and Silver Avenue & Goettingen Street.

At the June 24 meeting, which was held inside the vacant Albertsons store at 32nd Avenue and Clement Street, the CVS and Landmark Retail Group representatives, presented plans for the 14,271 CVS drug store to members of the neighborhood. Tesco's Fresh & Easy is using the other 50-60% of the space for a future grocery store. The two stores will be divided by a wall.

Also attending the meeting was Supervisor Eric Mar, who represents the Richmond District on the San Francisco City and County Board of Supervisors.

During the meeting, Supervisor Mar said he's had recent conversations with Tesco Fresh & Easy Neighborhood Market executives. In those conversations Mar said he was told two key things.

The First is the retailer remains committed to opening its Fresh & Easy stores in Northern California, including in San Francisco, which is something Fresh & Easy Buzz reported here in April and again in May, 2010.

The Second is that Tesco will be making a couple "big announcements" in the next couple weeks, which likely will include - but won't be the only one- when it will start opening the 37 confirmed Fresh & Easy stores (and numerous non-confirmed stores Fresh & Easy Buzz has reported exist) in Northern California. Eighteeen of those confirmed stores are in the San Francisco Bay Area; 19 are in the Sacramento/Vacaville Metropolitan region. (See my comment regarding the July 2 Tesco shareholders meeting.)

The Insider can't tell you right now with complete certainty that one of those big announcements Tesco is set to make in a couple weeks or less will be the announcement that it's acquiring Supervalu, Inc. I'm sure one though will be about when Tesco plans to start opening its Northern California stores.

But what I can say is the probability right now is at least 50-50 that Tesco could acquire Supervalu, and announce it soon. And if that happens - the acquisition - it will be a major game-changer for Tesco in America, and for U.S. food and grocery retailing, because it will be the first time in modern history, if ever, a foreign-based retailer would be one of America's top 5 food and grocery retailers.

Recent columns by 'The Insider'

~June 12, 2010: Will Phil Clarke Shake Things up at Fresh & Easy Neighborhood Market USA When He Becomes Tesco CEO in 2011?

~May 20, 2010: Welcome to Discountopia USA

~April 29, 2010: Heard on the Street: There's Something About Albertsons ... In Southern California

['The Insider' will be devoting additional columns to the topic of whether or not incoming (March 11, 2011) Tesco CEO Philip Clarke will "shake things up" at Fresh & Easy USA.]


gh said...

How much would a company like supervalu be worth?

I think tesco should have bought a supermarket when they first entered america. even if it was only making a small profit, it would have been a better base to build from than starting from scratch like f&e.

I cant see tesco buying supervalu for a few reasons, they are already more than £7 billion in debt so buying supervalue would maybe push it to £20 billon +.
Tesco have always gone for organic growth with only smaller acquisition like the the one in south korea that complemented the business they already had over there. so this would be a major change in policy if they bought supervalu.
I think to spend so much money to buy a major supermarket in a mature market place like america wouldnt give them the growth and value that they would get if they spent the money in asia.

I will keep reading buzz to see if anything does come of this.

Anonymous said...

I'm pretty sure Ahold was looking closely at acquiring Supervalu in late 2009 and early this year.

Anonymous said...

Regarding this article and your earlier one about Warren Buffett buying more Tesco stock, there was a discussion among a group of investors at the recent Berkshire Hathaway annual meeting in Omaha. One topic was Tesco's making an acquisition in the U.S. Supervalu came up as a good acquisition among four of the six investors in the discussion. I was one of them. I'm from Arizona and familiar with Fresh & Easy. I basically agree on your analysis that Tesco isn't likley to ever be much of a player with it in the U.S. One of the other Berkshire investors who has experience in FTC matters also said he didn't think the FTC would block an acquisition of Supervalu by Tesco if it to happen because Tesco has little market share with Fresh & Easy. I wanted to ask Warren during the Q&A session why he was buying so much more Tesco stock since Fresh & Easy is doing so poorly. But I didn't get a chance to. Maybe he knows something in light of your article. Don't know. But Supervalu's stock hit a 52 week low yesterday. So something has to give.