In a grocery retail market chock-full of competition, chains are increasingly finding that in order to make money, they have to spend it, too — and oftentimes lots of it. Loyalty programs, systems updates, price promotions, store remodels and other initiatives all drive differentiation in the marketplace.
For private equity firms, which thrive on a low-investment, efficiency-driven management, these programs are in sharp contrast to their philosophy. This has turned supermarkets into a prime target of private equity firms, which have increased their ownership and investment activity in the space. With a goal of buying low and selling high, many enterprises look to improve a retailer's balance sheet and then make a quick exit, often within three to five years.
“Private equity is about one thing and one thing only: Return on investment,” Craig Rosenblum, a senior director with Willard Bishop, told Food Dive.
But is what’s good for private equity also welcomed by grocery retailers? The answer, according to sources interviewed by Food Dive, is complex and ever-changing.
Gauging the benefits of an investment
Back in June, the chief executives of two major private equity owned grocery chains, Ian McLeod of Southeastern Grocers and Rick Anicetti of The Fresh Market, resigned within a week of each other. Both chains have struggled to update their stores in light of tepid sales, leading some industry observers to conclude that the two executives departed because their companies are under-capitalized. Southeastern Grocers is owned by Dallas-based Lone Star Funds while Apollo Global Management acquired The Fresh Market last year for $1.36 billion.
Rosenblum said Southeastern Grocers operates in a dangerous middle ground, with budget stores such as Walmart and Aldi on the low end and experience-driven stores including Publix on the high end. He said the company needs to remodel its Winn-Dixie and Bi-Lo stores so they’re better differentiated in the marketplace — an expensive proposition that private equity often is reluctant to embrace.
"Private equity is about one thing and one thing only: Return on investment."
Senior director, Willard Bishop
Southeastern has instituted price cuts and remodeled some stores to include more fresh items. But increasingly, it's opting to convert its Winn-Dixie and Bi-Lo stores to either its discount Harvey’s Supermarket banner or its Hispanic Fresco Y Mas brand.
“Lone Star is kicking themselves at this point,” Rosenblum told Food Dive. “They thought they could scale their model and just keep expanding, gaining more stores and more share. The reality in the southeast landscape in particular is, if you’re not differentiating, you’re dying.”
Private equity firms, he said, measure success differently than supermarket operators. Instead of topline sales and an emphasis on volume, private equity prizes EBITDA and a return on invested capital. This approach helps retailers improve their operational efficiency, and they can pull struggling grocers back from the brink. However, stores requiring a deeper investment that won’t produce timely returns — particularly traditional chains — can struggle under private equity ownership, Rosenblum said.
Burt Flickinger, managing director with Strategic Resources Group in New York, noted some private equity firms are “enlightened” in their management of supermarket chains, while others have struggled to read the industry’s unique demands. The Fresh Market under Apollo is spread too thin outside of its North Carolina home base, he said, and so far is not spending enough money to implement center store remodels that would add more everyday products to aisles.
Similarly, he said New York City’s Fairway Market grew too quickly and struggled against specialty competitors under private equity firm Sterling Investment Partners, which bought the grocer in 2007. After emerging from bankruptcy last year, the chain sold itself to a private equity consortium run by Blackstone Group's GSO Capital Partners.
In May, supermarket veteran Abel Porter was hired to lead the company. Fairway is still struggling, but showing signs of improvement under its new president and CEO, Flickinger said.
“It’s not private equity turning Fairway around, it’s Abel Porter turning Fairway around,” he told Food Dive.
One of the most successful private equity firms operating in the grocery space, according to sources interviewed by Food Dive, is Cerberus Capital Management, which has grown Albertsons from a minor player to the second-largest supermarket chain in the U.S. The firm’s ownership, which dates back to 2006, is unusually long for private equity. But Cerberus has seen its investment grow as it purchased chains such as United Supermarkets, Jewel-Osco, and its biggest prize to date, Safeway, in a $9 billion blockbuster deal in 2014.
Flickinger credits Cerberus’ hiring of Bob Miller, a former head of Rite Aid and Kroger's Fred Meyer banner, as Albertsons’ chief executive. Under Miller, the grocery chain has taken a decentralized approach while also emphasizing operational efficiency. Larger prizes have eluded Albertsons of late — most notably a failed bid for Whole Foods and a long-desired IPO — but Miller has said the company plans to continue acquiring regional chains and rolling out services such as online shopping and home delivery.
According to Walter Deacon, principal at Boston Retail Partners, hiring strong leaders and letting them set company strategy is a key to success for private equity firms like Cerberus.
“In most cases, the private equity firm will help put the pieces in place, but relies on the retailer’s management team’s decision-making to achieve financial success,” he told Food Dive.
Deals set to pick up
According to management consulting firm A.T. Kearney, private equity deals in the grocery space have actually cooled during the past few years. Last year, private equity and other financial firms were responsible for 16% of the total value of deals in grocery space — down sharply from 43% in 2012. At the same time, the value of mergers and acquisitions in food manufacturing and retail reached a post-recession high of $469 billion. This included 58 mergers valued at $1 billion or more.
Numerous factors contributed to private equity’s share drop, most notably high asset prices and a willingness to cede to "strategic acquirers with strong balance sheets and synergies with target companies," according to A.T. Kearney. However, the firm notes many private equity firms are accruing capital as they wait for better conditions for an acquisition. Their "dry powder," as A.T. Kearney calls it, has swelled to a record $1.5 trillion and should come into play very soon.
"[Private equity] and other financial buyers will move off the sidelines, deploying vast amounts of 'dry powder' to acquire consumer or retail companies that offer synergies with their existing portfolio businesses," the firm said in a June report.
“With more under-performing grocers, private equity firms will have their eye on this market, and it is very likely acquisition activity will heat up.”
Principal, Boston Retail Partners
Amazon’s foray into grocery retail through Whole Foods has already devalued many retailers, and could have even more of an impact once the e-commerce giant tinkers more with the stores. Combined with the downward price pressure exerted by discounters Aldi and Lidl, as well as Walmart, the fallout could be a collection of attractive pickups for private equity, according to Deacon.
“With more under-performing grocers, private equity firms will have their eye on this market, and it is very likely acquisition activity will heat up,” he said.
But will private equity be able to navigate an increasingly disruptive industry? While sources said it depends on the firm, they note that private equity generally has adjusted to the nuances of operating in the grocery space. This insight, along with a keener focus on operational efficiency and controlling costs, could benefit struggling retailers.
“They’re starting to recognize that strategy of buying, cleaning up the balance sheet and sucking up the cash and profits doesn’t always work,” said Rosenblum. “Now, they’re making sure the pieces of the puzzle come together in such a way that the topline is going to continue to grow, and then they can drive efficiency through aggregation and expansion’.”
Flickinger pointed to recent developments at 99 Cents Only Stores as an example of private equity making positive changes in food retail. Shortly after Ares Capital bought the dollar chain in 2011, it installed former executives from Canada’s Alimentation Couche-Tard that were “incongruous” with the discount-focused business, according to Flickinger. Less than two years later, Ares and 99 Cents Only replaced them with U.S. grocery executives, including Geoffrey Colvert, a former senior vice president with Kroger who became 99 Cents Only’s chief executive, as well as Jack Sinclair and Jason Kidd, both from Walmart.
The company began to focus more on food offerings, and saw sales improve as a result.
“Ares Capital literally recruited the dream team of Colvert, Sinclair and Kidd, and they’ve completely turned around 99 Cents Only by focusing on food,” said Flickinger.
Rosenblum said he expects private equity acquisitions in the coming months and years to center more on value and specialty retailers that have a clear path to increased returns. Traditional grocers, he noted, often require too much investment to stay competitive, though a well-though-out plan to incremental gains certainly wouldn’t be out of the picture.
“You’ve either got to go to the value side or the experience side,” Rosenblum said. “If you’re in the middle and you just happen to be a ‘me too’ grocer, it’s a very difficult place to be.”
As far as which grocers could be the next targets for acquisition, sources were reluctant to pinpoint specific names. Most, however, agreed that some struggling regional grocers could be of value, along with natural and organic retailers that come in at the right price. Experts also see Hispanic grocers as a prime target for investment, given their favorable demographics and experience-focused model.
"Hispanic grocers are able to locate very strategically in markets that are changing," Diana Sheehan, director of retail insights with Kantar Retail, told Food Dive. "It's all about finding those gaps in the marketplace."