By David Orgel 
Financial analyst reports aren't usually riveting reads, but there was a notable exception after Safeway's recent conference call that discussed its Blackhawk Network gift card venture.
"Then came the bombshell, and it was called Blackhawk," wrote analyst Perry Caicco at CIBC World Markets.
"Essentially, Blackhawk appears to be the most attractive business model we have ever seen," wrote John Heinbockel and fellow analysts at Goldman Sachs.
Meanwhile, Edward Kelly and Jay Carlington of Credit Suisse titled their Safeway report "Mea Culpa," because they had to change their investment outlook as "Blackhawk is a much more meaningful initiative than we (and the Street) thought."
What is Blackhawk and why did it jolt the hard-to-surprise analyst community?
Blackhawk is a unit created in 2001 to build new marketing initiatives for Safeway, but its potential is only now becoming clear. Its primary business to date is marketing third-party gift cards of nearly 200 partners, including Best Buy, Nordstrom, Barnes & Noble Booksellers, and the iTunes Music Store. The cards are distributed to a network of about 60,000 retail locations, including those of Safeway and other supermarkets, such as Publix, Ahold and Giant Eagle. Safeway and Blackhawk earn commissions on the sales of these cards.
Blackhawk, not willing to be a one-hit wonder, has diversified to include open-loop cards for companies such as Visa and MasterCard, and sports, entertainment and telecom cards. The company plans to roll out more initiatives and build an international presence over the next few years.
The financial payback is impressive, to say the least. Blackhawk has grown at the rate of 100% in each of the last few years. It is expected to account for some $100 million in pretax earnings in 2007.
But in that good news lies a problem. Analysts weren't aware Blackhawk was so strong. It is, in fact, contributing a larger share than expected to Safeway's earnings. Unfortunately, that means Safeway's core business is responsible for a smaller contribution than thought.
It must be said that Safeway's core business has become quite impressive in the last year or so. Its lifestyle format is showing good results that last well beyond the grand-opening year. Safeway has moved quickly to roll out the new format across its markets and has even produced six lifestyle versions to provide more flexibility.
Still, Safeway will need to be clearer in outlining how this core business is performing compared to other ventures, such as Blackhawk. Investors were surprised after understanding Blackhawk's contribution. With the core business performing so well right now there was probably little harm done. But at some point the core business may hit a speed bump, perhaps resulting from gas prices or other economics turning against supermarkets, or from Tesco's upcoming U.S. entry. At that point it will be even more important to understand precisely how the core business is doing vs. unrelated growth ventures.
Meanwhile, Safeway shouldn't ever get so excited about non-core ventures that it lets the primary business slip. Blackhawk is impressive, but its wings will not carry the main franchise.