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Observers see change on horizon for Whole Foods

Investment could speed maturity cycle, but at a price

Industry observers tend to agree that the emergence of a new investor in Whole Foods Market could be a catalyst for massive — and some say, long-awaited — changes at the natural foods giant, but few could envision a scenario under which those changes are paid for given a challenging environment for food retail in general and Whole Foods in particular.

As reported earlier this week, Jana Partners along with a group of individual investors disclosed they had amassed 8.8% of Whole Foods’ stock, and intended to influence the once fast-growing retailer to reconsider any number of its current practices.

This has prompted many to reset their own expectations for Whole Foods, speculating, for example, that its relatively slow move toward areas like loyalty and analytics would begin to move faster, while new store builds — including the nascent 365 value concept — could slow considerably.

Burt P. Flickinger III, managing partner of Strategic Resource Group, did research on Whole Foods and its competitors on behalf of Jana prior to its disclosure statement Monday, predicted the investors would hasten a transition from Whole Foods’ start-up roots to a mature company that would mix founding spirit with professional experience and a strategic eye.

“Like a lot of businesses, Whole Foods needs to transition from a entrepreneurial founding management to more professional management,” Flickinger said.

“What Jana tends to do is buy companies that still have tremendous growth potential and strong consumer franchises that are ahead of the curve in terms of connecting with the consumer but potentially behind the curve backstage in terms of marketing, merchandising, and supply chain and information systems.”

These changes, however, are likely to come at a price, and are made more difficult by an increasingly competitive environment that some have said is at the heart of Whole Foods’ sales recent sales challenges.

Kelly Bania at BMO Capital this week raised her target price for Whole Foods on the prospect of accelerated advances in loyalty, analytics and category management at the retailer, given the support of Jana. “However,” she added, “we continue to see risk that a deeper investment in price and/or employees, wages and in-store service will be necessary to support a more material turnaround in same-store sales trends given the increasingly competitive food retail backdrop, particularly for WFM's core natural, organic and specialty offering.”

Another source, who asked not to be identified, was more blunt: “The only way the activists are successful long term is if they tank earnings in the short term by making a big investment in price.”

Scott Mushkin of Wolfe Research said this week that its studies has shown Whole Foods “has done little to narrow its price gap with the competition,” leading to the negative comps and a slumping price that made Whole Foods attractive to activists in the first place. “While we believe there are a number of strategic actions the WFM management team should take, such as further slowing store growth, getting its prices in line and refocusing on its superior store experience, all of these in the short run lead to lower earnings.”

Mushkin was also skeptical that a strategic or private buyer could step in, saying Whole Foods remains “overvalued,” and that resources required to invest in more competitive prices could hurt sales by interfering with store experience. “The bottom line with WFM is the issues regarding competition, pricing, and service levels remain the same no matter the owner or the operator,” he said.

Flickinger, however, was more positive on the prospect of Whole Foods finding a new parent, speculating that possible strategic buyers could include Albertsons Cos., or foreign buyers like Germany’s Metro AG, Canada’s Jim Pattison Group or Australia’s Wesfarmers, noting a foreign buyer could support Mackey’s vision of a worldwide presence for Whole Foods. These companies might ultimately have to await a reworking under a private owner, however. “That’s the typical path, but I think Whole Foods has the potential to improve significantly enough that it could attract a strategic buyer.”

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