MONTVALE, N.J. - The gravitational force between A&P and Pathmark appeared to intensify last week when A&P here said it would issue a special dividend that investors - and some analysts - interpreted as prelude to a long-anticipated merger with rival Pathmark.
A&P's payout of $7.25 a share rewards its stockholders with $300 million in cash generated by the sale of its Canadian assets last summer. It could also facilitate an A&P-Pathmark merger by lowering A&P's stock to a price at which Pathmark's majority owner, Yucaipa Cos., could gain a meaningful stake in the combined entities, analysts told SN.
Deal speculation sent stock in Carteret, N.J.-based Pathmark soaring more than 11% on 10 times average volume last week despite reporting a $14.6 million fourth-quarter loss, declining sales and a grim short-term outlook. Pathmark's bond prices similarly increased in the face of worsening leverage statistics, analysts said. A&P stock also saw unusually heavy trading last week, though analysts noted the anticipation of a special dividend and acquisition speculation has propped its stock price for months.
"The perception in the marketplace is that a combination of A&P and Pathmark is a desirable thing, and A&P has made no secret of its desire to play a role in the consolidation of the Northeast," Karen Short, analyst for Soleil Securities, New York, told SN.
"Without the acquisition rumors in the marketplace, the bonds would have been down, in our opinion," Bryan Hunt, a debt analyst for Wachovia Securities, Charlotte, N.C., told SN. "The credit metrics deteriorated relative to a year ago: Debt-to-EBITDA ratio went from 4.6:1 to 5.3:1. Given the guidance the company gave us, leverage is likely to go higher in the short term."
While the market clearly smelled a deal, analysts were divided as to how soon something could transpire, if at all. A merger between the companies, each suffering partly as a result of competing with one another, could yield millions in cost savings and aid profitability but would ultimately require a harmonious blend of the company's respective majority owners: The Tengelmann Group, which owns 53% of A&P, and Ron Burkle's Yucaipa Cos., which controls more than 40% of Pathmark.
The dividend could pave the way for such a merger because the cash it removes from A&P's balance sheet will be reflected in a lower stock price following the payment April 25, analysts explained. That would provide Yucaipa with a larger ownership stake in A&P if A&P buys Pathmark using stock. "It resets the share price for a possible share-heavy consolidation move by A&P," Perry Caicco, an analyst for CIBC World Markets, Toronto, said in a research note.
"I don't have any insight as to what Yucaipa is thinking, but historically they have taken large positions in the companies they invest in," Short added. "They would want a slightly more significant stake than 10% or 11%."
Short and Caicco were among the analysts who said they expected a deal between A&P and Pathmark could happen soon. But others, including Hunt and John Heinbockel of Goldman Sachs, New York, suspected a deal could be further down the road. Each side found support for their contentions last week during Pathmark's quarterly conference call.
John Standley, Pathmark's chief executive officer, noted some of the initiatives launched shortly after his arrival late last summer have begun to pay off. An early retirement program and labor buyout will result in $12.5 million in savings expected to be realized in the current fiscal year, which began Jan. 29. Online auctions to reduce costs for items and services could save $6 million this year and the company has reduced the high shrink levels associated with a round of store merchandising resets and remodels that increased the mix of perishable items in stores. More recently, Pathmark hired a slew of new senior executives and amended its credit agreement to increase borrowings.
He added that the company has targeted an additional $20 million in cost reductions to help offset rising costs for pension, energy and insurance, and that Pathmark was working on a new store prototype it hopes will be ready to roll out in 2007. Capital spending will be around $70 million in fiscal 2006, covering eight major and eight minor renovations, he said.
Quarterly sales of $999.3 million decreased 0.4% from the same period a year ago and same-store sales fell 0.8%. Earnings before interest, taxes, depreciation and amortization of $27 million fell by $18.4 million due in part to $5.9 million in shrink, and $12.5 million in higher costs and charges to implement merchandising changes and buyouts. A $14.6 million net loss compared favorably to a net loss of $301.6 million in last year's fourth quarter.
"We made progress laying the foundation for a successful 2006," Standley said, adding, however, that he expected the company could be "treading water" through the second quarter as it cycles historically low shrink figures.
"If you look at the behavior of the company, does it correlate with a company that may be for sale? Last week they obtained an amendment on their credit facility to enhance their liquidity. Two, they've hired a lot of senior-level managers. That's not behavior of a company that's for sale; that's the behavior of the company that's trying to build its infrastructure to turn around," Hunt said.
Heinbockel in a research note said a deal is more likely in the longer term than the short term "for operational, not [for] financial reasons," including the fact that neither company is currently profitable and both have new executives engineering complex turnarounds (Eric Claus joined A&P as CEO shortly before Standley joined Pathmark).
"Most successful mergers are done from a position of pure strength - unfortunately, that is not the case right now," Heinbockel wrote. "Patience is an attribute in this case."
Short disagreed. "I look at it as a complete waste of resources for both of them to do turnarounds without combining forces," she said. "It will make for a bigger [integration] project, but you'd save a lot more money by combining now than two years from now."
Pathmark's issues - most related to high internal costs - could be solved by merging with A&P, she added.
A&P's dividend was funded by excess cash generated by the sale of its Canadian assets to Metro last summer - a deal fetching more than $1.4 billion for A&P that wiped out millions in debt but introduced pressure to improve money-losing U.S. operations.
Remarks by Christian Haub, A&P's executive chairman, have been increasingly confident in the company's ability to effect consolidation.
In announcing the dividend last week, Haub said the payment "makes it possible to [reward] our stockholders for their support while also providing the investment capability to complete our turnaround, grow our business and address strategic opportunities that will arise."
