Can Yucaipa Cos. consolidate the Northeast the way it did the West and Southwest?
It is certainly in the midst of trying — though it looks like a long haul before the A&P/Pathmark combination Yucaipa has already sculpted will be in financial shape to attract an ultimate buyer.
Still unclear is if or when Yucaipa will try to broaden its Northeast holdings — possibly by adding any number of smaller regional chains and potentially Shaw's in New England if Supervalu opts to sell — and, once that happens, what its exit strategy will be.
Ron Burkle, managing general partner of Yucaipa, told SN his next move in the Northeast will probably depend solely on what opportunity comes up first.
“I'm always being asked what my plans are, but you can't know what the circumstances are until a company becomes available — and opportunities come along at a good clip. You simply have to be ready,” he explained. “Our position is, consolidation is necessary and we want to be the most aggressive at pursuing it.
“People have told me opportunities like the ones we've been involved with come along once in a lifetime. But if you keep your eyes open, those ‘once-in-a-lifetime opportunities’ can come around pretty often.”
Burkle said he has no way of knowing how long it will take for Yucaipa to achieve its goal — the sale of a rationalized network of chains in the Northeast.
“The challenge is to be ready and have your house in order — and the money available — to take on more things,” he said.
“For a company to be competitive in this environment, it needs to have a strong niche or have a market share exceeding 20%,” Burkle explained.
The A&P/Pathmark combination has a market share estimated at 25% in the Greater New York market.
After more than 25 years of buying companies, consolidating them and bundling them for sale, Burkle has become a much-studied figure within the industry.
To Bill Bishop, principal at Willard Bishop, Barrington Ill., Burkle is “a playmaker — no question of that — and in today's world, that's a good thing to be, because if there's any shortage in the food business today, it's a shortage of confident vision and leadership.
“He's proved in the past he has a brilliant eye for identifying value and building a company up to realize that value and then selling it off; and his other strong point is, he's able to get money from people to invest, and that's three times — no, four times — more important today than it was three to five years ago.”
Karen Short, a New York-based analyst with BMO Capital Markets, Toronto, said she doesn't always see the leadership results a Yucaipa takeover promises.
“Yucaipa has a great track record for making money, but I'm not sure it has the ability to fix businesses,” she said. “And until the hiring last month of Ron Marshall [as chief executive officer of A&P], Yucaipa seemed to be standing around on the sidelines in the Northeast.”
Gary Giblen, managing director of Quint-Miller & Co., New York, said Burkle is “a grave dancer — not a bad thing to be but someone who simply buys companies at depressed valuations and isn't going to make generous offers for those properties.”
According to Andrew Wolf, an analyst with BB&T Capital Markets, Richmond, Va., Burkle has enjoyed his greatest success “coming in at the bottom of the industry's business cycle, when asset values are relatively cheap, which is where we are today.
“The issue for Yucaipa now — with A&P losing half its operating profit in the most recent quarter and with a new CEO just coming in — is that its Northeast holdings need to be stabilized before it can increase its bandwidth, and it's not clear how long that will take.”
Challenges at A&P
Just as Yucaipa had to deal with some serious issues during its roll-up of the Western U.S., it appears to be facing some serious challenges with the Pathmark-A&P combination in the Northeast, observers said — challenges only exacerbated when A&P management sought to operate the two companies as one.
“Pathmark always has historically had problems,” Jonathan Ziegler, principal at PUPS Investment Management, Santa Barbara, Calif., pointed out. “Despite having stores in highly dense areas, it has always struggled on price going up against ShopRite, and management just couldn't seem to make it work.
“But the company has amazing real estate, and Ron Burkle apparently recognized that when he bought into Pathmark years ago. And now Pathmark has merged into a company with problems of its own,” Ziegler said.
Giblen agreed that A&P hasn't been able to revitalize Pathmark's price image, adding that it hasn't been able to improve the cost of goods, either.
“There was an expectation the combined A&P/Pathmark entity could get better deals from C&S Wholesale, but there are no signs the chain has been able to get better flow-through of deal money, which has led to an inability to leverage prices at Pathmark and a failure by both chains to improve the cost of goods.”
Short said one of the challenges at Pathmark is reestablishing its reputation as a price operator.
“Yucaipa originally invested in Pathmark with the goal of selling it, so it's legitimate to think price increases may have been implemented to help stabilize operating cash flow,” she noted.
“Since A&P acquired Pathmark, A&P's former management — led by Eric Claus — felt strongly that Pathmark was a price-oriented format that needed to bring pricing down, which is what it tried to do.
“But you need a lot of volume to make up for price cuts, and Pathmark has not been generating that kind of tonnage, so EBITDA has continued to show significant deterioration.
“I believe Pathmark still has decent brand equity, so if it can really reestablish its price image, it should be able to get customers back. But that hasn't happened yet.”
For A&P, EBITDA had been good until the most recent quarter, though Short said it's not clear if that had to do with consumer perceptions of the chain's pricing or a lack of direction as top leadership transitioned.
Another observer told SN a primary problem for the merged entity was the decision by A&P management to run the Pathmark stores its own way, with its own people.
“In Southern California, Yucaipa deliberately kept Ralphs, a conventional operator, and Food 4 Less, a discount operator, as separate formats with separate managements, and that was critical to the success of both when they operated under the same ownership,” the observer pointed out.
“But the A&P people hadn't done a big merger before, and they tried to convert Pathmark to their own way of doing things — and it didn't work.
“Many companies screw up mergers because they assume no one does it better than they do, so they get rid of the people from the acquired company. But that usually doesn't work, and it's usually best to keep the best of both companies.”
When it became clear A&P's approach wasn't working, the chain brought in a new president and CEO — Ron Marshall, who had held those positions with Pathmark more than a decade earlier.
Burkle declined comment on the integration challenges, but said, “Ron [Marshall] is a good manager, and he understands that Pathmark has its own identity with customers, and part of his strategy will be to restore that identity.”
Burkle said Yucaipa also has five of its people working with A&P and Pathmark to improve both businesses: Bill Bailey in human and labor relations, Tom Dahlen in marketing, Mark Orr in pricing, Steve Mortensen in finance and administration, and David Green on special projects. “All five have worked for Yucaipa over the years,” he explained. “They've come off the bench and are on loan to A&P.”
As for Yucaipa's endgame in the Northeast, Burkle isn't saying. “When we invested in Pathmark, we said the Northeast needed to be consolidated, and we would try to be the consolidator, or at least try to be part of the consolidation process,” he said.
“We offered to buy A&P, but the Tengelmann family [that owns the majority share] didn't want to sell, though they believed in consolidation and offered to buy Pathmark.”
Opportunities in the Northeast
Burkle declined to pinpoint what other companies in the Northeast might be on his radar. At one time, he said he had considered combining Pathmark with Wild Oats Markets, in which he had a significant investment, and some of the East Coast companies Supervalu had acquired from Albertsons — but that strategy didn't work out, he said, because of Supervalu's lack of interest in selling assets and the eventual sale of Wild Oats to Whole Foods Market.
Getting to the endgame stage in the Northeast could take awhile, Short pointed out, “with nothing likely to happen in the next year at minimum because A&P probably can't be turned around that quickly to sell at a reasonable multiple. And there would have to be additional companies added to the mix before a company like Kroger might consider a deal,” she added.
One could make “a compelling argument,” Short added, for combining the A&P/Pathmark property with Philadelphia-based Acme and Boston-based Shaw's — both of which are owned by Supervalu, Minneapolis.
“But with those four chains combined, it's hard to see who could buy that large a company, unless it was a private equity consortium,” Short said.
Giblen said it took Yucaipa 10 years to roll up the West Coast, and it's been only five years since Yucaipa bought into Pathmark. “And before any sale occurs, A&P is going to have to show better results, because Burkle isn't going to sell at a low valuation.”
He said “it's quite possible” Supervalu will eventually sell Shaw's, which would enable Yucaipa to move into New England, “where companies like Demoulas and Big Y could become targets. And Weis Markets in Pennsylvania could sell.”
Wolf said he agreed that Shaw's would make “a nice fit, if it were available, but when Supervalu sold a handful of Shaw's stores in Connecticut earlier this year, Yucaipa didn't go after them — presumably because A&P needs to get its profitability stabilized before it can become a platform to add other businesses.”
Bishop noted that, “Once you get beyond A&P and Pathmark, it's not easy figuring out what other companies to take out.”
According to another observer, “There are still a handful of small players in the Northeast that would enable Yucaipa to make a couple of good plays — plus larger and midsized chains like Acme or Shaw's or Demoulas — and a whole host of other possibilities opens up if Yucaipa decided to move into Upstate New York.”
The primary disadvantage to a scenario that attaches Acme to A&P/Pathmark, Bishop said, is “that A&P and Pathmark already have a significant presence in Philadelphia, where Acme is the market leader, so that could be problematic.
“But Shaw's is a logical addition — a company that's had a host of challenges of late from Stop & Shop in the Boston area and, in northern New England, from Hannaford, both companies owned by international operators [Ahold and Delhaize, respectively].”
As for an endgame strategy, Bishop said Yucaipa could do an IPO “or, perhaps more logically, sell to someone like Kroger, or even Safeway.”
Asked about potential interest from foreign buyers, Bishop cited several possibilities.
“Sainsbury has been there and done that,” he pointed out. “But Casino [which once owned Smart & Final] is a possibility, whereas Carrefour would probably want more larger stores to operate hypermarkets.
“And Tesco is an interesting possibility, though the primary impediment for them might be avoiding opening a second front,” given their small-format Fresh & Easy stores in the West.
Given the questionable performance of those small stores, Giblen said Tesco could be a potential buyer “for an opportunity of that size.” He also said Belgium-based Delhaize Group or Netherlands-based Ahold might want to increase their U.S. holdings.
Short also suggested Ahold might want to grow its U.S. store base with a Northeast acquisition, “particularly since its stores and the A&P and Pathmark stores all are supplied by C&S Wholesale Grocers, and all are union operations — though Ahold let a deal to buy Pathmark go years ago because it didn't want to give up some stores the government would have required it to sell at the time.
“A Delhaize acquisition would be less likely because Delhaize prefers self-distribution, and the C&S supply contract with A&P runs through 2018 — and it also prefers operating on a non-union basis.”
Midwest Also Ripe for Consolidation
After the Northeast, where else is Yucaipa likely to train its sights? Burkle said it's doubtful he will seek to consolidate the Southeast “because, unless you own Publix, I'm not sure how you're going to consolidate the Southeast — and right now Publix is not for sale.
“When Winn-Dixie was going through Chapter 11 in 2005, we looked at the Southeast and decided Publix was the outstanding operator in that area while Winn-Dixie was more vulnerable to Wal-Mart.
“We didn't want just to acquire sales — we wanted a strong company — so we passed on Winn-Dixie because we saw no opportunity to win there.”
Another potential area for consolidation is the Midwest, industry observers said.
“There's definitely a need to consolidate the Midwest because it's not necessarily the healthiest of regions, with companies like Marsh, Roundy's, Supervalu distribution and Nash Finch doing business there,” Short said.
Wolf offered a similar opinion. “You've got to go where the fishing hole is good, and the Midwest is still very fragmented, with a large number of independent operators, plus companies like Roundy's and Spartan Stores.”
When Burkle was asked if he's interested in focusing on the Midwest, he told SN, “We like Bob Mariano [chairman and CEO of Milwaukee-based Roundy's], and if he was interested in working with us, we would take a hard look at the Midwest.”
Mariano worked for Burkle when Yucaipa owned Dominick's Finer Foods, Northlake, Ill., in the mid-1990s. Burkle declined to comment on industry speculation that Yucaipa had an interest in acquiring Roundy's but was turned down.