Grocery Store Merger Faces Long Road Before Approval

Ever since the pending mega-merger between Kroger and Albertsons, the two largest grocery store chains in the country, was announced in October, the companies have argued that the marriage will be good for consumers, employees and communities.

But the biggest winners in the $24.6 billion deal may be the private-equity giant Cerberus and a group of investors. They have already made big profits in their long-term investment in Albertsons and hope to make billions of dollars more through the merger.

The buyout group was a step closer to a big payday last week when the Washington State Supreme Court declined to review a case brought by the state attorney general that tried to stop a dividend payment to Albertsons’ shareholders, arguing that it would financially weaken the company if the transaction fails.

The decision clears the way for Albertsons to pay its shareholders a $4 billion dividend. The buyout group, which owns 73 percent of the company, will receive the biggest share, or $3 billion, of the dividend, of which $2.5 billion will come from cash and about $1.5 billion will be borrowed and put on Albertsons’ balance sheet. Albertsons said it would immediately begin the process of paying the special dividend.

The legal challenge to the dividend was the first in what will likely be a long and arduous process for Kroger and Albertsons, and their plan to create a behemoth with $200 billion in annual revenues and 5,000 stores across the country operating under well-known chains like Safeway, Ralphs and Vons.

The companies have said regulatory approval for the complicated transaction won’t happen until early next year and may require the sale or spinoff of hundreds of grocery stores. Washington Analysis, a research firm in Washington, D.C., that focuses on political and regulatory policy, put the odds of the merger successfully closing at 35 percent.

At a time when consumers are already withering under high food prices, consumer advocates argue that the deal would wipe out any meaningful competition in numerous cities and communities and ultimately lead to consumers paying more.

Union officials have attacked the deal, saying it puts jobs at risk as antitrust regulators will probably force the sale of hundreds of grocery stores across the country.

“Is my store going to be one that closes? Is my livelihood going to go away?” asked Kyong Barry, 60, a front-end manager at a Safeway in Auburn, Wash., She is a member of the United Food and Commercial Workers International Union, which has 350,000 members working in stores owned by Kroger and Albertsons. For the past 15 of her 20 years working at the grocery store, Ms. Barry said she had perfect attendance before a bout of Covid just before Thanksgiving forced her to call out sick. “This is a very scary time for us while they try to pay themselves $4 billion that we helped them make.”

And even independent grocery store chains are fretting about the merger, saying it will result in higher food prices and make the already competitive landscape more difficult.

“When the large power buyers demand full orders, on time and at the lowest cost, it effectively causes the water-bed effect,” said Michael Needler Jr., the president and chief executive of Fresh Encounter, a chain of 98 grocery stores based in Findlay, Ohio. “They push down, and the consumer packaged goods companies have no option but to supply them at their demands, leaving rural stores with higher costs and less availability to products.”

The two grocery store chains and investment firms involved insist the deal isn’t about a payday for investors.

“Our merger with Albertsons provides meaningful, measurable benefits to America’s consumers, associates of both companies and the communities we serve,” Kroger said in a statement.

Albertsons said in a statement that it had “grown tremendously with the help of our sponsors and other investors.” It added that it had spent billions of dollars to modernize its stores and build digital and technology platforms, as well as to improve associate wages, benefits and training programs.

For the private-equity giant Cerberus, which was co-founded by the billionaire Stephen Feinberg and oversees $60 billion in assets, getting into the grocery business was relatively easy. Getting out has proved much more difficult.

For years, the grocery store industry had low growth yet was intensely competitive, with Walmart, Target, Costco and others increasingly elbowing their way into food shoppers’ carts. As grocery store chains struggled to compete against the big box behemoths, consolidation happened and private-equity firms moved in, sometimes with disastrous results.

Corporate buyout specialists generally raise money from big investors, like pension funds for state employees, teachers, police officers and firefighters, and then buy undervalued or underappreciated companies. To maximize investment returns, the buyout firms typically leverage their cash with loans that are taken out by the company itself.

For most buyout funds, the hope is to fix or improve the company and make profits in a public offering or by selling the company to another buyer within four to seven years. In other instances, the debt piled on the company for the buyout overwhelms it, as was the case in 2016 and again in 2020 when the New York grocery chain Fairway Markets filed for bankruptcy.

Cerberus moved into the grocery business 17 years ago when it acquired 655 struggling stores owned by Albertsons sprinkled around Florida, Texas and Northern California for $350 million in equity. In 2013, the investors put up $100 million in cash and took out $3.2 billion of debt to acquire more than 800 stores from Supervalu. About a year later, more stores were added when the group contributed $1.25 billion to acquire more than 1,300 stores from Safeway. The rest of the $9 billion purchase of the Safeway stores was financed with debt, pushing Albertsons’ total debt to more than $12 billion.

“Our story with Albertsons is one of a long-term partnership that has created thousands of union careers and invested billions into stores, infrastructure and local communities,” Cerberus said in a statement. “It has also supported the retirement savings of individuals, universities, nonprofits and others who have entrusted us as a fiduciary.”

But various efforts by the investors to find a lucrative way to cash out of the grocery store business have been thwarted several times as Albertsons has struggled with net losses for several years.

In 2017, when Albertsons turned a small profit, the investment firms paid themselves a cash distribution of $250 million.

Later, an attempt in 2018 to cash out of the investment fell through when a proposed reverse merger with the drugstore chain Rite Aid was scuttled after the drugstore chain’s shareholders opposed it.

Albertsons went public in the early months of the pandemic, but its offering was lackluster. Still, the investors sold $800 million worth of shares and another $1.7 billion was raised from some hedge funds and used to do a share buyback.

But for Albertsons, the pandemic significantly changed its fortunes. As consumers worked from home and ate fewer meals at restaurants, grocery store profits soared. Albertsons’ profits nearly quadrupled to $1.6 billion in 2021 from $466 million in 2019.

The higher profits allowed Albertsons to pay its shareholders nearly $500 million in dividends over the past three years.

The sky-high profits also attracted a suitor. In early 2022, a grocery store chain identified as Party A in securities filings emerged with an offer to buy Albertsons for $41 a share. But as the potential buyer was going through due diligence and shortly after Albertsons’ financial advisers raised the idea of a multi-billion-dollar dividend payout to shareholders, the buyer walked away.

After scrambling to look for alternatives, another buyer was found. In October, Kroger announced it would acquire Albertsons in a complex deal that would pay all shareholders $34.10 a share. But that value will decrease by $6.85 a share when the $4 billion dividend to all shareholders is paid and could decline further if, in order to receive regulatory approval, hundreds of stores are placed in a new company that would be owned by Albertsons shareholders, including the private-equity firms.

“That’s where the most uncertainty lies, how many stores will they have to divest?” said Arun Sundaram, an equity analyst at CFRA Research. “That could be another $4 a share, which means, at the end of the day, if the deal goes forward, shareholders could receive $23 a share by our estimate.”

For the buyout firms and other investors, which had about $2 billion invested in total in the various grocery store acquisitions, their 73 percent stake in Albertsons would be valued at more than $9 billion. That is on top of the $1.5 billion in profits they’ve already made and the $3 billion from their share of the dividend when it is paid.

“The returns will ultimately be pretty good and probably beat the stock market” over the length of the investment, said Jeffrey Hooke, a former investment banker and author of the book “The Myth of Private Equity,” who is now a finance lecturer at Johns Hopkins Carey Business School. “But the Albertsons shareholders have been hanging onto this company, or its predecessor, for almost 17 years, and that’s a very long holding period for private equity firms. It’s only natural for them to want to seek an exit.”