News broke Monday morning that the Kroger/Albertsons merger we and other SA analysts had thought a promising development may not happen. The story appeared in this morning’s New York Times. Leading the opposition to the merger are the United Food and Commercial Workers (UFCW), who fear job losses; small and middle-market grocers, who fear being boxed out of their supply chains by “Big Food” chains; and consumer advocates, who fear that the merger would end meaningful competition in some markets.
How a Good Deal May Go Bad
The Kroger dividend, which had been scheduled to be paid in November, was held up by a court challenge. The challenge was dismissed last week after a hearing. The company announced it was paying the dividend January 20th at a rate of $6.85 per common share, or roughly $3.921 billion. It was to be financed from $2.521 billion from cash and $1.4 billion from borrowings added to the Albertsons balance sheet. ($200 million of which has been repaid, according to the December financials.)
One analyst has opined that the deal has only a 35% chance of being achieved and then only sometime next year.
We had rated the deal a “hold” back in October, waiting for the outcome. We said:
Overall, assuming all goes well with the merger – never a certainty in these things, but far more routine in retail than elsewhere – the combined Kroger entity (i.e., including Albertsons) will have significantly superior value creation, over the medium and longer term, than its Walmart competitor and many others in the retail defensive sector.
That all seems now in jeopardy, vis-a-vis Albertsons.
Were the deal to fall apart, it will put a significant challenge on Albertsons financial model given Albertsons extraordinary level of debt ($13.3 billion in current liabilities as of December 2022 and a current ratio of just 0.82 compared to an industry average of over 1.12, or 30 bps higher.)
And the debt burden will be coming from a somewhat depleted cash pool. At December, a month after the extraordinary dividend was to be paid and as shown on its balance sheet, but which was delayed by the court filing, cash, equivalents, and restricted cash, was only $4.420 billion according to the ending statement of cash flows from December. So that figure, from December, is now reduced by the $3.721 billion portion of the dividend that was paid from cash on hand, leaving what we would estimate at just $699 million of cash on hand, excluding January operations, computed as follows:
|Available Cash, per 12/3/22 SCF||$4.420 billion|
|Dividend paid January 20th||($3.921 ” )|
|Loan repayment by 12/3/22||$0.200 “|
|Estimated cash at January (today)||$0.699|
The reduced cash position is notable because it was the principal reason that Albertsons was enjoined from making the dividend payment. Taken together with the NY Times’ observation that Albertsons prospered during the pandemic while people were cooking at home, and are now returning to factories, offices, and stores, it should give investors pause.
Of course, if the merger deal falls apart, Albertsons would not be required to divest of its stores in local markets where Kroger has business. But that seems like small consolation. Albertsons owners, Cerberus, have been trying to shed the company at profit for years, according to the NY Times. If the Kroger deal goes bust, they may very well offer up the company to get out at an optimal price. But that price is likely to be quite a bit less than today’s close of around $21. Investment Strategy: In as much as no Justice Department review of the merger deal is expected until “early next year”, according to the Times, I recommend that investors holding Albertsons should cover their positions with puts or stop loss orders in the high teens or low 20’s. Speculators might want to jump in with January, 2025 puts in the range of $20 as a collapse of the Kroger deal will put profit margins for the company at risk and drive down the stock price. But, overall, in the presage to a 2024 election year, it’s reasonable to believe that the Biden Administration will want to keep in the good graces of the UFCW as well as consumers who have been throttled by inflation.
Note: Our commentaries most often tend to be event-driven. They are mostly written from a public policy, economic, or political/geopolitical perspective. Some are written from a management consulting perspective for companies that we believe to be under-performing and include strategies that we would recommend were the companies our clients. Others discuss new management strategies we believe will fail. This approach lends special value to contrarian investors to uncover potential opportunities in companies that are, in our view, otherwise in a downturn or overvalued. (Opinions with respect to such companies here, however, assume the company will not change).