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Safeway Could Be On Kroger's Grocery List

NEW YORK (The Deal) -- Safeway (SWY - Get Report) could be the latest player to join the wave of consolidating grocery chains after confirming it is considering possible transactions, and sources said they believe it could draw interest from rival Kroger (KR - Get Report) in addition to various private equity firms.

Pleasanton, Calif.-based Safeway on Wednesday confirmed that it is engaged in discussions regarding a potential sale of the company.

In addition, Safeway revealed plans to pursue strategic options for its 49% stake in Mexican grocery store chain Casa Ley SA and its intentions to distribute its remaining 27.8 billion shares in the Blackhawk Network Holdings Inc. gift card business to shareholders.

The announcement by Safeway, which has been facing shareholder pressure to improve financial results, comes amid increasing deal activity in the grocery and supermarket space over the past couple of years.

Among recent deals on the larger side have been Kroger's $3.54 billion acquisition of Harris Teeter Supermarkets Inc. on July 9, representing an enterprise value-to-Ebitda multiple of about 7.33. SuperValu Inc., on Jan. 10, 2013, sold its five retail chains - Albertson's LLC, Acme, Jewel-Osco, Shaw's and Star Market - to an investor group led by Cerberus Capital Management LP for $3.3 billion in cash and assumed debt.

More recently, on Sept. 10, Albertson's agreed to buy family-owned Texas grocery chain United Supermarkets LLC.

Financial terms weren't disclosed, but one source said at the time that Albertson's likely paid between 6.2 times to 7 times United Supermarket's trailing 12-month adjusted Ebitda.

Based on that range and Safeway's $1.58 billion in Ebitda during fiscal 2013, a deal for the chain would be valued between approximately $9.27 billion and $11.06 billion.

While Safeway didn't disclose the parties it has already held talks with, Cerberus' name has surfaced in reports that claim it would be

interested. Cerberus officials couldn't be reached Thursday.

Sources said the pairing between the private equity firm and Safeway would make sense, given Cerberus' success in the space and the opportunity for significant synergies.

"Somehow Cerberus has made private equity ownership of supermarkets work pretty well," said John Loeb, a principal at food industry-focused investment bank J.H. Chapman Group LLC, in a phone interview. "They've clearly done a good job with Jewel. They were falling behind in the market, as well."

Antony Karabus, president of SD Retail Consulting LLC, said that, in addition to Cerberus and other PE firms, a deal with Kroger could also make sense.

"Kroger is fantastic at absorbing companies and they're an unbelievably well-run company," he noted.

The announcement is the latest in a string of moves by new CEO Robert Edwards, Safeway's former CFO who replaced Steve Burd in the top spot upon his retirement in May. Only a couple of months ago, Edwards discontinued all operations in the Chicago market and he recently sold the company's Canadian operations, Canada Safeway Ltd., to Sobeys Inc. for C$5.8 billion ($5.22 billion).

Though Karabus thinks a sale of the company as a whole is the most likely route, the second-most probable action would be "selling off the pieces that aren't core and focusing all capital investments in the markets that are strongest - in California - so they can get the most upside."

Still, given how well the company's stock has done over the past several months, it could be an ideal time to sell, he added.

Shares of Safeway, which trade on the New York Stock Exchange as SWY, have surged nearly 70% over the past 12 months. The stock added another 2.05% to finish at $35.30 on Thursday. Despite gains over the past 12 months, the company's value in terms of market capitalization has deteriorated quite a bit in recent years as it has failed to keep up with other grocers in the space. Safeway had $8.5 billion market capitalization as of Feb. 19, but its five-year high of $10.5 billion occurred on April 22, 2010.

"Safeway was a national chain that had a cookie-cutter store, but they weren't really ahead of the industry on anything," Loeb said. "They cannot compete with Whole Foods (Market Inc.) and all the aggressive high-quality food stores."

Safeway officials didn't return any calls. Kroger officials couldn't be reached.

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