Fairway Failure Shows Danger of Overpromising Before the IPO

The Lessons From Fairway's Fall From Grace
  • Grocer is now worth less than its board compensation in 2013
  • Planned to open 300 stores, for growth of about 2,400 percent

Next time a company tells potential investors that it’s “Like No Other,” they might think twice about handing over their money.

When Fairway Group Holdings Corp. went public three years ago, it told investors that its chain of gourmet grocers -- then numbering just 12 stores in Greater New York -- could grow by about 2,400 percent, or an additional 300 sites nationwide. This week the company filed for bankruptcy having never made it farther than Lake Grove, Long Island.

With the filing, Fairway’s dream of becoming nationwide gourmet grocer passed its sell-by date. Competition from its own new stores, as well as Whole Foods Market Inc. and Trader Joe’s Co., cannibalized revenue at older locations. Meanwhile grocery and meal-kit delivery services like FreshDirect and Blue Apron Inc. kept time-pressed shoppers away from its doors.

“They had a great business going, with a great regional brand,” said Brad Snyder, executive managing director at Tiger Capital Group. “The IPO became a distraction for management and ownership, and the result of that was they felt compelled to grow at a rate that outpaced their execution abilities.”

New York-based Fairway and its shareholders, including private equity backer Sterling Investment Partners LP, sold shares in the company for $13 apiece in April 2013. The stock priced at a dollar more than the top of its marketed range, valuing the grocer at about $536 million.

On Thursday, Fairway’s stock closed at about 25 cents a share, wiping out more than $500 million in equity market value since the listing. The company runs just 15 stores, well below the 22 locations it told IPO investors it expected to have in the New York area by the end of this year.

Representatives for Fairway and Sterling didn’t respond to requests for comment.

In retrospect, the risks listed in Fairway’s IPO prospectus seemed to point to its demise. It warned that new stores could cannibalize existing sales competition. It also noted that the competition could move in next door. Then, there was the threat that “consumer preferences, buying trends and spending levels” might change.

Hurricane Sandy

Not all risk factors are so predictable. Months before the IPO, Hurricane Sandy shut its Red Hook, Brooklyn store -- one of its most successful -- for more than 16 weeks. Net sales at that location during the same period a year earlier had totaled $25 million. By the time it was up and running again, Whole Foods was close to opening a new store just two miles down the road, complete with a greenhouse and rooftop beer patio.

Rivals have come from all quarters, said Shilpa Rosenberry, vice president of global consumer strategy at Daymon Worldwide. On top of upscale grocers like Whole Foods, shoppers can now choose from cut-price entrants like Aldi Stores Ltd., with outposts in Queens and East Harlem, as well as farmers’ markets across the city.

The array of choices means big weekly trips to the neighborhood grocer are a thing of the past.

“A few years ago, Fairway had a very special place in the market,” as shoppers flocked to its specialty coffees, cheeses and olive oils, said Rosenberry. Now, “everyone has upped their game,” she said.

Growth Story

Had Fairway stuck to its expansion plan, it would have been a production on a grand scale -- and equity investors paid to get a piece of that growth story.

The IPO valued Fairway at about 15 times adjusted Ebitda for the fiscal year ended April 2012, according to data compiled by Bloomberg. That compared with 13 times Ebitda for Whole Foods and 5.2 times Ebitda for Safeway Inc., the second-largest U.S. supermarket chain.

Based on Thursday’s close, those shares now trade at 0.96 times adjusted Ebitda for the year ended March 29. The market value of the company is just $11 million -- less than Fairway awarded its directors in 2013, when they made a collective $12.1 million.

The grocer paid the three Sterling partners who served on its board -- Chairman Charles Santoro and directors Michael Barr and William Selden -- cash and stock-based compensation valued at more than $8.1 million in fiscal 2014 and 2015. Selden surrendered some of his restricted stock units when he resigned from his director position in November 2014.

Of the 570 companies to go public since 2013 in the U.S. with IPOs bigger than $50 million, Fairway has fallen more in market value than all but four other businesses, according to data compiled by Bloomberg.

“They were a bit on shaky ground on their current local expansion and very unproven on national expansion,” said Kathleen Smith, principal at Renaissance Capital Ltd., which manages IPO-focused exchange traded funds and analyzed Fairway’s IPO. It’s a lesson for management teams aiming to take their own companies public, she said.

Fruit Stand

Fairway had come a long way from its roots as a fruit-and-vegetable stand founded by Nathan Glickberg in 1933. The business settled into a storefront on Manhattan’s Upper West Side and in the 1970s, Glickberg’s grandson Howie expanded the floor space and added groceries and specialty foods to the offerings.

Fast forward 30 years to 2007, when Sterling invested about $90 million to take a majority ownership stake and a role in advising the company. Sterling recouped $86 million in dividends and share sales in the IPO, retaining 81 percent voting control.

With the help of private equity partners on Fairway’s board, Sterling guided the company’s real estate purchases for new stores, developed its management team, upgraded its financial systems and improved margins, Sterling’s website said in 2014. Fairway eventually paid $31 million in fees to a Sterling affiliate, including a $9.2 million payment to end its management agreement in connection with the IPO.

While Fairway tried to grow, the company’s real estate strategy didn’t help, said Ryan Severino, senior economist at Reis Inc, a commercial real estate research firm.

“Their portfolio is a mixed bag -- some more affluent places and some less affluent places,” Severino said. “In retail that is usually difficult to pull off.”

The grocery business has never been easy, operating in a low-margin environment where the main products are highly perishable. Fairway’s not the first to fall by the way -- A&P Stores Ltd., Haggen Inc. and Fresh & Easy Neighborhood Market Inc. all filed for bankruptcy in the past year.

The company said Monday that its proposed restructuring plan would cut about $140 million in secured debt. All creditors but senior secured lenders would be paid in full, and union contracts would be honored.

“Their ambitions were steep, considering the competitive market,” said Daymon’s Rosenberry. “The idea of opening up stores for all retailers on every corner as part of a growth strategy is kind of a thing of the past.”

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