Two words explain why grocery giant Kroger decided to go after a small-fry, money-losing supermarket chain: Chicago and Wal-Mart.
Kroger on Wednesday said it was buying Milwaukee-based Roundy's for $800 million including debt, a transaction that will bring the chain's Pick `n Save, Mariano's and Metro Market stores under its umbrella. The $3.60-per-share price tag is roughly 60 percent more than Roundy's average price in the days before the announcement -- a steep premium to pay for a company that at first blush doesn't exactly look like a trophy asset.
Roundy's hasn't increased annual same-store sales since 2008 and is burdened with a debt load six times its pre-deal market value. What Roundy's does have is stores in Chicago, where Kroger lags behind peers, and in Wisconsin -- where Kroger doesn't have any supermarkets.
Scale is everything in the fight for shoppers' dollars as growth sputters and competition looms from upscale purveyors and big-box chains such as Wal-Mart. That's why food retailers have spent a record $29 billion on takeovers so far this year.
No one knows this better than Kroger, which seems bent on becoming as big as possible in its quest to take on Wal-Mart. With a little over $108 billion in sales last year, Kroger generated more revenue than either Amazon, Target or Walgreens, and it's not too far behind CVS and Costco. Buying Roundy's fills out another piece of the map and increases the odds that customers will turn to Kroger for their produce and cold cuts.
There's also a potential growth story in Roundy's Chicago stores, which operate under the Mariano's banner. The combination of low prices with specialty departments seems to be working there and Kroger could replicate the model in other urban areas. All the better to take on Wal-Mart.
Kroger has typically acquired companies that don't require much fixing, though. Take Harris Teeter, for example. Kroger paid up for the Southeast chain, but it got a well-run, growing business with above-average margins. That's not the case with Roundy's.
The Roundy's deal values the chain at about 0.2 times its sales, below the industry median. In that respect, the purchase is a bargain, but one could argue you should get a bargain on a company with challenges.
Kroger's willingness to take on Roundy's with all its warts shows just how aggressive it's willing to be in its quest to compete with Wal-Mart.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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