Deals

Gillian Tan is a Bloomberg Gadfly columnist covering deals and private equity. She previously was a reporter for the Wall Street Journal. She is a qualified chartered accountant.

Sprouts Farmers Market Inc. may soon be a closely held company. Again.

The organic grocer is in preliminary talks to merge with Albertsons Cos., according to Bloomberg News, in a deal that would value the company at north of $3 billion. The timing is no coincidence: Just this month, Sprouts dipped below its July 2013 IPO price of $18 a share for the first time. (And prior to last week when deal speculation emerged, the stock had tumbled 40 percent over the previous 12 months, in part due to margin pressures from food-price deflation). 

Pricing Pressure
A deal for Sprouts could be coming at a time when the company (and broader industry) faces deflationary pressures
Source: Bloomberg

Still, it's easy to see why Sprouts is coveted. Although its same-store sales have been trending down, it still outpaces rivals: 

Still Growing
Sprouts beats many competitors when it comes to same-store sales
Source: Bloomberg Intelligence

Same goes for growth in overall sales: Sprouts's 6 percent gains in its latest quarter outshone the industry median 2.9 percent. 

Double Trouble
Even after declining, Sprouts's sales growth is roughly double the industry median
Source: Bloomberg Intelligence

And its profitability margins exceed those of most publicly traded rivals (meanwhile, Albertsons's Ebit margin for the first three quarters of fiscal 2016 was just 1 percent, paling in comparison to Sprouts's at 5.3 percent):

Profiteering
Despite facing the same challenging environment, Sprouts beats most rivals on a suite of profitability measures
Source: Bloomberg Intelligence

Cost savings from a merger between Phoenix-based Sprouts and Boise, Idaho-based Albertsons would be significant. Barclays Plc analysts reckon a merger could boost earnings before interest, taxes, depreciation and amortization by as much as $150 million, driven by stronger bargaining power in renegotiating supply agreements and an elimination of some operating costs. 

Assuming those synergies in their entirety, Sprouts's projected 2017 Ebitda could reach $450 million, meaning it could seek a valuation of roughly 10 times that -- or $30 a share. While that's roughly double the multiple Albertsons paid for Safeway Inc. in 2015, it's not out of the question. Admittedly, that deal was back in 2007 -- and that same year, Whole Foods Market Inc. paid around 11.2 times Wild Oats Markets Inc.'s forward Ebitda in its deal for the natural grocer (arguably a better comparison). 

Sprouts no longer carries a heavy debt load -- which likely hasn't gone unnoticed by Albertsons -- and an acquisition should enable it to pay down its own borrowings a little easier. That in turn should make an IPO of the combined company more palatable, down the road. 

Sprouts has delivered healthy profits to private equity in the past. It was majority-owned by Apollo Global Management LLC, which made about $2 billion, or 10 times its original investment, when it sold its last slab of shares in the company a little under two years ago. 

Should Albertsons and Sprouts reach a deal, Cerberus Capital Management (which has backed the larger grocer since 2006), will be hoping those fortunes repeat. But it can't count its pennies yet -- Albertsons could easily find itself in competition with other grocers who face the same slowing growth and deflationary pressures, as well as competition from the likes of Amazon.com Inc. and Wal-Mart Stores Inc.

Kroger Co., for example, has hinted at M&A and Gadfly has previously identified Sprouts as one of its many options. Assuming similar synergies as an Albertsons deal (which is conservative) and that the company pays for a deal with a 50-50 mix of cash and stock, Kroger could pay $30 a share and still have a deal be immediately accretive to earnings, according to data compiled by Bloomberg.

To customers, Sprouts promises "healthy living for less." From a potential buyer though, it can -- and should -- demand a premium. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Gillian Tan in New York at gtan129@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net