Harris Teeter Seen Worthy of Best Price Tag: Real M&A

Harris Teeter Supermarkets Inc., the U.S. grocery-store chain that’s boosted sales every year for a decade, is poised to secure the industry’s highest takeover valuation since 2007.

The $2.1 billion company said this month it hired JPMorgan Chase & Co. to advise on talks with suitors after two private-equity firms expressed interest in acquiring the Matthews, North Carolina-based chain. Royal Ahold NV, the Dutch owner of Stop & Shop and Peapod in the U.S. Northeast, also is interested, people with knowledge of the matter said last week.

Harris Teeter should fetch more than recent supermarket deals because it’s well-run, with a growing store base and higher margins than rivals, according to Diamond Hill Capital Management Inc. Northcoast Research Holdings LLC and Bank of Montreal both estimate bids could come in at about $55 a share, 29 percent more than yesterday’s stock close. A takeover for that price would value Harris Teeter at 9.3 times earnings before interest, taxes, depreciation and amortization, the steepest multiple among U.S. food retailer deals since Pathmark Stores Inc. was acquired in 2007, the data show.

“It is expensive relative to your regular supermarkets, but this isn’t your regular supermarket,” Louis Meyer, a special situations analyst at Oscar Gruss & Son Inc. in New York, said in a telephone interview. “It’s a pretty good business and a good brand name. It’s not a situation where, absent a deal, everything falls apart.”

Attracting Suitors

Catherine Becker, a spokeswoman for Harris Teeter, declined to comment beyond the grocery chain’s Feb. 13 statement, when it said it hired JPMorgan to assist in holding talks with suitors after being approached by two buyout firms. The company didn’t mention possible bid prices or provide further information.

An offer of $55 a share would imply a deal value of $2.8 billion, including Harris Teeter’s net debt. At 9.3 times its trailing 12-month Ebitda, the price tag would represent the highest multiple for a U.S. food retailer deal larger than $100 million since December 2007, data compiled by Bloomberg show. That’s when Great Atlantic & Pacific Tea Co. paid 9.9 times Ebitda for Pathmark. Earlier that same year, Whole Foods Market Inc. bought Wild Oats Markets Inc. for the industry’s steepest valuation at 15 times Ebitda, the data show.

“We haven’t seen those kinds of valuations in a while,” Chuck Cerankosky, a Cleveland, Ohio-based analyst for Northcoast Research, said in a phone interview. “With Harris Teeter, you have a very strong regional chain with an exceptional management team, a growing store base and a differentiated format. That immediately puts discussions back into the historic Ebitda levels.”

Financial Strength

The industry’s only two post-recession deals involving public companies were Supervalu Inc.’s sale of five chains to a Cerberus Capital Management LP-led investor group announced last month and Bi-Lo LLC’s takeover of Winn-Dixie Stores Inc. about a year ago. Those transactions were struck at an average of 2.2 times Ebitda, the data show.

A sale of Harris Teeter wouldn’t come from a position of weakness, Oscar Gruss’s Meyer said. Harris Teeter’s annual revenue has risen in 24 of the last 25 years, the data show. While profit slid in the last two years, analysts project the chain will report a record $119 million of net income for fiscal 2013, which ends in September, data compiled by Bloomberg show.

Lagging Shares

Harris Teeter earned 3.6 cents in operating profit on each dollar of sales in the last 12 months, exceeding rivals Safeway Inc., Supervalu and Kroger Co., the data show. Still, Harris Teeter climbed just 2 percent in the past year, trailing the 13 percent gain that consumer staples stocks in the Standard & Poor’s MidCap 400 Index had over that span.

The shares, which ended yesterday at $42.76, were valued at 19 times this year’s estimated earnings, the same as the average ratio for U.S. food retailers larger than $500 million, according to the data.

“The stock is kind of trading in line with conventional supermarkets, and arguably it shouldn’t because it is a very well-run company,” Karen Short, a New York-based analyst at BMO, said in a phone interview. “The two private-equity firms seem to believe Harris Teeter’s undervalued, otherwise it wouldn’t have been approached.”

Today, the shares climbed 0.6 percent to $43.

Because Harris Teeter is already well-managed and buyout firms tend to prefer weaker targets that have room for improvement, the company may be better suited for a buyer in the supermarket industry, Short said.

Recession Recovery

“It’s been a challenging economy for food retailers,” Northcoast Research’s Cerankosky said. “Not all of them have come out of the recession in great shape, and Harris Teeter is one of those that has been able to do it. A strategic buyer would benefit a great deal from Harris Teeter.”

Amsterdam-based Ahold has contacted JPMorgan and is seeking more information on the sale process, a person with knowledge of the matter, who asked not to be identified because the negotiations are private, told Bloomberg News last week.

Harris Teeter’s 211 stores, predominantly in North Carolina, Virginia and South Carolina, would help Ahold expand in mid-Atlantic and Southeast states where population growth trends are more favorable than in the Northeast, BMO’s Short said. Ahold owns the Stop & Shop and Giant chains, with stores stretching from New Hampshire to Virginia, and already generates more than half of its revenue and operating profit in the U.S.

“Ahold is my conclusion on the most likely buyer,” Short said. “In general, they’ve had an acquisitive history.”

Big Buyer

Ahold has made at least 66 purchases in the last 20 years, including its $2.9 billion takeover of Stop & Shop Cos. in 1996 and $2.8 billion acquisition of Giant Food Inc. two years later, data compiled by Bloomberg show.

Ahold Chief Executive Officer Dick Boer said in an interview today that the company would consider acquisitions as a way to fuel growth as it weighs how to utilize cash raised from its $3.1 billion disposal of a stake in Swedish retailer ICA. When asked about Ahold’s interest in Harris Teeter, Tracy Pawelski, a spokeswoman, said the company doesn’t comment on speculation.

Publix, Kroger

Publix Super Markets Inc. and Kroger, the largest U.S. grocery-store chain, also are possible suitors for Harris Teeter, though less likely to pull the trigger, according to Short and Oscar Gruss’s Meyer. Publix hasn’t been an active acquirer and Kroger might not want to add to its already long list of store banners, Meyer said. According to Kroger’s website, it operates almost two dozen grocery-store chains, six convenience-store banners and a handful of jewelry-store names.

Maria Brous, a spokeswoman for Lakeland, Florida-based Publix, and Keith Dailey, a spokesman for Cincinnati-based Kroger, said the companies don’t comment on speculation.

There’s no guarantee that any discussions will result in a transaction, especially if the parties can’t agree on a price. Should a private-equity buyer make an offer that’s conditional on financing, that may make it difficult to close the deal, Northcoast Research’s Cerankosky said.

Still, Kapish Bhutani, a Columbus, Ohio-based analyst for Diamond Hill Capital, said he’s confident Harris Teeter will do right by its shareholders and that the company demonstrated that by entertaining the private-equity firms’ interest. Diamond Hill Capital oversees $10 billion, including Harris Teeter shares.

“This is a pretty solid business,” Bhutani said. “The stock is undervalued even without the possibility of a takeover, so with that possibility it becomes even more interesting. We think they will make a good decision.”

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