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| Customers shop at the Safeway at Market and Church streets in S.F. Experts say Safeway's private label business and technology expertise are strong, as is its management. Photo: Mike Kepka, The Chronicle
As a general rule in business, companies that attract the pockets of large private equity firms, especially ones named after a mythical three-headed hellhound, are in deep trouble.
Safeway Inc.'s decision to sell itself to Cerberus Capital Management for $9.4 billion is no exception. The pending deal means the Pleasanton company, the second-largest supermarket chain in the country, concluded that it can no longer create value for shareholders as a publicly traded business. Therefore Safeway's best option, the thinking goes, is to embrace Cerberus' super-smart turnaround experts to pull off a nearly impossible magic trick: make the supermarket business lucrative again.
The deal "will improve our competitive position," Safeway Chief Executive Officer Robert Edwards told investors on a conference call. "Our customers will benefit from significant cost-saving synergies and a stronger management team."
Private equity's primary goal - perhaps its only goal - is to make money for its investors within five years or so, not necessarily to ensure the survival of Safeway.
Of course, Cerberus would prefer to generate profits the old-fashioned way: running the business well. The firm is already heavily invested in supermarkets, having recently spent $100 million along with other investors to buy 877 stores from Supervalu Inc., including a boatload of Albertsons locations. Cerberus plans to use the combined heft of Albertsons and Safeway to create savings and enough firepower to take on Walmart and Amazon.
Worth noting: Supervalu also tried to get better by getting bigger. The retailer borrowed a lot of money to buy Albertsons, the same stores it eventually sold to Cerberus on the cheap.
Plenty of value
If Cerberus fails to revitalize Safeway, it still needs to give its investors some sort of return. As it so happens, Safeway does have plenty of valuable assets that could fetch an attractive price even if everything goes to Hades.
The company operates around 1,300 stores, mostly on the West Coast. Safeway owns about 48 percent of those locations and leases the rest, according to its annual filings. In addition, the company boasts 20 top-notch manufacturing plants and 13 distribution centers and warehouses.
"The land provides some value protection" in case the business deteriorates, said Ezra Perlman, a partner at Francisco Partners, a private equity firm in San Francisco. "There are certain things they can do to the assets that can boost value."
In other words: Sell! Sell! Sell!
"From San Jose and San Francisco to Seattle, that land is becoming more and more valuable every quarter," said Burt Flickinger, the managing director of Strategic Resources consulting group in New York. "Safeway is sitting on a heap of the best of the best real estate."
It's hard to see what exactly Cerberus brings to the table other than heaps of debt.
Remember, Cerberus is not spending $9 billion of its own money. Instead, the firm will borrow most of the money from banks and use Safeway's cash to pay the loan interest, and pledge Safeway's assets as collateral.
Right now, debt is so inexpensive and plentiful that Cerberus can still earn fantastic returns no matter how well Safeway performs, Perlman said.
"It's all about financial engineering," Perlman said. "You can borrow so much money on cheap and flexible terms. They are getting a good price."
Good track record
Interestingly enough, Safeway is already one of the nation's better performing supermarket chains. The company enjoys stable sales and healthy gross margins. That's not a small feat given intense competition from Walmart and even Target, which has considerably boosted its food offerings in recent years. Safeway's private label business and technology expertise are the best in the industry, Flickinger said.
As for Cerberus' brain power, Safeway's leaders are already more than capable, he said. "Safeway developed top management teams in every key area," Flickinger said.
Before the Cerberus deal, Safeway stock was up 65 percent over the past 52 weeks; it dropped 2.2 percent since the news broke.
Perhaps the only thing Safeway lacked was confidence it could keep appeasing shareholders on its own.
Safeway Inc.
Founded: 1915
Headquarters: Pleasanton
CEO: Robert Edwards
Employees: 138,000 (full time and part time)
Number of stores: 1,335
2013 sales: $36 billion
2013 profits: $3.5 billion
Thomas Lee is a business editor and columnist at The San Francisco Chronicle. E-mail:tlee@sfchronicle.com Twitter: @ByTomLee
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