Whole Foods (WFM) stock climbed more than 8.5% today for no particular reason. Or, in Wall Street parlance, people think it’s a takeover target.
Such things usually go nowhere, and I have not yet heard any particular suitors attached to Whole Foods. But such a deal does, indeed, make sense. At least from a private equity perspective. Here are 7 reasons why:
1. The stock is cheap: Whole Foods currently is trading around a four-year low, despite 50% higher revenue and 40% higher EBITDA. Not to mention so much interest in its main product category that retail giants like Wal-Mart (WMT) and Target (TGT) are trying to ape it. Private equity is always looking for a bargain. (Yes, I used Whole Foods and bargain in the same paragraph without even a hint of irony).
2. Leverage light: There is nothing private equity firms like more than companies that they can load up with debt, and Whole Foods is just begging for it. It has absolutely no long-term debt, and only around $60 million of capital lease liabilities. Even if current management dislikes the idea of debt — and it does — it may like the possible alternative of activist shareholders even less.
3. Favorable comp coming: The nation’s largest supermarket chain, Albertsons, is expected to go public later this month. Were it to price in the middle of a range set earlier today, its initial market cap would be around 12.5 times EBITDA. Whole Foods is currently trading at less than 10 times EBITDA. Oh, and it’s worth noting that Albertsons is currently owned by a private equity firm.
4. Past is predicate: Whole Foods is not a stranger to private equity. In 2008, Leonard Green & Partners invested $425 million for preferred stock that equated to around a 17% ownership interest. The deal worked out well for both sides — with Whole Foods stock subsequently climbing and Leonard Green later exiting with substantial profits. In fact, the partnership was considered so positive that Whole Foods still had a pair of Leonard Green partners on its board of directors. Having a minority investor is different than having an “owner,” but at least co-CEOs John Mackey and Walter Robb should have a positive predisposition toward the asset class (and perhaps know how to navigate it a bit). And that goes both ways as private equity, despite its reputation, prefers to partner with existing management than find new C-suiters.
5. Alt assets: When purchasing retailers, private equity firms often favor those that own at least some of their own real estate. Not so much to ride rising property value, but because they can work in sale-leaseback transactions that remove a bit of the risk. Whole Foods doesn’t own the majority of its stores, but it’s got enough that could help make a prospective buyer feel a bit more comfortable.
6. Chop chop: Private equity likes to talk a lot about operational efficiency (read: cost cuts), and Whole Foods this week acknowledged some bloat by saying it would lay off 1,500 employees. Expect there are other areas of the chain’s cost structure that could be slimmed down.
7. Price point: Were a private equity firm to bid a 20% premium to today’s closing price (remember, it finished up 8.5%), that would mean around $13.5 billion. That’s at the outer limits of manageable right now for private equity, but outer limits count. By keeping with recent Federal Reserve guidance, a private equity firm could pull around $8.5 billion in debt to finance the deal, meaning it would need $5 billion in equity. But lots of big deals are being done above that limit, particularly if the business has strong cash-flow (which Whole Foods does). So a private equity buyer would likely need to come up with around $4 billion in equity, which could be done either by partnering with another private equity firm (which firms tend to avoid doing right now) or by tapping their bigger limited partners for co-investments (which firms do all the time right now). Again, tough but doable.
To be clear, none of this means Whole Foods will get a takeover offer. Or that it would come from private equity, particularly given that relatively few firms have deep sector expertise (it’s tough to imagine Cerberus wanting more grocery exposure, although Leonard Green would be an interesting minority co-investor for a larger firm).
But stocks don’t normally spike on a Friday for no reason. They spike when there are seven reasons.
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