In the not too distant past, when food retailers wanted to grow in size and scale, they either built new stores or acquired local or regional competitors. And when companies wanted to innovate, they innovated. Things are a little different now.
While scale may be more important than ever today, the types of acquisitions and the reasons for making them are rapidly expanding, while the old model of replication through acquired and newly built units doesn’t necessarily hold the promise it once did. The shopping habits and expectations of consumers have so drastically changed in recent years that retailers are securing new and surprising partnerships, investments and acquisitions that might have seemed unimaginable only a few years ago.
Consider a handful of the investments food retailers have forged in the last two years: Hy-Vee got together with chain of burger restaurants. Walmart shelled out $3 billion for an online retailer, then went to work acquiring a string of digitally native brands to sell on it. Consumer goods companies are investing in brands with virtually no chance of moving the needle on sales, but instead are providing a glimpse into the kinds of foods absorbing at least some of the volume that used to belong to them. Disparate retail partnerships like Aldi and Kohl’s, Kroger and Boxed, and Albertsons and Rite Aid have been tendered, pursued, consummated or the subject of rampant speculation. H-E-B, Target and Walmart have all bought delivery companies in the last few months. Even delivery companies themselves are reaching for new capabilities and additional firepower: Instacart earlier this year acquired Unata, a leading provider of digital shopping technologies for grocers.
Deals such as these between retailers, manufacturers and solutions providers acquiring innovation or new capabilities aren’t necessarily coming instead of those that provide scale and reduce costs, but in addition to them. Retailers with an eye on the consumer are rapidly evolving into vertical “mashups” that in some ways are beginning to resemble Amazon—which itself isn’t just an innovative retailer, but a media, technology and manufacturing company that also isn’t averse to buying that which it cannot develop on its own. Its acquisition of Whole Foods Market last year is perhaps the best example of the new model for creative hybridization taking hold of the retail industry.
Favorable Conditions, Desperate Times
To be sure, consolidation is a long-term trend, with plenty of examples through the years of companies using it to do more than just add geographic reach and scale. The Kroger Co., for example, for years has maintained that it looked at mergers as a means to simultaneously acquire new capabilities. But M&A is also a confidence business supported by favorable conditions, and at the moment, a strong economy and low cost of capital has quickened the pace of deals.
Food-related companies made more acquisitions in 2017 than any year on record since 1999, according to The Food Institute. Of the 591 deals tracked by the organization in 2017, one-third involved food processors, and 11% involved food retailers, highlighted by the Amazon-Whole Foods hookup.
“The math of doing M&A is still very favorable,” said Karen Martin, managing director of BMO Capital, in a recent Food Institute webcast. “When c-suites and boards feel confident, there’s often more M&A activity. In the c-suite mindset, they’ve seen a 50% appreciation in their trading multiples in the last few years, and they’ve seen their cost of capital cut in half over the last 10 years. They have new money from private equity getting more creative, and there is an abundance of capital looking for investment.”
Still, the ultimate driver of deals is the changing consumer, who is pursuing new and more convenient ways to shop. Many are rejecting legacy brands and shopping constructs, while increasingly larger numbers of consumers are eating healthier and demanding more of brands. Consumers have also come to expect the kind of seamless conveniences online shopping offers in all of their commerce interactions.
“It’s always the consumer,” says Bryan Gildenberg, chief knowledge officer of Kantar Retail. “Amazon wouldn’t be driving change if the consumer didn’t like it. [Amazon CEO] Jeff Bezos is a smart guy, and Amazon is a wonderful platform, but he’s the first person who’d tell you that if Amazon didn’t solve a problem for consumers, then Amazon wouldn’t be doing it.”
What companies like Amazon have done, Gildenberg says, is enable shoppers to meet many of their demands; and, in doing so, it has widened the competitive set vs. legacy brands and retailers.
“The one practical thing that technology does is allows an experience to proceed at a speed that was never possible before,” he says. “So now, if I’m a retailer, I’m not just competing with another retailer—I’m competing with every online experience one could have in terms of speed to satisfaction, and that’s hard. Consumers have always wanted things that are meaningful; they just didn’t have the time to get that. They’d have to make a special trip to a store or a farmers market … that carries the one thing you like. Now, you can find those things when you want to. The ability for consumers to opt into the things they care about is one of the great things technology enables.”
Scale Matters More Than Ever
Amazon’s ability to invent and invest in the future of shopping is supported by superior economic firepower, drawing billions in response from legacy competitors and increasing the pressure on them to seek deals and add scale.
“Amazon is building an ecosystem that is radically changing retail,” says Scott Moses, managing director and head of food retail and restaurant investment banking for advisor PJ Solomon. Amazon’s low cost of capital and high valuation provides it with “a near limitless ability to invest in transformational competition for grocers,” he says.
“Amazon’s market capitalization is over $700 billion,” Moses says. “It has grown nearly $400 billion since January of 2017. That’s more than CVS, Walgreens, Kroger and Costco are worth today—combined. It’s also more than Walmart is worth.”
Scale is the single largest determinant of a retailer’s credit rating—and by extension, its cost of borrowing—giving larger players the ability to out-invest their smaller counterparts. That’s why when unconfirmed speculation over a potential Kroger-Target merger recently circulated, analysts for the most part came out in strong support. Many of them also saw Albertsons’ acquisition of Rite Aid primarily as a scale play, although it also brought potential advantages of playing in the healthcare field and a means to address debts and new capital by accessing the public markets.
Cross-format partnerships designed for scale provide some indication that mergers between like formats—Albertsons-Safeway and Ahold-Delhaize, to name two scale deals that combined supermarkets primarily—are nearing maturity.
“In terms of the big players combining operations in the traditional model, we’re in about the seventh inning,” says Keith Anderson, SVP of strategy and insights for Profitero. “There will be a few more, but I think we’ll see relatively fewer in the next decade.”
In the meantime, traditional retailers remain under pressure to continue investing in their businesses—but their priorities have changed, says Andrew Wolf, an analyst following food retail companies for Loop Capital. Leaders such as Walmart and Kroger are now devoting capital that once went to new stores toward investments in service and digital capabilities.
“Walmart barely builds new stores anymore,” Wolf says. “Walmart Neighborhood Markets were once the savior of the store network. Now it’s like, ‘Who needs ’em?’”
The perception that physical locations are under siege from the growth of e-commerce has also soured investors on deals to acquire physical spaces, which is also helping to send investment into new areas.
“All things being equal, one large retailer buying another to add square footage is a tough sell to investors because there’s a real and perceived sense that square footage is less productive than it used to be,” says Gildenberg. “The one thing that most investors don’t want their capital chasing are assets that aren’t performing as well as they used to, and for most stores, that’s true.”
According to Wolf, retailers are on the sidelines building and buying stores because they’re not clear yet as to how big a bite the move toward e-commerce and delivery will take from brick-and-mortar. Some analysts believe it will eventually lead to hundreds of store closures.
“A store shakeout is upon us,” Wolf says. “And until retailers get a better idea of how much of the business is going to online through home delivery, they have to hold and see how it plays out. So when they talk about investing in service, that’s home delivery and click-and-collect.”
New models for business combinations can also been seen among manufacturers. In the same way the changing shopper has put stores in danger, the legacy packaged goods brands inside them are also under siege. Scale and efficiency matter in those businesses, too, which is transforming under the influence of private investors such as 3G Capital. The investor has put together combinations such as Kraft and Heinz, and has embarked on a massive effort to take costs from them, sparking others to do the same.
With fewer internal resources and legacy brands facing slower sales, “M&A has become the new R&D,” says Martin of BMO Capital. “What [CPG] entities are facing now is a lack of internal innovation. They’re facing a consumer market that is moving toward more authenticity, cleaner ingredient stacks and authentic brands with stories,” which in turn are “really changing the landscape.”
It’s also forcing companies to invest in new brands that resonate with young consumers. These deals don’t necessarily provide a sales lift as much as they widen potential access to consumers. Concurrently, retailers and brands are also investing in new concepts earlier than they traditionally have.
Walmart’s Store No. 8, for example, is an R&D lab for emerging technologies affecting retail with an eye on applications years in the future. Companies such as Campbell’s Soup, Unilever, 7-Eleven and General Mills have all established their own venture funds to help develop brands that may one day capture loyalty. Speaking at the recent Shoptalk conference in Las Vegas, Lauren Jupiter of the venture fund AccelFoods said retailers were coming to the early-stage food investor seeking innovation in areas such as breakfast foods.
“You’ve got two types of investments going on,” says Gildenberg. “You’ve got deals where you’re trying to get bigger and scale up, and you’ve got companies buying natural, organic and entrepreneurial brands to find growth. There are those looking to scale with a financial model that it can make work, like 3G Capital, which is taking costs out of the system; or Albertson-Cerberus, which likes to own things they can generate cash from. Then you have companies like Walmart buying Jet and Bonobos. These things don’t bring scale, but instead ‘access’ to different kinds of customers and a way to serve those customers who want something different than their parents had.”
Anderson believes “these are deals about future growth—somebody buying a meal kit company, or something that is subscale and not going to impact the top-line today, but gives you the potential to grow in 10 years. Often, that’s not purely about what the company being acquired offers today. Sometimes it’s about a team, or an underlying capability or technology.”
When Walmart bought Jet.com, for example, it got more than a promising e-commerce brand. It also got the new CEO of its global e-commerce division in Jet.com founder Marc Lore; technology that rendered Walmart’s EDLP strategy in a virtual form; and a platform for which future acquisitions such as Bonobos, ModCloth and Moosejaw could serve as content.
“Jet was growing quickly off a small base relative to Walmart’s scale, but they had some interesting technology,” Anderson says. “At the end of the day, they were buying Jet’s vision and talent.”
Finally, Anderson points out, retailers have opportunities to cash in on technologies and capabilities focused on a specific part of the shopping experience that may be exiting the venture stage, but is still unable to stand on its own. H-E-B’s acquisition of the popular delivery app Favor and Target’s acquisition of Shipt could fit this model, he says.
New Partnerships in the Next Frontier
Food retailers today aren’t just seeing innovation in acquisitions, but also in partnerships, which are taking creative new forms inspired by shifting consumer trends and their effect on legacy constructs.
Department store retailer Kohl’s, for example, recently said it would lease space in at least 10 of its stores to hard-discount food retailer Aldi. This melding of somewhat strange bedfellows has potential to address any number of issues facing retailers today. For Kohl’s, the share of its merchandise drifting to online shopping channels in recent years has left it with stores that are probably too big. At the same time, Kohl’s is also looking to grocery as a means to draw more frequent store traffic.
Aldi, whose low-price and private brand-heavy model is clearly resonating with consumers today, needs to support Kohl’s beyond efficiency; and Kohl’s may bring Aldi locations and visibility its cost model wouldn’t otherwise support.
Industry observers will be watching this partnership closely to see the extent to which similar collaborations could proliferate in physical retail in the years to come.
Companies are also dipping their toes into concepts that are adjacent to or could augment their current capabilities. Companies such as Kroger and Wakefern Food Corp. are quietly developing hard-discount fights in Ruler Foods and PriceRite, for example. Kroger also took an equity investment in the millennial-friendly fresh chain Lucky’s Market. While results of these concepts are unclear, both are growing, typically in areas where Kroger doesn’t have a strong traditional supermarket presence.
Further along the continuum is a recent uptick in food retailers moving to adjacent businesses such as foodservice and restaurants. Some are looking beyond the store, such as Hy-Vee’s goal, which it revealed last summer, to become the country’s largest franchisor of the Wahlburgers casual restaurant chain. At the same time, it announced a partnership with the Orange Theory fitness chain.
“These unprecedented collaborations reinforce our company’s longstanding commitment to health and wellness, culinary expertise and customer experience,” said Hy-Vee Chairman, CEO and President Randy Edeker when the partnerships were announced. “However, they also represent a bold step to deliberately evolve our business to meet the change in our customers’ lifestyles and spending habits. These partnerships keep us on the leading edge as the retail grocery industry evolves.”
Hy-Vee’s Wahlburgers investment news acknowledged recent government data noting that the balance of dollars spent on food at home vs. food away from home had tilted toward the latter. Interestingly, the Wahlburgers news was followed shortly by the West Des Moines, Iowa-based chain’s announcement to downsize some of the full-service restaurants in its stores, indicating that one of the country’s pioneers in combining restaurant and food retail was getting a more nuanced look into how to position a restaurant extension.
Sources anticipate it’s only a matter of time before additional kinds of restaurant-retail hybrids evolve, either in the lab or on the acquisition market. Could a supermarket company acquire a company such as Panera Bread, or vice versa? It’s not out of the question.
PJ Solomon recently added a new advisory specialist in the restaurant space, says Moses, who has advised dozens of food retailers over the years, including recent deals on the sale of growth equity in El Rancho and Lucky’s Market to Albertsons and Kroger, respectively; Marsh Supermarkets’ bankruptcy liquidation sales; Mi Pueblo’s sales to private-equity investors; and Kroger’s acquisition of Roundy’s Supermarkets.
“Sophisticated observers of the grocery sector know that it’s not only about supermarkets, supercenters, club stores, drug stores and discounters, but also about competing with restaurants for share of stomach,” he says.
Illustration by Doug Chayka