Safeway’s Blackhawk Move Is a Head-Scratcher

by Marc Bastow | September 6, 2012 12:21 pm

Perhaps you’ve never heard of Blackhawk Network Holdings. But if you shop at Safeway (NYSE:SWY[1]) or some of the company’s other chains, you’ve run into it without even knowing it.

You know all those prepaid gift cards lining fully one side of an aisle in the store? Thank Blackhawk.

You see, Blackhawk — which was incorporated in 2006 in Pleasanton, Calif. — is a major supplier of prepaid telecom, sports and entertainment cards to North American retailers for sale to retail customers, runs the payment and gift card operations for Safeway, and is 49% owned by Safeway.

It’s also (from all indications) very profitable, with operating earnings to Safeway of around $42 million — out of $111 million total for Blackhawk — according to Cantor Fitzgerald analyst Ajay Jain.

So analysts and investors were a little surprised when Safeway announced plans Wednesday[2] to spin off a minority share of its stake in Blackhawk sometime in the first quarter of 2013. According to estimates by Janney Capital Markets’ Jonathan Feeny (as reported by Reuters), Blackhawk could command an enterprise value of around $936 million.

Investors were cheered by the news, sending Safeway up just over 4% on the day, a nice pop for a stock that has been clobbered by more than 20% on the year.

So what gives?

Safeway’s operating income of $1.1 billion in 2011 dwarfs any contributions from Blackhawk, but the company is locked into fierce competition within the supermarket industry as it undergoes slow but steady changes.

Not only does Safeway face traditional operators like Kroger (NYSE:KR[3]), SuperValu (NYSE:SVU[4]) and others, but that whole old guard is under siege itself on a number of sides: Grocery offerings from big-box stores like Target (NYSE:TGT[5]) and Wal-Mart (NYSE:WMT[6]), dollar stores like Dollar Tree (NASDAQ:DLTR[7]) and Dollar General (NYSE:DG[8]), and on the high-end/healthy side by Whole Foods (NASDAQ:WFM[9]) and Trader Joe’s.

The net result is a squeeze on Safeway — though the company managed to inch sales forward in the last quarter[10], its profits were plundered. While cash flow remains positive, the future remains uncertain as it spent just more than $1 billion last year to open new stores and refurbish older ones. Safeway’s dividend yield is a sweet 4.2% after a recent hike (and also thanks to the stock’s decline), so investors waiting for a rebound in the share price at least have that to fall back on … at least as long as it doesn’t pull a SuperValu[11].

But for the life of me, I can’t figure out what the play is on the spinoff.

The cash generated from the proceeds is … well, nice, but not anything that moves the needle too much. Safeway has been repurchasing its own stock, including 11.6 million shares in the second quarter for a cool $240.4 million (Do the math: Roughly $20 per share, which is now worth $185 million), so perhaps they are in the market to buy more.

Perhaps management believes it’s nearing the valuation peak for Blackhawk. Competitor Green Dot (NYSE:GDOT[12]) went public in 2010 at $36 per share, but the stock is now trading at just under $12. And let’s face it: Everyone is in on the prepaid card gig, including JPMorgan (NYSE:JPM[13]) and American Express (NYSE:AXP[14]), just to name a couple biggies.

If Safeway management has any options in the company, it might be tempted to get them monetized before the business is cannibalized down the road; as a privately held company, it’s difficult to determine who owns what in terms of numbers of shares in Blackhawk, but the possibility exists that this is the play.

Of course, when you consider that Safeway’s peak came more than a decade ago, and it’s been mostly downhill from there with no answers in sight … maybe the impetus is a simple, “Well, why not?” A let’s-just-put-it-out-there-and-see-what-happens management moment.

We can speculate all we want about the reasons or the timing, but one thing is a little more certain: It doesn’t fix Safeway’s core issues, so it shouldn’t be considered a reason to move into the stock.

Marc Bastow is an Assistant Editor at InvestorPlace.com. As of this writing he does not hold a position in any of the aforementioned securities.

Endnotes:
  1. SWY: http://studio-5.financialcontent.com/investplace/quote?Symbol=SWY
  2. Safeway announced plans Wednesday: http://in.reuters.com/article/2012/09/05/us-safeway-blackhawk-idINBRE8841G720120905
  3. KR: http://studio-5.financialcontent.com/investplace/quote?Symbol=KR
  4. SVU: http://studio-5.financialcontent.com/investplace/quote?Symbol=SVU
  5. TGT: http://studio-5.financialcontent.com/investplace/quote?Symbol=TGT
  6. WMT: http://studio-5.financialcontent.com/investplace/quote?Symbol=WMT
  7. DLTR: http://studio-5.financialcontent.com/investplace/quote?Symbol=DLTR
  8. DG: http://studio-5.financialcontent.com/investplace/quote?Symbol=DG
  9. WFM: http://studio-5.financialcontent.com/investplace/quote?Symbol=WFM
  10. inch sales forward in the last quarter: http://investorplace.com/2012/07/safeway-q2-proft-down-shares-fall/
  11. pull a SuperValu: http://investorplace.com/2012/07/supervalu-a-supermarket-special-victim-svu/
  12. GDOT: http://studio-5.financialcontent.com/investplace/quote?Symbol=GDOT
  13. JPM: http://studio-5.financialcontent.com/investplace/quote?Symbol=JPM
  14. AXP: http://studio-5.financialcontent.com/investplace/quote?Symbol=AXP

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