TFM had apparently been looking to sell itself, and The Kroger Co (KR) appeared to be the most likely acquirer, until Apollo stepped in.
The deal doesn’t stop Kroger, or anyone else, from bidding more. However, the price seems to be pretty generous, and shareholders should be pleased. The entire organics market has been under pressure for the past year or so, as competition has been increasing and same store sales have been declining.
The TFM Stock Deal by the Numbers
TFM’s trailing-12-month net income was $62.8 million. Thus, the deal came in at about 22x earnings. That seems mighty generous considering the five-year annualized earnings estimates were only 7.6%, and earnings were expected to be flat the next two years.
Yet the deal is particularly generous on a cash flow basis. The Fresh Market had $150 million in operational cash flow, and only $44 million in free cash flow. So the deal comes in at about 9x operational cash flow and 31x free cash flow.
These are very high multiples for a business that isn’t really doing all that well. This leads me to suspect this is just the beginning of a larger deal, which I’ll come back to in a moment.
WFM is an $11 billion company with $526 million in TTM net income, or about 20x earnings. Thus, on a net income basis, Apollo paid the same multiple for TFM as its mega-rival is worth. That seems odd.
It also suggests that WFM is fully valued, since clearly TFM is not of the same caliber.
WFM generated $974 million in operational cash flow, and $648 million in free cash flow. A 9x operational cash flow multiple puts WFM’s valuation at only $8.77 billion, while a 30x free cash flow multiple puts its valuation at $9.7 billion. Thus, WFM might even be overvalued on that basis.
Sprouts trades at $4.3 billion valuation, or 33x net income of $129 million, so that’s off-the-charts overvalued by comparison.
So why would Apollo pay a Whole Foods valuation for The Fresh Market? Whole Foods has 435 stores to Fresh Market’s 177. USA Today reports that George Golleher, the former CEO of Smart & Final Stores Inc (SFS) and Ralph’s Grocery Company is apparently an investor in the deal.
I think this is just the beginning of consolidation in this space. Savvy private equity and an experienced grocer do not overpay for an organics operation that is in decline. Private equity buys out companies that have robust cash flow. Private equity buys operations where it can improve cash flow even more, then spin them out later as an exit.
By leaping in front of Kroger, I would next expect Apollo to make a run at Sprouts, albeit for no premium. Then, either they run at Whole Foods and make a massive organics chain or they sell the Fresh Market-Sprouts combination to Kroger.
As of this writing, Lawrence Meyers had no position in any of the stocks mentioned.
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