In one of the biggest deals in the history of the US grocery industry, Kroger last week said that it plans to buy rival Albertsons for $24.6 billion.
The deal will allow Kroger to better compete with Walmart, which is the biggest player in the industry, owning some 22% of the US grocery market. Commanding greater market share will allow Kroger to better negotiate better rates with suppliers and invest more in technology to reduce costs. If combined, Kroger and Albertsons would make up 13% of the US grocery sales and reach some 85 million households across the US.
Kroger said it would buy Albertsons for $34.10 a share in cash, which is above Albertsons’s stock price of $27.20 as of this writing, suggesting that investors do not think a deal between two big supermarkets will pass regulatory scrutiny.
It’s tough to make money in a low-margin business, particularly as the industry has gotten more competitive with new players, from Uber to Target, offering food or selling more of it. “That drives people to eventually say I need to get bigger,” said Ken Fenyo, the president of research at Coresight Research and a former executive at Kroger.
But the merger also comes during a time when the public spotlight is on soaring inflation and federal regulators are scrutinizing big mergers, marking an unusual moment for the grocery industry.
The $24.6 billion deal comes during a time of regulatory scrutiny
Under the Biden administration, the Federal Trade Commission has more than doubled its letters of investigation over mergers or similar transactions in 2021 versus the year before, which has surfaced in the food delivery industry.
The merger is facing backlash across the political spectrum, including Utah Republican senator Mike Lee and senators Elizabeth Warren and Bernie Sanders, a Democrat and and an Independent, who say that the combined power of two major grocers will lead to higher prices for customers.
Kroger and Albertsons, which operate stores in overlapping regions, said they will sell up to 375 stores to receive clearance from regulators. The deal is expected to close in early 2024, pending regulatory approval.
Private equity is looking to unload
As part of the deal, Albertsons will pay a cash dividend of up to $4 billion to its shareholders. The biggest shareholder of Albertsons is Cerberus Capital, which has owned a controlling stake in Albertson’s since 2006. Albertsons held on unusually long rather than selling to “ultimately seek out an attractive offer from one of the few larger grocers that still remain,” wrote Tim Clarke, a senior PE analyst at PitchBook, in an email. In other words, Cerberus is looking to squeeze more profits for shareholders from a low-margin business.
Kroger wants to keep up with online grocers like Walmart, Amazon
Both Walmart and Amazon are part of a very competitive environment, particularly around e-commerce. “You could go back probably five years ago pre-pandemic when you could probably ignore e-commerce or at least do a deal with Instacart,” said Fenyo. “But the game has really changed.”
During the pandemic, many supermarkets added pick-up and delivery infrastructure to meet the demand for online shopping. But those costs add up. “E-commerce has put a lot of pressure on the profitability and operating costs of the retailer,” he said. One way for these firms to reduce costs is to merge, which will give them scale to be more efficient.
Amazon’s share in the grocery business, including Whole Foods, is in the low single digits, but the company has been expanding its checkout-less technology, including cashier-less stores and using a palm print to pay for groceries. “Right now everyone’s focused on what’s Amazon doing, what’s Walmart doing and how do I position myself to be competitive, you know, the next three, five, or even 10 years,” Fenyo said.
With the takeover of Albertsons, Kroger will have more data on customers, which will help create more personalized shopping experiences. “I think that really puts a lot of pressure on retailers in grocery, frankly, in any industry to make this a specialty,” he said. “And it’s really something a lot of retailers haven’t invested in, don’t really necessarily have the capabilities they’re going to need to compete in what’s really going to be increasingly a data-driven business.”
The merger will address rising inflation
The Russia-Ukraine war and the pandemic have led to skyrocketing food prices, which affects grocers as well as shoppers. Scaling allows Kroger to better negotiate supply chain relationships and to invest in technology to run a more efficient operation.
“The whole industry is squeezed now because the prices they pay suppliers rise. And the question is to what extent they can roll it over to customers,” said Yakov Amihud, a professor at NYU Stern. “And, of course, the weakened ability to really deliver to customers, their margins are squeezed. The result is that their profitability can decline.”
To cut costs Walmart is looking to own more of the supply chain. In August it invested in a beef supplier, which allows it to have more control over pricing.
Whether the merger will raise grocery prices or lower them is up for debate. On a conference call with analysts and investors this week, Kroger said they plan to invest $500 million in reducing prices. But regulators and consumer advocates say with more market power comes more control over pricing and that companies can simply redirect any increase in profits to shareholders, rather than bringing down monthly grocery bills for shoppers.