New Giant On The Block

Metro buys A&P Canada.

It's often said that when you go grocery shopping, what you buy — and how much you spend — depend on how hungry you are. The same could be said for Quebec-based grocer Metro Inc. ( TSX:MRU.SV.A), which announced Tuesday a $1.78-billion deal to buy A&P Canada, the second-largest food retailer in Ontario. A deal for A&P Canada's 236 stores has been expected since May, when management at the U.S. parent company ( NYSE:GAP) announced they were looking for strategic alternatives for their Canadian assets. When it closes as expected in August, the acquisition will increase Metro's network of stores to 579, and push annual sales from $6.1 billion to about $10.5 billion.

While even Metro president and CEO Pierre Lessard admitted in a conference call to analysts that “the price may seem a little high,” he also acknowledged buying A&P was a deal that Metro had to make happen. “We looked at it as a very valuable asset,” said 63-year-old Lessard. “It was a unique opportunity we could not let go. We had to grow our scale.” And with rival grocer Sobeys Inc. ( TSX:SBY), the country's second largest after Loblaw Cos. Ltd. ( TSX:L), considered by many retail analysts to be the most likely and most logical candidate from a synergies point of view to acquire A&P Canada, Metro knew it had to make a compelling offer now, or forever lose the chance to push outside Quebec, where it now gets about 90% of its revenue. (Metro already has a small operation in Ontario, under the Loeb banner, mainly in the Ottawa region.)

The acquisition, expected to close in August, gives the grocer a 24% market share in Canada's largest province. Metro expects synergies of $60 million, achievable over a 24-month period, primarily from procurement, store operations and distribution. A&P Canada operates the A&P, Dominion, Food Basics, The Barn and Ultra Food & Drug Banners, while Metro operates Metro, Metro Plus, Super C and Brunet stores in Quebec and the Loeb banner in Ontario.

Under the deal, A&P Canada's parent, Montvale, N.J.-based The Great Atlantic & Pacific Tea Co., will get $1.2 billion in cash and $500 million in Metro shares, giving it a 16% stake in the Quebec grocer; Metro will also assume $83 million in A&P Canada debt. The deal is valued at about 10.7 times A&P's earnings before interest, taxes, depreciation and amortization, adjusted to include a two-year agreement, worth $20 million annually, for Great Atlantic to provide IT services to Metro. Including the synergies Metro expects to realize, the deal is worth 7.9 times A&P Canada's EBITDA.

The opportunity for Great Atlantic to still keep a hand in the Canadian grocery market through an equity stake, while selling an asset in order to raise cash to improve its troubled core operations in the U.S., likely gave Metro a leg up on competing bids. “This is really the best outcome for A&P,” Great Atlantic CEO Christian Haub said on the analyst conference call. “It fullfills our short-term needs but also provides the most long-term value.”

Metro shares soared on the acquisition news, rising by $3.75 to $31.25 on the TSX by the end of trading Tuesday. But shares of Sobeys, based in Stellarton, N.S., were punished by investors as the company failed to execute a deal that would have given it a bigger presence in the important Toronto-area market, boosted its Ontario market share and offered synergies in areas such as distribution with its current operations. Said CIBC World Markets analyst Perry Caicco in a research report: “Althought the price was higher than we had projected, Sobeys has let a tremendous strategic asset, with plenty of synergies, pass.” He downgraded Sobeys shares to “sector underperformer,” with a target price of $38, from “sector overperformer” and a target of $50. Sobeys shares dropped Tuesday by $3.03 to $38.10.

Merrill Lynch analyst Patricia Baker said in a note “the news is not good for Sobeys,” adding that the A&P assets were “a jewel in Ontario, with many downtown Toronto locations we believe were coveted by Sobeys.” The missed opportunity, she added, means that “instead of a strong #2 position, Sobeys will now remain the third player in the key Ontario marktplace.” Nationally, she says, Sobeys remains the second-largest grocer, “though barely now, and still a distant second to Loblaw Cos Ltd.”

Sobeys shares had risen since May on speculation that it would do whatever it took to acquire A&P Canada. But in the end, Metro turned out to be the more hungry shopper.