Can Sobeys change leaders and conquer Western Canada at the same time?

An audacious idea had been stewing in Paul Sobey’s head for more than a decade. The fourth-generation keeper of the Sobeys grocery legacy wanted to buy Safeway, a rival chain, and add its 213 stores to his empire. A successful takeover would thrust his company ahead of most of the competition while solidifying its standing in Western Canada, an area of relative weakness for the company. But how could he pull off the acquisition without drawing the attention of the competition?

He’d had problems with previous deals. Word of Sobeys’ previous mega-merger—the 1998 purchase of the Oshawa Group for $1.5 billion—was leaked before it was announced. In 2005, he lost out to Quebec’s Metro Inc. in a bidding war for A&P’s Canadian supermarkets. If he was going to claim Canada Safeway, Sobey believed secrecy would be key.

Negotiations between executives at Sobeys and Safeway were to remain entirely confidential. Discussion sessions were often held in hotels in neutral locations, to shield the $5.8-billion deal from competitors. The negotiation effort was even given a code name—“London”—further adding to the secrecy.

And this time around, there was complete silence. Thus, no bidding war. Michael Van Aelst, an analyst at TD Securities, called it the “strategic coup of the year.”

“Nobody knew about this,” says a grinning Paul Sobey, longtime CEO of Empire Co. Ltd., the parent company of Sobeys. “All the articles always talked about other players doing this. They never talked about us doing this,” he adds in a mocking tone, obviously delighted at surprising his rivals. “Everybody was shocked.”

His pride is justified. A Toronto Star article from October 2012 reported that Safeway’s western Canadian stores were “a prime target for retailing behemoths like Loblaws and Metro.” There was no mention of Sobeys.

The takeover, completed in November, dramatically boosts Sobeys’ national market share from 13% to 18%, catapulting it well ahead of a pack that includes Walmart Canada (12%), Montreal’s Metro (11%) and Costco (10%). Sobeys remains in second place to Loblaw, which boasts control of 27% of the Canadian grocery market, but the Safeway purchase turns Sobeys into the market leader in Western Canada, including in the high-growth Alberta market. That’s a significant milestone for a company that had trailed its biggest competitor in every region of the country, even on its home turf in Atlantic Canada. The merger is also expected to save Sobeys $200 million annually, and boosts its buying volume by nearly 40%—granting purchasing power to a company keen to keep its prices low in an ever-more-competitive environment.

“You can’t sit on your haunches and milk a business,” Sobey says. “Otherwise, you might as well get rid of it.”

Significant challenges remain for the 106-year-old grocery giant, which remains headquartered in Stellarton, a town of 4,500 in the heart of Nova Scotia’s former coal country. Sobeys must now integrate Safeway’s web of stores into its own network, while avoiding the costly setbacks that marred the company’s earlier purchase of the Oshawa Group, which ran IGA stores across the country. In that case, IT integration issues cost the company millions of dollars—and caused a five-day system crash. Low inflation, sluggish sales and “cautious, cherry-picking” Canadian shoppers pose their own challenges, forcing the country’s grocers to pressure suppliers, drop prices and employ myriad sales. In the Canadian grocery business, said Perry Caicco, the managing director of equity research at CIBC World Markets, “your weekly business depends entirely on the strength of your latest flyer.”

At the same time, Empire has undergone a significant management change. Paul Sobey retired on Dec. 11, after 15 years as both Empire’s chief executive and the face of the current Sobey generation. The 56-year-old was replaced by Marc Poulin, who has been the president and CEO of Sobeys since June 2012. Poulin now holds the president and chief executive titles at both Sobeys and Empire, the parent company. A tricky merger can trigger a company’s decline on its own, as can a leadership change. Yet Sobey bet his family’s legacy on doing both at once.

Paul Sobey was born into one of Canada’s most successful business families; his last name is lit in large green letters above grocery store entrances across Canada. As a teenager in the 1970s, however, he didn’t want to work in the family business at all.

“I said, ‘I’m going to get my own summer job.’ So I ended up working with Atlantic Wholesalers, which was owned by Loblaws,” he says, laughing heartily.

Sobey rode alongside that company’s truck drivers, helping to unload cargo at stores in and around his hometown of Stellarton. “That lasted about three weeks. They must have found out who I was from the head office. They suggested they didn’t need me anymore,” he recalls. He later worked as a “mule” for the provincial highways department, hauling logs from the woods to make room for a new stretch of Pictou County road. Joining the family business, young Paul soon realized, might not be so bad after all.

The Sobeys grocery empire began modestly in 1907 when J. W. Sobey started delivering meat with a horse-drawn cart. J.W.’s son, Frank, was the true empire builder. An ambitious entrepreneur, Frank Sobey transformed the company into a Nova Scotia powerhouse, a blend of grocery stores, movie theatres and real estate holdings.

Frank, who died in 1985, was Paul Sobey’s grandfather. On this day, Sobey is sitting in his grandfather’s former home, a 1960s-era building that overlooks Pictou Harbour. The former residence, known as Crombie House (named for its location in Abercrombie, just outside Stellarton), is now used for functions and family gatherings. (Eighty members of the Sobey clan convened there for a party over the holidays.)

The building is also home to the family’s art collection, which includes works by Tom Thomson, the Group of Seven, Emily Carr and Alex Colville. (Free tours are offered to the public each Wednesday during the summer.) A wall of paintings by Cornelius Krieghoff hangs behind Sobey as he sits at a large dining room table, recalling a visit to Crombie House after his graduation from university. He sat with his grandfather and father, David, and mentioned that he’d like to get into the food business. “I remember Frank turned around and said, ‘What do you want to get in the food business for?’” Sobey says, using a grumpy-old-man voice to impersonate his late grandfather. “We’ve got a lot of people in the food business. Why don’t you go out and learn something new. Why don’t you take finance or do something else so you can add something to the business.”

Sobey took his grandfather’s advice and became a chartered accountant. He worked in Toronto for a spell before joining Empire full-time in 1982. In 1998 he was named president and CEO. That same year, Sobeys gobbled up the Toronto-based Oshawa Group for $1.5 billion. The acquisition tripled Sobeys’ size and made it a truly national player—taking the company further into Central and Western Canada. Today it’s a $17.6-billion company with more than 1,500 stores in all 10 provinces, under banners such as IGA, Foodland, FreshCo, Thrifty Foods and Lawton’s Drug Stores.

Yet the Oshawa merger also saw Sobeys flounder through an IT debacle as it tried to bridge the two grocery entities with one enterprise software platform. The Oshawa side included 25 different checkout systems (the result of its own acquisitions), and Sobeys struggled to integrate the tangled mess. “I think we were trying to do too much, too fast,” Sobey admits.

The two-year struggle peaked in December 2000 when Sobeys’ SAP software system crashed and stayed down for five days during the busy holiday rush. The company took a month to recover from the disruption, and was forced to scrap the new system—a move that resulted in an after-tax charge of $49.9 million, or 82¢ a share.

“We made some mistakes, obviously,” Sobey says. He doesn’t expect a repeat of that situation as Sobeys works to integrate the Canada Safeway stores.

His family’s company, he insists, is now much better at change management. “The Oshawa deal was a complete learning experience. It was new,” he says. Plus, the Safeway pieces should “plug and play,” meaning they’ll integrate easily into the Sobeys network, though he admits that it will require “a pretty long extension cord.”

Integration errors aside, the Oshawa acquisition was a clear win for Sobeys. “Its Oshawa purchase in 1998 has been nothing short of a home run, delivering scale, growth, and talent,” notes Scotia Capital analyst Patricia Baker in a recent report. Empire’s shares have advanced 428% in the years since, and the deal has provided Sobeys with a “big win” in Quebec. Baker notes that Sobeys has fared far better with the Oshawa Group than Loblaw did with its purchase of Provigo, which was made around the same time. Empire has delivered annual returns of 13.5% since the Oshawa merger (up to the 2013 fiscal year); Loblaw, meanwhile, has delivered annual returns of 3.2%.

Kathleen Wong, an analyst at Veritas Investment Research, links Sobeys’ recent performance in part to the company’s “significant investment” in logistics and distribution. She notes the company rationalized distribution facilities in Ontario, Quebec and Atlantic Canada, while opening automated distribution centres in Vaughan, Ont., in 2009, and in Terrebonne, Que., in 2012. “Those two facilities helped Sobeys to increase its warehouse and distribution capacity significantly and reduce distribution costs,” she says.

The Oshawa acquisition also brought Marc Poulin over to the Sobeys side. At the Oshawa Group, Poulin was the vice-president of grocery merchandising, and he became president of Sobeys’ Quebec division for 11 years before his appointment as Sobeys’ president and CEO in June 2012. In December he replaced Paul Sobey as president and CEO of Empire, meaning Poulin now helms the parent company and its primary subsidiary. He’s now responsible for overseeing the Safeway integration, a process he says will require three years—and plenty of trips to Western Canada. “There’s been lots of flights to Calgary lately,” he says by phone from Sobeys’ Mississauga office, “including one tonight.”

Poulin, 52, calls the Safeway acquisition “truly transformation,” noting it will make Sobeys a dominant player in Western Canada, an area where until recentlythe company had a relatively weak presence—even with its 2007 purchase of Thrifty Foods in British Columbia. Sobeys now boasts market share of 23.4% in Western Canada, giving it a slight edge over Loblaw. “It changes significantly the dynamic of the company and its ability to compete in the Canadian marketplace,” Poulin says of the merger.

If anyone else was taking over Sobeys, analysts might be worried. But Poulin’s long history with the company—he was there during the Oshawa merger—makes it far less risky to change leaders while integrating a competitor, says Wong. “Marc has already witnessed the integration of two grocers.”

Paul Sobey agrees, calling Poulin an “excellent choice” for Empire’s chief executive post. “Here’s an individual that came up through the organization and understands our culture,” he says, adding that Sobeys’ offering in Quebec, under Poulin, is “one of the best in North America.”

As for his new position at the top of the Empire pyramid, Poulin doesn’t think it’s such a big change. After all, he was already helming Sobeys, which accounts for more than 98% of Empire’s consolidated sales, and 94% of its adjusted net earnings.

Up until 2000, Empire was—as Patricia Baker puts it—a “true conglomerate,” a holding company with a wide variety of assets and investments. During Paul Sobey’s tenure as CEO, however, the company shed peripheral assets, including a stake in Wajax, a distributor of construction and manufacturing equipment, and a 25% stake in Hannaford Bros., a New England–based grocer. “During my term, my focus has been trying to simplify the organization, trying to simplify the management structure within the organization, and trying to focus on our areas where we truly wanted to grow and develop—that’s the food and related real estate business,” Sobey says. “I knew where our focus should be.”

In 2007 Empire took Sobeys private, thus streamlining the organization. Up to that point both Sobeys and Empire were publicly traded companies.

More recently, in November, Empire Theatres sold 46 theatres to Cineplex Inc. and Landmark Cinemas. The two deals brought in $248 million. (Sobey says his hard-driving grandfather would often go to movies at the local Jubilee theatre “just to chill out.”)

Thus the Safeway acquisition can be seen as the culmination of a 15-year effort to hone Empire’s focus even more tightly on the grocery business and its related real estate. “This movement toward a food-focused strategy at Empire is not something new,” Poulin says. “You could argue we are—to take a food expression—putting all of our eggs in one basket.”

It’s possible, though, that Empire’s narrowing focus could hurt it. Increased pressures—like low inflation and a strong U.S. dollar that increases buying costs—have created a “tough hill to climb” for Canadian grocers, according to a recent note from BMO analyst Peter Sklar. Empire faced the “most potential downside,” because it lacks substantial non-grocery holdings to insulate it from the chilly competitive climate—unlike Loblaw with Shoppers Drug Mart, or Metro with its interest in Alimentation Couche-Tard, the Quebec-based convenience store operator.

Sobeys is attempting to compete, in part, by upping pressure on its suppliers. The company recently told suppliers to reduce their prices by 1%, retroactive to Nov. 3, as well as scrap any planned price increases for 2014.

The Safeway deal is also expected to deliver $200 million in annual savings. Wong predicts Sobeys’ savings will come from integrating the two companies’ distribution networks in Western Canada, and by merging administrative and marketing efforts. She also notes the Safeway acquisition will increase Sobeys’ buying volume by almost 40%, further boosting its purchasing power.

Yet Sobeys is looking to differentiate itself on more than just the price of milk and bread. Poulin says the company must also be a champion of the “better food movement,” pointing to two announcements from November. The first involved a new line of 14 products developed in partnership with celebrity chef Jamie Oliver, including Herby Lemon Flattened Chicken (made with Certified Humane chicken) and Scrumptious Seafood Pie. The second announcement was the unveiling in Burlington, Ont., of the first Sobeys “extra” location. The upgraded 58,000-square-foot store boasts an in-store chef, a Wellbeing Counsellor, a Cheese Ambassador, as well as expanded bakery and produce sections. “It’s a new prototype for us,” Poulin says. The goal, he adds, is to “help Canadians eat better, feel better and do better.”

Analysts seem to think that Sobeys’ big gambles will pay off. Scotia Capital’s Patricia Baker says Empire is “positioned to embark on a new era in its storied history.” Perry Caicco, at CIBC World Markets, describes the Empire-Safeway integration “as a long journey with a powerful ending.”

Sobey says both his grandfather and father marvelled at the company’s size and progress at the end of their respective management tenures. And he feels similarly. “I think we’re in an outstanding position,” he says. Sobey still has an office at Empire’s headquarters in Stellarton. He’ll remain on the company’s board and says he’ll act as a “custodian of the future success and wealth of the organization.” After 15 years as CEO, it was the proper time to depart Empire, he insists. “You always need fresh ideas and new thinking. If you stay in a position too long, you run the risk of …” He doesn’t finish the sentence. “It’s a good time.”

Sobey excuses himself from the table, where we’ve just concluded a lunch of French onion soup and salad, to take a call from his wife, Marsha. “I’m going to have to eat and run,” he says after returning to the table. A few minutes later, after entering the Crombie House kitchen to say goodbye to the staff, he’s in a black Mercedes, whisking down a Pictou County road that his great-grandfather may have navigated with a horse-drawn cart.