UK Bookmakers Give KKR 5-To-1 Odds On Safeway –

Kohlberg Kravis Roberts & Co. recently decided to step into the heated contest for Safeway Plc, Britain’s No. 4 grocery chain, confirming last month that it had approached the company and is now considering a bid for the grocer. KKR is not alone in its quest for Safeway, as the company is drawing interest from both Britain’s strategic heavyweights and some of the top financial players.

KKR is familiar with Safeway, having acquired its U.S. parent in 1986 for $4.8 billion. The following year KKR sold off the 11 UK supermarkets that were under Safeway’s umbrella to Argyll, which in 1996 decided to assume the Safeway name. In 1990 KKR made its exit, floating the U.S. grocer in an IPO that netted the firm over 55 times its original $129 million equity investment. The firm has also had other purchases in the supermarket industry, with acquisitions of Fred Meyer, Stop & Shop, Bruno’s and Randall’s Food Markets.

The interest in Safeway was sparked by the company’s agreement to be acquired by William Morrison Supermarkets in an all-stock deal that at the time was worth 2.5 billion pounds, or $4 billion. The offer valued Safeway’s stock at 238 pence per share, but in an indication of things to come, the stock ended the day nearly 8% higher than the proposal’s valuation, as speculation that new bids would emerge elevated the issue past the offer price.

And as expected, new bidders quickly surfaced. J Sainsbury Plc, Britain’s No. 2 supermarket chain, was the first to make an opposing bid, saying it would offer approximately 3.2 billion pounds, or $5.15 billion, in a cash and stock deal for the company. Wal-Mart, through its ASDA subsidiary, was next in line with rumors pointing to a potential all-cash bid in the same ballpark as Sainsbury. Among the other strategic players involved, Tesco, Britain’s largest supermarket chain, said near the end of January that it would join the fray with a possible bid at a “compelling” price, while British retailer Marks and Spencer Group Plc is also rumored to be entertaining thoughts of a possible offer.

Joining KKR on the non-strategic side of the bidding, British retail tycoon Philip Green has expressed interest in Safeway. Additionally, there has also been speculation that Texas Pacific Group would like to get in on the action, possibly as a joint bidder with one of the strategic players already involved, although the firm declined to comment on its involvement.

Because of the interest the company has drawn, Safeway has since retracted its recommendation to shareholders to approve its deal with Morrisons. “The board of Safeway continues to believe that a combination with Morrisons represents an opportunity to create a new dynamic force in U.K. food retailing. However, in light of the announcements by potential competing offerors, we are advising shareholders to await developments,” Safeway Chairman David Webster said.

While the interested parties have yet to provide any formal offers, the potential deal is drawing interest far beyond the boardrooms. London’s local bookmakers are offering odds of 5 to 1 for KKR to emerge as the winning bidder, placing its chances below those of Wal-Mart, Tesco and Sainsbury, respectively, according to spread gaming firm Financial Spreads.

However, with its interest in Safeway, KKR is betting that competition concerns will weed out some of the bigger strategic players, putting it in position to outbid the smaller firms, like Morrison. Any deal involving Tesco, Sainsbury or ASDA would face intense scrutiny from the Office of Fair Trading/Competition Commission. The three companies already control the local markets, with Tesco holding a 25.8% market share in Great Britain, followed by Sainsbury and ASDA, which hold a 17% share and a 15.9% share, respectively. William Morrison, meanwhile, would likely come in under the OFT/CC’s radar, as it holds only a 5.9% share.

It is unknown how the commission would view a bid from KKR. London investment bank Cazenove, in a report to clients, indicated that it believes the final outcome will be “distilled into one key issue” facing regulators. “Is [the OFT/CC] prepared to see the UK grocery market contract from four big players to just three?” Casenove further speculated that the regulators would focus primarily on the impact a potential merger would have on consumer prices, with added attention as to how a deal would affect the local markets.

While many believe that KKR, and any other buyout firm that enters the mix, would be immune to competition worries, Casenove disagrees: “We believe a private equity bid is a less plausible outcome from the current environment given that the OFT/CC would almost certainly treat such a development as being equivalent to takeover by an industry incumbent. This is because the almost inevitable outcome of a [private equity] bid would be a break-up of the group (hence four becoming three), an outcome the OFT/CC would want to regulate carefully.”

And a recent decision by the OFT/CC confirmed that the it will scrutinize every bid, both financial and strategic alike, with its ruling that Philip Green would need to make a formal submission regarding his bid for Safeway.

Still, KKR reportedly would acquire Safeway with the intention of holding onto it and helping it grow, rather than breaking it up to sell off the pieces. Industry observers have also speculated that the firm would leave the current management in place if it were to win the bidding. However, KKR declined to comment on the story.

Credit Suisse First Boston apparently likes KKR’s odds, as the bank chose to relinquish its position as joint broker to Safeway and instead side with the New York-based firm in an advisory role. KKR is also said to be in talks with a number of investment banks, including Merrill Lynch and Lehman Brothers, to line up funding if it were to make a bid.

Despite all of the frenzy that surrounds the bidding for Safeway, it’s important to keep in mind that there’s a reason why the company is on the block in the first place. Sanford Bernstein, in a research note to clients, affirmed, “It is worth remembering that the underlying asset (Safeway and its portfolio of stores) is intrinsically a company in trouble.” The firm added, “Whichever company ends up with the troubled retailer will still have to invest a hefty sum (we estimate around 400 million pounds) in capex to integrate and turn-around a business that has not kept up with development in the rest of the market.” .