Another one bites the dust. Supervalu’s acquisition of Albertsons is a case study in why many mergers and acquisitions fail.
In 2006, Supervalu acquired 1,124 Albertsons stores for more than $6 billion in stock and cash. Supervalu also assumed more than $6 billion of Albertsons’ debt. At the time, the CEO of Supervalu said the company would not try to compete with the likes of Walmart and other big chains but would manage stores at the local level to better respond to local tastes. He said, “We leave management in local markets to make decisions. Food is a very personal thing.”
Food may be personal, but the company’s personnel strategy didn’t work out too well.
Since 2007, Supervalu’s stock has lost 83 percent of its value. Even though the company has reduced its long-term debt 17 percent over the past three years, the credit agencies think it is junk. The Moody’s and Standard & Poor’s ratings services downgraded Supervalu’s bond rating to just above default. Both agencies think the company’s aggressive pricing strategy is eroding profits, because it has done nothing to increase volume.
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In June, Supervalu announced that as many as 2,500 Albertsons employees in California and Nevada would be laid off. Last month, Supervalu Inc. dismissed CEO Craig R. Herkert. The company’s chairman, Wayne C. Sales, will take over and try to turn things around.
For many economists, the failed acquisition of the Albertsons stores comes as no surprise. Keeping local management goes against the economic theories that best explain the benefit of any acquisition.
Every year, hundreds of large corporations merge with or acquire other firms. Economists classify this activity as either horizontal, vertical or conglomerate, depending upon the nature of the business acquired.
Horizontal mergers occur when a firm in a similar line of business is acquired. Vertical mergers occur when a supplier or a customer is acquired (up or down the supply chain). Conglomerate mergers occur when a firm moves into an unrelated line of business.
The Albertsons acquisition clearly falls in the horizontal category. Economic theory then suggests that such an acquisition will succeed if it improves efficiency or produces synergies. The synergies, or the value added by combining businesses, comes from one of two sources — economies of scale or complementary resources.
Most often the merger produces benefits from cost efficiencies found in the larger operation. For example, horizontal mergers involve centralizing such functions as finance and accounting, which reduces overhead. Keeping too much management at the local level doesn’t line up with achieving economies of scale. Supervalu accomplished at least some of this, consolidating some functions at Albertsons with those of Supervalu.
Economies of scale may also result in a vertical merger when the company controls raw-material supplies or can sell directly to the end user. In some cases firms have valuable assets that complement those in another firm, and the combined firm becomes more efficient or better serves the customer.
While economic theory supports a merger strategy that achieves economies of scale or combines valuable resources, an often-cited reason for merging goes against economic theory. Management sometimes claims that a merger or acquisition will reduce risks in the company through diversification. But it is much easier for shareholders to diversify their portfolios of stocks than it is for management to run vast and complicated businesses. Diversifying the company itself is a poor reason for a merger or acquisition.
Historical evidence also supports economists’ skepticism. Merger-and-acquisition activity in the United States goes through cycles, and there appears to be a strong correlation between this activity, higher stock prices and low interest rates.
When stock prices are rising because the economy is doing well, many companies go on a buying spree. This pattern suggests that managers are motivated to acquire other firms as much by cheap financing as by any potential economic gains.
Further, research shows that the economic gains that do exist go to the seller, not the buyer. Selling shareholders gain the larger share of the benefits from any economies of scale, and acquiring shareholders break even at best. If Albertsons shareholders sold their new Supervalu shares within a year of the acquisition, they made out well.
The selling shareholders receive more in the deal because buyers generally overbid. To persuade the board of the target company to sell, the buyer must bid up the price of the stock over current market value. This erases much of the potential gain, while the accountants, lawyers and other advisers get away with their share in fees.
Supervalu can’t seem to run Albertsons any better than the previous management could. The economies of scale just aren’t there.
Perhaps this opens the door for local ownership of our local grocer.
PETER CRABB: Professor of finance and economics at Northwest Nazarene University in Nampa. Contact him at firstname.lastname@example.org.