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Empire Co Ltd (EMP.A-T), the operator of Canadian grocery chain Sobeys, said it is acquiring Safeway Inc's (SWY-N) assets in Canada for $5.7 billion, in a move that will nearly double its reach in the country's western provinces.
The $5.8-billion deal, Canada's biggest so far this year, resulted in generous premiums for Safeway, which said it would use the proceeds to pay down debt and buy back shares, and its shares shot up 30 percent in after-hours trade.
Empire will gain control of 213 full-service grocery stores, cementing its position as Canada's No. 2 grocer behind Loblaw Companies Ltd (L-T) at a time when competition from U.S. retailers Wal-Mart Stores (WMT-N) and Target (TGT-N) is heating up.
"We think it is a game changing deal for Empire," said Barry Schwartz, a portfolio manager with Baskin Financial, which owns more than 100,000 shares in Empire.
"This is a huge win for (Empire's) shareholders, and we expect a significant uptick in the stock tomorrow" he said.
Safeway's Canadian arm generated sales of $6.7 billion and over $500 million in adjusted earnings before interest, taxes, depreciation and amortization in the 12 months ended March 23.
The deal is expected to boost Empire's earnings immediately following the close of the transaction late this year.
The company expects roughly $200 million in annual savings within three years following the close of the deal by integrating distribution networks and reducing procurement, administration and marketing costs.
The all-cash transaction will be financed through equity and debt offerings, along with a lease-back deal on some real estate assets being acquired.
In addition to the grocery stores, it is acquiring about 200 in-store pharmacies, along with some liquor stores, fuel stations and distribution centers as part of the deal.
Empire also said it has identified roughly $1 billion in non-core assets sales that could that potentially be used to help pay back bridge facilities and other debt.
Safeway Chief Executive Robert Edwards said on a conference call that the company gained a substantial premium to the market multiples of U.S. retailers. The deal was unsolicited and Safeway did not conduct an auction for the assets.
Its shares jumped to $29.97 in trading after the closing bell in the United States on Wednesday.
Joe Feldman, analyst at Telsey Advisory Group in New York, said while Safeway trades at a multiple of about five times enterprise value to EBITDA (earnings before interest, taxes, depreciation, and amortization), it was raking in more than double that multiple for the Canadian assets.
Safeway's Canadian assets historically accounted for one-third of the company's operating profit, he added.
Cantor Fitzgerald analyst Ajay Jain said the deal would help deleverage Safeway's balance sheet but was no cure-all.
"We expect that after the dust settles following the latest announcement, Safeway will remain heavily levered and profitability of U.S. operations will continue to decline."
Empire, which has been in the food business for over a century, already owns some 1,500 stores in 10 provinces with retail banners that include Sobeys, IGA, Foodland, FreshCo, Price Chopper and Thrifty Foods.
The takeover, subject to a review by the Competition Bureau, is expected to close later this year. Empire declined to comment on whether it expects the agency to compel it to divest certain assets to win approval.
Canadian rating agency DBRS put its ratings on Empire under review, highlighting concerns that the acquisition heightens its financial risk profile, but it also said Empire credit risk profile could remain consistent with an investment grade rating.
Scotiabank and Morgan Stanley acted as financial advisers to Empire on the acquisition. Stewart McKelvey and Sullivan & Cromwell LLP acted as its legal advisors.