By Alex Gavrish, Etalon Investment Research; author of “Wall Street Back To Basics


Jana Partners’ stake

Jana Partners, a well-known activist hedge fund managed by Barry Rosenstein, disclosed a 6.2% stake in Safeway Inc. (NYSE:SWY) in September 2013. It would be interesting to know at what price the hedge fund acquired the shares. Here it gets little more complicated, although relatively straightforward. By digging dipper into the SEC filing one can gather the required information. Part of the position, or 9.12 million shares, was acquired at an average price of $26.54 – as disclosed by the trades made in the last 60 days preceding the disclosure. Another part of the position, or 2.3 million shares, was acquired sometime before the 60 day period so the average cost in unknown. Taking the volume-weighted average price of Safeway’s stock for the period of approximately one month – a period since the announcement of the Canadian transaction (more on it later) until the beginning of a 60 day period for which the trades are disclosed, we get a price of $24.13 per share. By combining these two parts one can estimate the total cost of shares acquired to be in a range of $298 million for an average cost of $26.05 per share. The remaining part of the position was acquired through the purchase of call option contracts on Safeway’s shares. By allocating the remaining amount of the total cost disclosed in the SEC filing ($318.9 million), the cost of these option contracts is estimated to be $21.4 million, or 6.7% of the total cost, which is reasonable. The actual cost of shares acquired by exercising option contacts would be about $27.93 per share (exercise prices and amount of contracts are disclosed in the SEC filing, but we omit them here for simplicity).  Combining these three parts of the position, we arrive at a total average cost of $26.5 per share.

Safeway’s financials

Safeway Inc. (NYSE:SWY) is a Fortune 100 company and one of the largest food and drug retailers in North America. Based on a recent stock price of $32.71 per share, Safeway has a market capitalization of $7.8 billion. In June 2013, Safeway announced a sale of its Canadian operations to Sobeys Inc, a Canadian food retailer and wholly-owned subsidiary of Empire Company Limited (TSE:EMP.A), for CAD 5.8 billion in cash or about CAD 4 billion in after-tax proceeds. The proceeds of this transaction are expected to be used to pay down $2 billion of debt and to buy back shares. Share repurchase authorization in the amount of $2 billion was promptly announced in October 2013, bringing the total amount of outstanding buyback authorization to $2.8 billion.

Concurrently with the disclosure of a stake by Jana Partners, Safeway adopted a one-year stockholder rights plan, or, in other words, a poison pill, which will become effective if a shareholder acquires 10% or more of the outstanding common stock (15% in case of a passive institutional investor). In October 2013, Safeway reported third quarter results and announced the intention to exit the Chicago market, where operations at 72 Dominick’s stores have been weak and unprofitable.

Safeway is also a majority owner of Blackhawk Network Holdings Inc (NASDAQ:HAWK), which conducted an IPO in 2013. Safeway still owns a 73% stake which is valued at about $956 million, based on a recent price of $25.19 per Blackhawk share. Based on a 2013 guidance provided by company for continuing operations (excluding reclassification of Dominick’s to discontinued operations), Safeway expects to have a proforma adjusted EBITDA of $1.7 billion, free cash flow of $600 to $650 million, and capital expenditures of $850 to $875 million. Based on this guidance, Safeway is currently valued at an estimated EV/EBITDA multiple of x5 (after accounting for the proceeds from the Canadian transaction).

Shareholder activism or a timely trade?

It is safe to assume that sale of Canadian operations served as a catalyst for Jana Partners to take a position. So far, it proved to be a right decision as the company announced large share buyback plans and also decided to exit unprofitable Chicago area operations. However, a poison pill adopted by Safeway Inc. (NYSE:SWY) might be a hint by management to activist investors to “hold their horses” and give the company time to deliver on its restructuring process. A subsequent sale by Jana Partners of part of its position might be indicative that although there is a potential for price appreciation, it is not a get rich quick scheme, and a longer time period might be required to reap the benefits of the investment.