Fitch: Safeway Downgrade to 'B' Category Likely Upon Acquisition by Cerberus

CHICAGO--()--Fitch Ratings expects to downgrade Safeway Inc. to the 'B' category assuming the acquisition of the company by AB Acquisition LLC, as announced yesterday, is completed as proposed. AB Acquisition is the Cerberus-controlled entity that owns the Albertson's supermarket banners, among others. Post the transaction, leverage is expected to be in the 6x range versus 3.6x at year-end 2013.

Fitch's current Issuer Default Rating (IDR) for Safeway is 'BBB-' on Rating Watch Negative. As of Dec. 28, 2013, Safeway had $4.2 billion of debt outstanding, including capital leases. A full rating list is shown below.

Fitch would likely take a rating action at some point following the 21-day 'go shop' period, assuming no other circumstances or bidders for Safeway arise. The transaction will be subject to Federal Trade Commission (FTC) and shareholder approval and is expected to close in the fourth quarter.

The transaction is valued at $40 per share, for a total equity value of $9.4 billion. The $40 purchase price includes $32.50 per share in cash, proceeds from non-core asset sales (the sale of Safeway's 49% stake in Mexico-based Casa Ley and its real estate development company Property Development Centers, LLC) of $3.65 per share, and the distribution of shares of Safeway's Blackhawk subsidiary to current shareholders valued at $3.95.

Together with Safeway's net debt of $1.3 billion ($4.2 billion of debt net of its available cash of $2.9 billion), the enterprise value is $10.7 billion. Based on 2013 EBITDA of $1.6 billion, the takeout EV/EBITDA multiple is 6.5x.

AB Acquisition plans to fund the cash purchase price of $7.6 billion ($32.50 per share times 235 million shares) and repay part of Safeway's existing debt with $7.6 billion of debt, a $1.25 billion of equity contribution, and part of Safeway's cash.

Of Safeway's existing debt of $4.2 billion, $250 million will mature prior to closing in August 2014, another $1.3 billion is expected to be repaid at or before closing ($400 million term loan, and note issues maturing in 2016 and 2017), and $1.4 billion of notes with contingent change of control clauses will likely be put following closing (notes maturing in 2019, 2020 and 2021). That leaves $750 million of notes maturing in 2027 and 2031 and $425 million of capital leases that would remain outstanding post-closing.

Fitch assumes that anticipated debt repayment totaling $2.95 billion will be financed in part with $2 billion of Safeway's available cash of $2.9 billion ($4.6 billion of year-end 2013 cash less a tax payable of $1.2 billion and Blackhawk cash of $550 million).

Adjusted debt/EBITDAR pro forma for this transaction (after factoring in the expected debt repayment described above) is 5.9x (assuming $8.8 billion of book debt and $12.1 billion of lease-adjusted debt and EBITDAR of $2,046 million) compared with 3.6x at year-end 2013. This does not take into account any asset sales that are likely to occur, including store dispositions that are mandated by the FTC. Currently, 25% of Safeway's store base or roughly 330 stores overlap with Albertson's stores (within a 2-mile radius), and Fitch therefore expects a meaningful number of store dispositions could occur.

The combination of Safeway and AB Acquisition's existing banners (including Albertson's, Jewel-Osco, Acme, Shaw's and Star Market) would create a stronger #2 player in the supermarket sector. The combined company would enjoy strong local market shares in areas where the two companies overlap, including the west coast, mountain states and Texas. These larger market shares would improve its competitive profile in key markets on top of the expected cost and buying synergies.

Fitch currently rates Safeway as follows:

--Long-term IDR 'BBB-';

--Senior unsecured notes 'BBB-';

--$1.5 billion bank credit facilities 'BBB-';

--Short-term IDR 'F3';

--Commercial paper 'F3'.

The ratings are all on Rating Watch Negative.

Additional information is available at 'www.fitchratings.com'.

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Contacts

Fitch Ratings
Primary Analyst
Philip Zahn, CFA, +1-312-606-2336
Senior Director
Fitch Ratings, Inc.
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst
Monica Aggarwal, CFA, +1-212-908-0282
Senior Director
or
Media Relations
Brian Bertsch, +1 212-908-0549
brian.bertsch@fitchratings.com

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Contacts

Fitch Ratings
Primary Analyst
Philip Zahn, CFA, +1-312-606-2336
Senior Director
Fitch Ratings, Inc.
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst
Monica Aggarwal, CFA, +1-212-908-0282
Senior Director
or
Media Relations
Brian Bertsch, +1 212-908-0549
brian.bertsch@fitchratings.com