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Whole Foods/Wild Oats Merger May Benefit Kroger And Other Chains

Jim Prevor’s Perishable Pundit, August 21, 2007

As soon as the announcement was made, we ran a piece entitled Whole Foods To Acquire Wild Oats: Circling The Wagons As Others Sell Organics. The piece brought a complimentary note from one of America’s most esteemed specialty food retailers:

Just a note to say how much I enjoyed your “take” on the merger between Whole Foods/Wild Oats. As a WFM stockholder, I will be closely watching this developing story.

— Russ Vernon
West Point Market
Akron, Ohio

You can learn more about Russ here. You can also hear a speech Russ gave to The Entrepreneurship Institute on the subject of “Would you do business with YOU?”

Whether anyone is going to be doing business with Wild Oats is still in question. In the article that Russ responded to, we pointed out the issue:

Probably the most common question the Pundit has been asked is whether anti-trust authorities will allow the acquisition.

They should, but much depends on how you define “the competition.” If you believe there is a separate category of, say, “health food supermarkets,” then the FTC would be hesitant to approve. Wild Oats is the best shot at being a true competitor to Whole Foods, and allowing them to merge would be seen as anti-competitive.

A more reasonable view of the market, though, is that Whole Foods is part of a larger food retailing industry and in that industry it has an insignificant market share.

Then, as we said might happen, even though the FTC would be incorrectly analyzing the market, an announcement by the FTC was made — and we published a piece entitled, FTC May Block Whole Foods From Buying Wild Oats, pointing out the FTC’s lack of understanding of food retailing:

The flaw in the government’s reasoning is that it thinks there is an “organic supermarket business,” when, in fact, this is better understood as a marketing emphasis.

The products sold at a Whole Foods or a Wild Oats are sold in supermarkets, supercenters, warehouse clubs, via the Internet and many other outlets.

And in any case, the barriers to entry in opening these types of stores are quite low — Publix is going to do it with its Greenwise concept, Supervalu did it with Sunflower, and if the demand is there others will do it as well.

In the end we expected reason would triumph and the deal would be approved. Then, however, came word that the Founder and CEO of Whole Foods had been blasting Wild Oats under a pseudonym on stock boards on the Internet — a story we chronicled in Whole Foods Suffers From CEO’s Bizarre Behavior. Although the CEOs behavior technically shouldn’t really affect the case, we thought it probably would:

This will give the FTC an opportunity to kill the deal because it makes Whole Foods seem obsessive about Wild Oats. He didn’t post secretly about Kroger or Safeway — it was Wild Oats.

Yet U.S. District Court Judge Paul Friedman did come out against the FTC and allowed the merger, although the FTC has appealed that ruling.

The District Court Judge also denied the FTC’s request for stay, preventing the merger until the appeal is heard, though Whole Foods did agree to the FTC’s request that it not close the transaction before Aug 20th. This gave the FTC time to request a stay from the U.S. Court of Appeals for the District of Columbia, which is under consideration, but in the meantime the Court has blocked Whole Foods from consummating the merger. The court did emphasize that it was making no judgment on the merits of the case but put the deal on hold as it needed more time to review the matter.

John Mackey, Whole Foods CEO, has made statements that probably don’t help the Whole Foods cause. Forbes quotes him this way:

Whole Foods’ outspoken chief executive John Mackey said July 31 the company would act quickly at the first opportunity to close the deal.

"If we’re allowed to go through and close this transaction, we’re going to do so," he said then. "We’ll start closing stores and integrating the companies … Once the eggs get scrambled, they’re kind of hard to unscramble."

It makes it seem as if he has a plan to close stores — which Whole Foods has denied — and that his goal is to seize an opportunity to make it difficult for the Court to undo a merger, which won’t endear him to the Court and will make the Court more hesitant to allow a merger to go through until the Court has made a definitive judgment. Even if John Mackey does plan all this, it is hard to see the upside from talking about it.

Although Judge Friedman’s decision was issued under seal because it contains confidential information, he apparently did not buy the FTC’s claim that there was a separate industry of “organic/natural supermarkets” and thus did not see a monopoly being formed.

One thing clear is that Kroger wasn’t worried about the Whole Foods/Wild Oats combo. On August 8, 2007, Kroger gave Whole Foods a present by announcing a major expansion of its organic commitment:

ORGANICS GO MAINSTREAM AS KROGER
EXPANDS ITS OWN LINE
TO INCLUDE MORE BREAKFAST AND DINNER ITEMS

More Than 60 Additional Items Will Be Added
To Retailer’s Exclusive Private Selection Organic Line

CINCINNATI, Ohio, August 8, 2007 — The Kroger Co. (NYSE: KR), one of the nation’s largest retail grocery chains, is expanding its line of organic foods this month, making it easier and more convenient for customers to find organic products they want at their neighborhood store.

Kroger’s expanded organics line is being sold under its exclusive Private Selection® brand and includes more than 60 products such as pasta, waffles, tea, peanut butter, snacks and milk. Most products will be available in Kroger’s family of stores by the end of September. Private Selection Organic™ items can be found throughout the stores including refrigerated cases, produce, cereal, canned vegetables, baking and juice aisles.

“This is an easy way for customers who want to try organic foods to do so at their own pace,” said Linda Severin, vice president of Corporate Brands at Kroger. “Our customers tell us they are interested in trying more organic foods and this expanded assortment is designed to help them do that during their regular shopping visits with us.”

Kroger’s Private Selection Organic products always carry the USDA Organic Certified seal, assuring at least 95% of the ingredients used are organic. The seal means the products are free from antibiotics and growth hormones and have no added artificial preservatives or chemicals

Kroger’s expanded Private Selection Organic line is offered in addition to the Company’s Naturally Preferred® natural and organic foods line, first introduced five years ago. Kroger and its family of stores offer over 300 Naturally Preferred brand items, including baby food, cereal, snacks and soy products. These products are minimally processed and use all natural and organic ingredients. They contain no artificial colors, preservatives or flavors. Many of these products are also organic and contain ingredients that are certified organically grown and free of herbicides and pesticides.

This release was the best possible news for Whole Foods: The nation’s largest conventional grocer announces an expansion of its organic efforts and thus confirms the Whole Foods argument that despite a cultural predilection internally to focus on Wild Oats, the competitive arena for organics and natural foods is vast.

Now the interesting question is why Kroger issued this release just as this decision was being considered by the judge.

Very possibly, it is pure coincidence. Kroger was ready to announce it, and Wild Oats is so small compared to Kroger, it didn’t even register that this announcement could have impact on the judge’s decision. Kroger is a very big company, after all, and its CEO certainly isn’t involved in every press release; so, perhaps, the announcement just happened.

Yet, maybe, just maybe, Kroger likes the idea of the merger. In markets such as Boulder, Colorado, Whole Foods and Wild Oats compete, and Whole Foods CEO John Mackey used that point to sell the merger to the Whole Foods board:

Austin, Texas-based Whole Foods and Wild Oats, the two largest natural-food chains in the U.S., have tussled in Boulder since 1998. That’s when Whole Foods built a 39,000-square-foot store in its rival’s backyard. The competition was poised to intensify when Wild Oats planned to open a new 40,000-square-foot flagship store in the Twenty Ninth Street mall, barely a mile from Whole Foods’ outpost.

Wild Oats originally planned to open the store in March but has since postponed it because of design and construction problems.

Whole Foods executives worried that Wild Oats’ new store would result in $150,000 in lost revenue per week for their company and planned to respond with a major store renovation, according to the Federal Trade Commission’s complaint. Whole Foods also contemplated special deals, such as a 10 percent discount for customers who brought in a Wild Oats bag to recycle, according to e-mails cited by the FTC.

By buying Wild Oats, Whole Foods will “avoid nasty price wars in Portland (both Oregon and Maine), Boulder, Nashville (Tenn.) and several other cities,” Whole Foods CEO John Mackey said in an e-mail to his board. The FTC cites the e-mail in the first page of its lawsuit seeking to block the deal.

Obviously Whole Foods would benefit from avoiding a price war with Wild Oats, but the real winner might be other retailers. After all, if Whole Foods maintains high prices on organics, it provides a kind of umbrella protecting the whole market. A high price level at Whole Foods allows mainstream supermarkets — such as the King Soopers, the Kroger division in Colorado — and Wal-Mart to slip in underneath.

So if the FTC is right and the merger will reduce competition, it is companies such as Kroger that will benefit.

This whole merger, though reminiscent of the way they built Whole Foods, may actually be yesterday’s strategy anyway. Whole Foods is now building large stores with lots of foodservice and spas. Integrating the many smaller Wild Oats stores is likely to distract Whole Foods’ management from that transition.

The U.S. Court of Appeals for the District of Columbia has set an accelerated schedule, giving Whole Foods only until Wednesday, August 22, 2007 to respond to the FTC’s request for a stay. The FTC must respond the next day with its counter-arguments. This is a rapid schedule in what often is a glacial process, so gives a clue that the court intends to move fast on this one.

Which means that if the Court rules with Whole Foods, we could have the acquisition completed this week. Whether that is really good for Whole Foods is another question entirely.

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