Market Applauds Whole Foods-Wild Oats Merger

Shares of both companies rose by double digits Thursday on Whole Foods' unexpected takeover bid for the beleaguered Wild Oats chain, its largest competitor. Whole Foods closed up 14% and Wild Oats shares ended the day up 17%.

The proposed cash deal, announced late Wednesday, is valued at $565 million, or $18.50 per Wild Oats share. Management has already approved a merger agreement. Wild Oats operates 110 natural and organic grocery stores, mostly in western states and British Columbia, Canada. Whole Foods, the country's largest organic grocer, operates 191 stores in the U.S., Canada and the United Kingdom.

A tender offer is slated to begin Tuesday to buy up all outstanding shares of Boulder, Colo.-based Wild Oats. Whole Foods will also assume Wild Oats' existing net debt of $106 million. Yucaipa, the investment firm that holds 17.5% of Wild Oats shares, indicated its support for the deal, making its approval far more likely, according to Bear Stearns analyst Robert Summers.

John Mackey, chief executive of Austin, Texas-based Whole Foods, said the buyout would shore up the chain's market share in three regions where its presence is weakest: the Pacific Northwest, Rocky Mountains and Florida.

"The growth opportunity in this category has led to increased competition from many players, most of whom are not dedicated natural and organic foods supermarkets, but are considerably larger than we are," Mackey said in a prepared statement. "We have made 18 retail acquisitions in our history, many of which were platform acquisitions from which we have been able to accelerate our growth geographically."

Whole Foods shares plummeted nearly 30% over a disastrous 10-day stretch in late October and early November, and Wild Oats shares dropped about 20% in the same period. Both companies saw shares drop further as investors decided they were past their sell-by dates.

Wild Oats, which was already in turmoil following the October resignation of CEO Perry Odak, went through further management upheaval in December when CFO Robert Diamond quit, a move that followed the closure of eight stores in Arizona and warnings that 2006 results would be worse than the company originally projected.

"It was widely speculated that Wild Oats would be sold, but I don't think there was any speculation that Whole Foods would be the acquirer," says Scott Van Winkle, an analyst with Canaccord Adams. "This isn't the type of acquisition they usually do. This is taking out their biggest competitor."

At Whole Foods, a former Wall Street darling, weakening sales pasted the stock in the closing months of 2006, prompting shares to decline nearly 40%. The trend looked to continue this year until the company unveiled better than expected fiscal first-quarter numbers along with its merger announcement.

Same-store sales for the three months ended Jan. 14 increased 7%, beating Wall Street projections of 6% growth. The chain saw same-store sales rise 13% in the year-ago period. Whole Foods also missed Wall Street's earnings estimate of 41 cents a share, reporting earnings of 38 cents a share, a drop from the year-ago results of 40 cents a share.

Nevertheless, the numbers were better than most investors anticipated, and coupled with the news of the merger, proved to be a more effective market inducement than double coupons.

"Whole Foods is not only up because of the acquisition of Wild Oats, it's up because there was very negative sentiment and investors believed that comp-store sales in the quarter were going to be weaker," Van Winkle says. "You got a relief rally in the stock."

The good news wasn't a relief to the growing number of short sellers who were betting against Whole Foods. The number of shares sold short increased to 10.6 million as of Jan. 9 from 9.8 million as of Dec. 9. That represented 7.5% of the public float, and some of the boost to Whole Foods shares Thursday was surely due to short-sellers unwinding their positions and creating a short squeeze.

While many mergers are marked by difficulty integrating the new acquisition, analysts on this deal say there's no need to panic. There will still be growth and some will be organic.

"Whole Foods should be able to drive much faster productivity gains through synergy potential and scale," Summers, of Bear Stearns, wrote in a Thursday research note.

Van Winkle wrote Thursday that while Wild Oats offers Whole Foods neither a previously untapped regional market nor a new area of retail expertise, the opportunistic deal will wind up benefiting shareholders. He wrote that Wild Oats same-store comps should improve within 12 to 18 months, as Whole Foods stores are nearly twice as productive. Now that its fortunes appear to have stabilized, the deal should provide an added benefit fairly soon.

"This was Whole Foods' toughest year-over-year earnings comparison, and the stock is cheap [relative to the competition]," he says. "Everybody knows that '07 is going to be bad year, a transition year for them, their '08 prospects were just improved by the acquisition. It's a defensive move, but it does have its financial benefits."

Shareholders who hang on to this stock may have to wait a bit, but they should be able to reap the benefits of Whole Foods' management now that the Wild Oats deal is nearly sewn up.