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Food Fight

Just as the Sears/Kmart and Federated/May mergers underscored the diminishing role of department stores (and therefore danger signs for the traditional mall), the proposed $17.4 billion buyout and break up of Albertson's Inc., has similar implications for strip centers.

Moreover, the presence of Kimco Realty Corp. in the deal continues a company trend in profiting from a distressed retailer's real estate.

Strip center owners have long claimed their properties were “recession proof,” because everyone needs to buy necessities like food and drugs. But what's becoming clear is that that buying activity doesn't have to occur at the traditional grocers. The Albertson's break up confirms that the grocery industry is being transformed. Discount grocer SuperValu Inc. suddenly vaults into position as No. 3 in the country in terms of sales (behind Wal-Mart Stores Inc. and Kroger Co.).

Albertson's demise leaves Kroger and Safeway as the only national mid-price grocers in a segment that's being increasingly dominated by superstores run by Wal-Mart and Target Inc., discount chains like SuperValu and upscale players like Whole Foods and Wild Oats markets. With the addition of 1,124 Albertson's locations, SuperValu now boasts the largest network in the U.S. with 2,656 stores.

Despite the changes afoot, many strip center owners think the deal will help the industry by weeding out the weak Albertson's and replacing them with more profitable businesses.

“Albertson's as a conventional supermarket format was not differentiating itself over the last couple of years,” says Stuart Tanz, president and CEO of Pan Pacific Properties. (Albertson's is Pan Pacific's third-largest tenant, but only represents 2.4 percent of its total base rent.). “SuperValu will come in and really re-create Albertson's as a different format altogether and it will be much more competitive.”

REIT analysts agreed. “The sale of Albertson's supermarkets is not a negative for Pan Pacific,” wrote Credit Suisse analyst Jessica Tully to investors. “In fact, we view it positively in Southern California.”

But the Albertson's deal does more than shape the grocery industry. It also is a microcosm of many of the story lines that have come to dominate the industry. Private equity, which has played a major role in retail buyouts in recent years, is also present in this deal with Cerberus Capital Management L.P. leading a group of five investors, including Kimco, purchasing 655 Albertson's and Super Saver stores for between $1 billion and $2 billion. (Analyst estimates vary.)

The deal is another in a line of transactions where a REIT made a direct investment in a retailer to capitalize on its real estate. Observers believe that the stores — predominantly in Northern California, Texas, Florida, the Southwest and the Rocky Mountain region — are the weakest, with the upside in the value of the properties' underlying real estate.

For Kimco, getting involved in the deal has two benefits. It can control the fate of Albertson's stores at some of its centers. But it also will have access to leases of Albertson's at properties it doesn't own where it can choose to continue operating the store, re-lease it to another grocer or sell the lease or space to another developer or grocer.

The Cerberus-led group said it plans to operate the stores, but Kimco has had good results helping to liquidate closed Kmart and Ames locations. The other three partners, Schottenstein Stores Corp., Lubert-Adler Partners and Klaff Realty L.P., also have experience. (The group is also buying 26 Cub stores from SuperValu in a related deal aimed at quelling any anti-trust concerns.)

Kimco's stake is one-fifth of the $2 billion. It typically leverages its acquisitions about 70 percent, so its total cash contribution to the deal is in the $120 million range — a relatively small play for the largest strip center owner in the country. “What they are likely to do — and what they've done in the past — is evaluate the stores in the next couple of years and they will determine whether they can make more money by leasing or selling the leasehold,” says Richard Moore, a REIT analyst with KeyBanc Capital Markets. “Over time, they will make more money because they are acquiring good real estate.”

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