Michael Santoli

Pricey Fairway IPO Leads Pickup in Consumer Offerings

Michael Santoli

The plausible and promised merger rush hasn’t yet begun, despite calm markets, cheap debt and cash-flush companies. But Wall Street’s new-stock assembly line is running again at moderate speed this year. Initial offerings in the first-quarter raised 37% more than the depressed IPO proceeds of a year earlier, according to Bloomberg.

So far, the equity-offering apparatus is mostly turning out low-tech, easy-to-understand consumer plays – often companies owned by a larger parent or buyout investors – in tune with current investor appetites for the steady and familiar.

An initial offering for Fairway Group Holdings Inc. (FWM) – a beloved low-frills New York City grocer featuring high-quality produce and prepared foods – was priced late Tuesday at $13 per share, above the anticipated range of $10 to $12. The stock immediately popped 30% higher as it began trading Wednesday morning. The deal raised $179 million, split between the chain of a dozen bustling, over-stuffed stores, and its private-equity and family owners, who sold a portion of their holdings.

Food foraging in New York

The eager reception to Fairway’s offering was no doubt helped in part by the number of New York-based analysts and fund managers who well know the capacious stores, with their kaleidoscopic displays of olive oils, encyclopedic cheese selection and aromatic bulk-coffee section. The company – with 13 stores now and plans to have 30 in metropolitan New York within five years – fits well with the current ethos of value-pricing, shopping-as-foraging and discerning urban-food sensibilities.

The original Manhattan store was a produce stand in the 1930s and the descendents of founder Nathan Glickberg remain involved. The local following is strong enough that, when new locations have opened, it has been a celebrated event.

All that said, this is a very pricey stock attached to a niche retailer that stands between the coupon-hawking mass-market supermarkets and the aggressive, beloved haute-grocers Whole Foods Market Inc. (WFM) and Trader Joe’s. This is not an easy group to fend off: Just this week, top-notch British grocer Tesco said it would end its effort to compete in the U.S., citing inability to profitably contend with the entrenched players.

The valuation on Fairway at the IPO price shows the company at more than 20-times its cash flow, defined as earnings before interest, taxes, depreciation and amortization, for the fiscal year ended last April. Whole Foods’ cash-flow multiple is below 14. Investors who have heard the marketing pitch for the Fairway offering say the company is confident it can raise profit margins as it builds a central food-prep and distribution center, imposes public-company financial discipline, increases house-brand promotion and opens new stores.

Fairway knows how to appeal to a New York crowd willing to endure packed stores in order to find national brands a bit cheaper than at overpriced small urban markets, along with specialty/organic foods.

Long shots driving stock pop?

For this reason, the company seems to have a clear path to meeting its profit and expansion goals for the next couple of years in adjacent areas. But puffed-up talk by Fairway executives about an ultimate rollout of 300 stores in the broader Northeast and nationwide seems like a longer shot – one that investors today should not count on happening. The initial pop in the stock seems to give the company too much credit for undemonstrated success.

Elsewhere on the upcoming slate of new stocks are a couple of other prosaic purveyors of consumer basics.

Blackhawk Network Holdings Inc. is a fast-growing, New Economy business about to be unleashed by slow-growth supermarket giant Safeway Inc. (SWY). Blackhawk is the leading distributor and processor of gift cards in retail locations. It processes transactions and takes a commission on the dollar amounts loaded onto the cards of a broad variety of retailers such as Amazon.com (AMZN), Starbucks Corp. (SBUX) and Apple Inc.’s (AAPL) iTunes Store. Revenue and profit last year both grew 28%, thanks to Blackhawk’s key position in the popular prepaid-card economy.

Blackhawk plays a favored Wall Street business: payment networks, especially mobile payments or “digital wallet” services. Blackhawk has technology to enable the sale and redemption of prepaid balances for its retail clients on mobile devices. Since October, when Safeway set plans to sell a Blackhawk stake in an IPO, Safeway shares are up 60% to above $26.

Blackhawk is to price its IPO Thursday between $20 and $22 per share, but it will certainly begin trading at a large premium to that offer price, at a price-to-earnings multiple now reserved for beloved growth stocks. Safeway will retain a 75% stake in Blackhawk after the deal.

Joe Cornell of Spin-Off Research, who tracks corporate divestiture deals, figures the sum-of-parts value for Safeway, assuming Blackhawk is priced at $21, is about $29, or approximately 10% above its current share price. With any big surge in Blackhawk shares, though, Safeway might become an attractive back-door way to own Blackhawk while playing the ongoing recovery in Safeway’s core business.

A below-the-radar shopping play is about to come from Valero Energy Corp. (VLO), which is about to spin off its retail gas-and-convenience-store operations as CST Brands Inc. on May 1. CST shares have begin trading on a preliminary “when-issued” basis under the symbol CST-WI at around $28 per share.

Spinoffs are frequently attractive stock investments, largely for mechanical reasons. Shares in a subsidiary are handed to shareholders of the parent company, and often are sold as unwanted extras or simply as a matter of policy by funds that own only stocks in a major index. In this case, Valero is in the Standard & Poor’s 500 but CST will not be.

This means once CST shares are handed out, they will come under immediate selling pressure by index funds and other large-stock asset managers. This typically creates good buying opportunities in spun-off stocks a month or two after a spinoff is completed.

These dynamics have allowed spinoffs to consistently outperform the broad market over time. The Bloomberg Spun-Off Company Index gained more than 50% in the year through last Friday, more than double the S&P 500 return, and year to date was up 17% versus 9% for the market.

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