About Alexandra Biesada

There’s an old saying that goes something like this: Be careful what you wish for, lest it come true. Take heed John Mackey!

Let me explain. In a previous post (read here) I mentioned that the Whole Foods Market founder and CEO was quoted as saying that if he could go back in time “we wouldn’t have done the Wild Oats acquisition.” Now a US appeals court ruling reversing the decision that allowed the $565 million purchase to proceed, has put the deal on hold, at least temporarily. The court has remanded the case for reconsideration to US District Judge Paul Friedman, saying that he erred when he dismissed the Federal Trade Commission’s claim that the deal violated antitrust law. The FTC opposes the combination saying it could stifle competition and lead to higher grocery prices.

From the point of view of WFM, the deal is a fait accompli as the company has already closed some Wild Oats stores, sold others, and is well down the road toward integration of the two chains. However the ruling, which states that “only in a rare case would we agree a transaction is truly irreversible,” leaves the door open for redress if the acquisition of Wild Oats is found to be unlawful. Of course, that has yet to be determined. (Read the appeal court’s opinion here.)

But even the prospect of reversal begs the question: How do you undo a (largely) done deal?

Potential consequences include a freeze on any further integration of the two chains, including ordering WFM not to close or rename any more Wild Oats stores. And if the FTC ultimately prevails it could order WFM to divest the Wild Oats stores it acquired to be run independently.

In a statement, WFM said that it was disappointed with the court’s ruling and was considering its legal options. Until then, the continuing integration of the Wild Oats business is in limbo while Whole Foods awaits the District Court’s response.

I wonder what Mackey is wishing now?

In my last post I noted that Costco Wholesale, the nation’s largest wholesale club (ahead of SAM’S CLUB), posted a healthy 5% same-store-sales gain in June, while less price-sensitive retailers showed weaker results. Now an update on Costco’s financial health reveals that the rise in sales came at the expense of profits as the company held the line on prices — even as its own costs rose — to please its members.

On Wednesday Costco warned that its fourth-quarter earnings (for the period ending Aug. 31) would come in well below analysts’ expectations. The warehouse club operator cited inflation, particularly high energy costs, as a root cause. Chief Financial Officer Richard Galanti noted in the announcement that Costco has been “holding selling price points to help drive sales and maintain the confidence of our members.”

Wall Street, not known for its loyalty, was quick to respond: Costco’s share price, up nearly 18% over the past year, fell almost 12% despite the company’s declaration of a quarterly cash dividend of $0.16 per share and an additional stock repurchase program of up to $1 billion. (That’s in addition to the $5.8 billion repurchase plan previously announced.)

Clearly, Costco is struggling to balance the interests of its shareholders with those of its members. So far, it appears to be favoring members. Loyal Costco shoppers, who are more affluent than members of rivals SAM’S Club and BJ’s Wholesale Club, have rewarded the retailer by renewing their memberships and buying more of its merchandise. Galanti noted that Costco’s sales continue to be strong relative to other retailers.

Wall Street, which in the past has knocked the company for lavishly rewarding employees with generous salaries and benefits at the expense of its bottom line, apparently feels that investors are getting short changed again.

Still as food, fuel, and other commodity prices continue to rise, Costco will eventually reach the point where it’s forced to blink and raise prices. In the meantime, Costco appears willing to see margins suffer in order to defend, and perhaps win, market share.

June was kind to retailers who lure shoppers with the lowest prices, overcoming consumer reluctance to spend in these uncertain economic times. Mega-retailers Wal-Mart and Costco posted solid results last month, with Wal-Mart’s same-store-sales up 5.8% (the biggest jump in years), while Costco posted a 5% gain in comparable sales at its US stores (excluding gas price inflation). It’s probably no coincidence that Wal-Mart and Costco happen to be the nation’s #1 and #3 sellers of groceries, respectively. Indeed, Wal-Mart posted its strongest results in the grocery category. For while consumers are looking for bargains, they seem to be sticking to necessities like food. While Target also sells groceries at nearly 220 SuperTarget stores, the nation’s #2 discount chain isn’t a force in grocery sales. Its same-store-sales (the best indicator of a retailer’s health) increased a modest 0.4%.

But low prices alone can’t stave off disaster. The latest in a growing list of retail casualties (including Linens ‘n Things, Sharper Image, and Whitehall Jewelers, to name just a few recent bankruptcies) is the ultra-low-price apparel chain Steve & Barry’s, best known as the home of the $8 dress and for celebrity-branded clothing from the likes of Sarah Jessica Parker, Venus Williams, and NBA star Stephon Marbury. The 275-door discount apparel seller filed for Chapter 11 bankruptcy protection last week and plans to shutter 100 outlets and may liquidate. In May, the chain was hailed in the business pages of The New York Times for its “obsessive attention to costs,” which allowed it to operate on razor thin margins. Reacting to the company’s fall, analysts blamed “a risky and fragile business model” coupled with more than $500 million in debt. Not a nice place to be in a credit crunch.

The company’s founders Steve and Barry in a statement placed the blame on a hostile business environment that “reduced funding to our suppliers, landlords, and our company.” Indeed, the two said sales have been strong right up to the bankruptcy filing. That may be. Nevertheless, the company is probably toast.

The Darwinian winnowing of the retail industry demonstrates the obvious: A sustainable business model is essential to long-term survival in a fickle industry and volatile economy. But that’s a lesson easily ignored when credit is easy to come by and consumers are charging up a storm.

When the current shakeout in the retail industry is over and the economy begins humming again, it’s a safe bet that the retail landscape will look very different than it did going into the current downturn. But that’s a subject for another post.

The deal never left the dock. After initially insisting that the combination of troubled Pier 1 Imports and Cost Plus was “a marriage made in heaven,” CEO Alex Smith said last week that Pier 1 was abandoning its unsolicited bid to acquire its smaller rival, less than three weeks after making its initial approach. The $88-million offer, which Cost Plus quickly dismissed as “distracting and ill-timed,” got a chilly reception on Wall Street. Goldman Sachs issued a pessimistic view of the proposed acquisition and lowered its earnings and price target, which drove down Pier 1’s stock. With both companies struggling to turn around their shaky businesses in a weak economy, this union looked doomed from the start, despite Smith’s assertion that given the two firms’ “similar customer bases and broadly similar business models” they are “an excellent fit.”

Upon pulling the plug, Pier 1 said it was unlikely it would be able to buy Cost Plus at a price that would make sense for its shareholders.

If there’s a silver lining to the current market malaise it’s that ill-conceived deals, such as the Pier 1/Cost Plus tie-up or the much-maligned Blockbuster/Circuit City combo, are becoming harder to complete. Indeed, a recent report from Thomson Reuters found that global M&A activity dropped 35% in the first half of 2008, as the credit crunch dried up cash needed to complete deals and economic uncertainty made companies and shareholders reluctant to take on additional risk.

Investors reacted to the news of both deals — and the subsequent release of weak financial results by Pier 1 and Circuit City — by driving down the stocks of all those involved. Indeed, Circuit City’s shares have sunk to their lowest level since 1991. As for the Pier 1’s shares, after decreasing 40% since its bid for Cost Plus was announced on June 9, they’ve rebounded a bit.

So for now, the boom in M&A and private equity buyout deals for retailers appears to be over. That’s bad news for investment bankers who’ve feasted on the fees deals generate. On the plus side, it provides an opportunity for struggling retailers to get their own houses in order, before taking on another chain’s problems.

Pity the long-suffering board members of Whole Foods Market who have to contend with founder and CEO John Mackey’s ill-considered blog outbursts. Mackey, who resumed blogging last month after a 10-month hiatus that resulted from the dust-up over comments he made under the online alias “Rahodeb,” has put his foot in his virtual mouth once again. But this time his comments weren’t posted to his CEO’s Blog, but instead appeared in an interview he gave in late May to another blog called Chews Wise.

Mackey, who can’t be accused of not speaking his mind, said “If I could go back in time, we wouldn’t have done the Wild Oats acquisition.” Say what?! The ink is barely dry on the controversial $565 million deal, which closed last August after a six-month battle with the Federal Trade Commission. The takeover also led to an investigation by the Securities and Exchange Commission following the revelation that “Rahodeb” had been secretly promoting his company’s stock and disparaging his rival’s management team in postings to a Yahoo stock message board. The investigation led to the suspension of Mackey’s blogging privileges until the SEC and the Whole Foods board completed their investigations. The good news, says Mackey in his blog, is that he’s free to post again “with the board affirming their complete support for me and the SEC recommending that no enforcement action be made against Whole Foods market or me.” The bad news, for Whole Foods shareholders anyway, is that Mackey still can’t keep his mouth shut.

Granted, his comments to Chews Wise focus more on the cost to him personally and the disruption to the company he built rather than the business merits of the deal: “We spent tens of millions of dollars in legal fees, we’ve been investigated, it’s been highly disruptive. I didn’t realize it would cause so much grief.” Really? The market leader in an industry with few competitors tries to takeover its #1 rival and he’s surprised by the FTC’s reaction? Don’t get me wrong. I supported the deal, because I viewed Whole Foods Market’s competitive universe more broadly than did the FTC. But Mackey and Whole Foods would have to have been incredibly naïve not to expect a messy fight. Indeed, the FTC is appealing the ruling that allowed the acquisition to proceed despite the fact that it’s a done deal.

Still, Mackey’s lukewarm support for the Wild Oats integration to date is less than encouraging. He says that from a “business perspective,” it’s too early to tell whether the merger will be an overall success” but added “We’re pretty happy so far.” How’s that for damning with faint priase? With food prices soaring and Whole Foods’ stock down nearly 40% since the acquisition, the board and shareholders would be better served by some outspoken cheerleading rather than Mackey’s characteristic candor.