the Market Basket saga: taking Arthur S’s position

Market Basket is a privately held New England discount grocery chain controlled by two third-generation branches of the founding family.  One branch, owning 50.5% of MB, is led by Arthur S. and has no role–other than being on the board of directors–in the day-to-day running of the firm.  The other is led by the largest single shareholder, Arthur T.

MB recently deposed Arthur T. as CEO and replaced him with two non-family members.  Warehouse and delivery workers struck when they heard the news (with the encouragement of Arthur T., some have suggested), preventing the 71 stores from restocking and effectively hamstringing the firm.  Recently, the Arthur S. branch has agreed to sell its shares of MB to Arthur T. for $1.5 billion.

Throughout this highly public dispute, Arthur T. has been portrayed as a benevolent retail genius, creating an immensely successful business with fanatically devoted employees and extremely loyal customers.  Arthur S., on the other hand, has been seen as a money-grubbing child of privilege who wants to fund his yacht and string of polo ponies by pillaging the workers’ retirement plans.

A lot of this may be true, for all I know.  And the issues rocking MB are all pretty routine third-generation family owned company stuff (see my earlier post on MB).  But in the feel-good story line being taken by the media, one fact is being overlooked.  From what little has been in the press about MB’s profits, it doesn’t appear to be a particularly well-run company.  Arthur S. is probably right that Arthur T. isn’t a good manager.

the case for Arthur S.

Let’s say I’m a member of the Arthur S family and I hold 5% of MB’s outstanding stock.  I receive a yearly dividend of $5 million.  My genetic good fortune is significantly better even than winning the Megamillions jackpot.  So in one sense I should have no complaints.

On the other hand, my share of the assets of MB is worth about $175 million.  Therefore, my annual return on that asset value is 2.9%.  That’s about half the return on assets that Kroger achieves.  It’s also just over a third of what Wal-Mart generates, but I’m confident MB doesn’t aspire to be WMT.

I presumably also know that good supermarket locations are extremely hard to find in New England and that those MB has established over prior generations are immensely valuable.  It’s conceivable that if MB were to conceptually divide itself into two parts, a property owning one and a supermarket operating one, and have the property arm charge market rents to the stores, MB would see that the supermarket operations lose money and are only kept afloat by subsidies from the property arm.  (This situation is more common than you’d think.  It was, for example, the rationale behind the hedge fund attack on J C Penney.  That fact that inept activists botched the retail turnaround doesn’t mean the underlying strategy was incorrect.)

Even back-of-the-envelope numbers suggest something is very wrong with the way MB is being run.  Personally, my guess is that the inefficiency has little to do with employee compensation or with merchandise pricing, although the former has apparently been the focus of the AS’s discontent.  I’d bet it’s in sourcing and in how shelf space is allocated.

At the same time, Arthur T is presumably blocking my every attempt at finding stuff out and is rebuffing board suggestions that he bring in help to analyze why his returns are so low.  If MB were a publicly traded company, I could sell my shares and reinvest in a higher-return business.  I’m probably not able to do this with MB.  Even if I were, the public intra-family feuding would suggest the stock wouldn’t fetch a high price.

I have two choices, then.  I can accept the status quo, or I can try to create a consensus for the family to sell the firm.  That latter is what Arthur S. chose to do.

the Market Basket supermarket feud

I decided to write about my sense of the stock market tomorrow.

Instead, I’m going to write about the struggle for control of the family owned, privately held New England supermarket chain, Market Basket.  That’s both because it says something about the value of supermarkets in the Northeast, and because the fight is typical of what happens in family owned firms in the second or third generation.

The story:  Two branches of the Demoulas family own Market Basket.  One, led by Arthur S. has no involvement in running the business; the other, led by Arthur T., does–or did until a short time ago.

As a result, according to Bloomberg radio, of some past impropriety on the part of the ATs, the ASs have voting control of Market Basket.  Last week the board voted to oust Arthur T. as CEO and replace him with two outsiders who presumably have a mandate to cut costs and prepare the 71-store chain for sale.

Hearing this, warehouse and delivery workers walked off the job, demanding Arthur T’s reinstatement.  Many other workers have staged protests.  Store shelves haven’t been restocked.  The chain is reported by the Boston Globe to be losing $10 million a day.

this is typical family owned company stuff

Many family owned businesses are started by one or two entrepreneurial relatives.  Firms like this tend to have:

–high financial leverage

–lots of family on the payroll

–content to have economic rewards come through salaries/perks for family members rather than paying out dividends

–concerned more about stability than growth.

By the second or third generation, ownership is diffused.  Grandchildren probably don’t want to be in the family business.  Recognizing the value of the stock they hold, they want to cash out.  They come into conflict with other family members, whose lives, heritage and hefty salaries are tied to the business.

New England supermarkets are valuable 

The Globe says Market Basket could be worth $3.5 billion.  There are apparently about a dozen shareholders.  That would imply something like a $100 million payday for even the smallest holders if the firm were sold.  Until recently, the firm had been distributing dividends of about $100 million a year, for about a 3% yield.

I haven’t tried to confirm any of these figures myself.

One important thing about New England, though, is that it’s a mature, heavily developed region.  This has two positive implications for Market Basket:

1.  It’s impossible for Wal-Mart, the ultimate supermarket killer, to get a strong foothold.  It simply can’t assemble parcels to build on or get local planning commission authorization to start construction.

2.  For the same reason, Market Basket’s 71 store locations have immense potential value to a competitor.

A side note:  in my town, the supermarkets are small, dingy and very dated.  Twenty years ago, a major chain purchased a large parcel of land which it thought was zoned for a supermarket, and on which it intended to build a superstore.  The project is still tied up in litigation spurred by “concerned citizens,” funded, I’m told, by the existing markets.

bones of contention with Market Basket

Store employees are reportedly much better paid than typical supermarket workers.  Starting pay is $4 an hour higher than the minimum wage.  Experienced cashiers can earn double the industry average of around $20,000 a year.  Market Basket puts 15% of wages into an employee 401k.  Arthur T. also apparently projects a sincere concern for employees’ welfare.

Employees assume, doubtlessly correctly, that Arthur T.’s ouster spells the end of above-average salary and benefits.  This for two reasons:

–Arthur S’s family understands that a dollar of wages to an employee is money that would otherwise be dividended to shareholders, meaning it’s money that comes directly out of their pockets.  If we assume that the average employee earns $4 an hour more than the industry median and that the 25,000 workers average 20 hours a week, then the  total “excess salary” paid by Market Basket yearly is $107 million.  My suspicion is that this is too low.  Still, a ballpark figure is that dividends to shareholders could double if wages and benefits are chopped back.

–Presumably, a trade buyer would pay less for a company if it had to take the reputational black eye of reducing staff and cutting compensation.  Market Basket could sell to a financial buyer, a private equity firm that would do the pruning.  In my view the equity owners have decided to maximize their personal payout by doing this unsavory task themselves.

To my mind, this is all par for the course for family owned businesses.  What is truly remarkable in this case, though, is how much publicity the ouster of Arthur T. has gotten.  The way employee sentiment has been galvanized is also noteworthy, although workers have a very clear–and large–economic interest in defending the status quo.

Company warehouse workers and truck drivers are playing a key role in the dispute, since their job action is the reason stores can’t restock.  Some press reports have even suggested that Arthur T., who is apparently one of a number of potential buyers of Market Basket, somehow helped them along in making their decision to walk off the job.  I have no idea whether this is correct, or whether it’s part of a movement to deny AT sainthood.