Posted on July 13, 2007 by David Laidlaw
Last month we presented at a capital raising event and were swapping ideas with Jeffrey Cohen, a Risk Arbitration/Event Driven manager who runs Silverado Capital Management. Risk Arbitration involves making investments in acquirers and takeover candidates during mergers and acquisitions. Managers that adhere to this strategy assess the likelihood of particular deals going through and invest accordingly. Mr. Cohen touted an options strategy that he was pursuing around the Whole Foods acquisition of Wild Oats.
Whole Foods, the largest natural foods grocer, reached an agreement to acquire Wild Oats, a similar retailer with a smaller national footprint, for $18.50 per share. The Federal Trade Commission (FTC) subsequently brought a suit in the Federal District Court of Washington DC to stop the acquisition based on the argument that the acquisition would create a monopolistic natural foods retailer that would be free to raise prices to the detriment of their consumers. Mr. Cohen argued very persuasively that the legal underpinnings of the FTC’s suit were weak and that he believed the acquisition would proceed at the agreed upon price.
US anti-trust laws prevent companies from acquiring their competitors in specific markets to create monopolies. The FTC’s suit, which is still pending, hinges upon the definition of what constitutes a market. The FTC argues in its complaint that the market for natural and organic foods is a distinct market from the broader market for groceries. The idea is that if Whole Foods acquired Wild Oats then the combined entity would raise prices for organic foods and the public would have no where else to buy these gourmet foods.
We agree with our colleague Jeffrey Cohen and believe that the FTC’s contentions are specious. The grocery market is large and contains a varied spectrum of sellers that cater to many different niches within the broader market. Whole Foods and Wild Oats cater to health conscious and gourmet shoppers who will pay a premium for organic and natural foods. However, this market is also served by a multitude of small local health foods stores and gourmet shops. Large national grocers such as Albertsons and even Wal-Mart are also introducing ever larger natural foods sections and organic items. Finally, farmer’s markets and delivery services sell premium food at premium prices to a health conscious public. Therefore, we believed that Whole Foods would be able to successfully argue that its acquisition would not allow it to raise prices given the abundant competition.
In light of these thoughts, we began to explore ways to exploit our conviction that the deal would proceed. The FTC has been on a losing streak by overreaching and trying to stop reasonable mergers. We also felt that the population the government was seeking to protect is the most affluent and best able to find alternatives and therefore doesn’t require much protection.
Many portions of the FTC’s complaint were originally redacted. However, when these segments were revealed on June 5, 2007, the investment thesis evaporated.
John Mackey, Whole Foods’ CEO, e-mailed his board members that his main rationale for pursuing Wild Oats was to be able to maintain and possibly increase pricing in those markets where it competed with Wild Oats. He stated that
By buying [Wild Oats] we will … avoid nasty price wars in Portland (both Oregon and Maine), Boulder, Nashville and several other cities which harm gross margins and profitability….Eliminating them means eliminating this threat forever, or almost forever.
Wow! It boggles the mind that a modern CEO would both believe this sentiment and also memorialize these thoughts. We think that any price relief that Whole Foods would realize would be only temporary. The organic and premium foods market will continue to draw fierce competition exactly because their margins are higher. However, we dropped our investigation of this idea once Mackey’s thoughts came to light since any judge or jury would have a hard time finding in favor of company whose CEO explicitly stated he was pursuing an acquisition to create a monopoly in specific markets and raise prices.