Play Along, Whole Foods – Bloomberg Gadfly

Its 10 percent stock jump Monday showed faith in the pledge by activist investor Jana Partners to fix the flagging grocery chain or sell it for a good price. After a six-quarter streak of terrible sales results, I’d wager shareholders would cheer anyone that might provide Whole Foods with a reality check.

The company’s refusal to adapt as competitors ate its lunch makes for an ironic downfall for a company credited with teaching a generation of consumers what organic food is and how to find healthier fare. But investors should be careful what they wish for. If the choice is between fixing or selling, long-term believers should hope for a repair job.

Chief Executive Officer John Mackey and other Whole Foods executives just got too cocky over the years. Smart competitors like Kroger Co., Sprouts Farmers Market Inc., and privately-owned Trader Joe’s commandeered its organic food playbook, and it turns out customers were happy to embrace similar products at cheaper prices.

As I wrote in February, Whole Foods was starting to tune into reality — two years after Gadfly and other critics urged change. Jana’s agitation suggests a lack of confidence in management’s ability to turn things around. If this activist can shake management enough to accelerate these changes, it could set the company on a growth path again.

Its grocery list of initiatives to improve operations, technology, return on invested capital, procurement, and pricing strategies is spot on. As is a new proposed slate of board members and consultants, particularly outsiders like food writer Mark Bittman and Diane Dietz, CEO of fast-growing skincare brand Rodan and Fields. Both have a good pulse on what consumers want (though this cannot be said about potential board member Glenn Murphy, who stepped down as CEO of Gap Inc. in 2015 after its namesake brand fell out of favor and sales fell).

The quickest and easiest choice would be to sell to private equity. But such buyers have terrible track records in retail — a familiar pattern is to load them up with debt, and watch sales bleed after gross under-investment deters customers.

A new strategic owner committed to invest and grow the brand, such as Kroger Co., or Trader Joe’s owner Aldi Nord, would prove better caretakers. The stumbling block here is that will be hard for any buyer to stomach the 51 percent premium Whole Foods is trading at versus its peers. And let’s just go ahead and count out the rumors that Amazon.com Inc. might emerge as savior — Amazon may want to get into the physical grocery stores game, but it would rather build its own rather than paying for aging retail castoffs.

Of course, Whole Foods shares have come down dramatically from their 2013 peak of $58.50. But it was already trading at 23 times forward earnings before the Jana stake was announced. Add in a 20 percent deal premium above Whole Foods’ $9.8 billion market cap on Friday, and it makes the grocer a hard target for any strategic buyer to swallow.

Jana is starting with a pretty strong foundation — Whole Foods has a valuable customer base, $15.7 billion in annual revenue, an enduring brand name, and potential for upside with a successful turnaround. The activist firm has the retail chops to make a convincing case it can push it in the right direction and lift its shares. Let’s just hope Whole Foods’ management and board of directors is smart enough to embrace Jana’s changes rather than fighting them.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

(Corrects to show that Bittman and Dietz are involved as consultants.)

To contact the author of this story:
Shelly Banjo in New York at sbanjo@bloomberg.net

To contact the editor responsible for this story:
Jennifer Ryan at jryan13@bloomberg.net