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Under pressure?: Largest outside shareholder could be pushing Marsh to find buyer

December 5, 2005

Marsh Supermarkets Inc.'s decision to seek a buyer might not have been made within the company's Indianapolis headquarters. It might have come from 115 miles away in Cincinnati.

That's home base for the c o m p a ny 's largest outside shareholder, A m e r i c a n Financial Group Inc., an insurer controlled by the family of billionaire tycoon Carl Lindner. A source knowledgeable about the discussions said AFG, a Marsh shareholder for more than two decades, grew tired of the lackluster performance of the grocery's stock.

Marsh officials aren't talking, and AFG Chairman Lindner and other executives did not return repeated calls. However, "It's not uncommon for [dissatisfied] shareholders to push for a sale," said Robert Shortle, president of Indianapolis-based Periculum Capital Co. LLC.

Indeed, Marsh shares are so thinly traded that a sale may be the only avenue for AFG to cash out its big stake. It owns 709,844 shares, or 19 percent of the company's Class A voting stock. Including the company's nonvoting Class B stock, it holds a 9-percent stake. Based on the Class A shares' trading price Dec. 1, the stake's worth $7.6 million.

The only shareholder with a larger holding is CEO Don Marsh, who directly or through immediate family owns 21 percent of the voting stock and 15 percent of all shares-worth a total of $12.6 million.

On Nov. 29, the same day Marsh announced it had hired the investment firm Merrill Lynch to explore a sale, Don Marsh told employees in a videotaped message that the decision was partly "for the enhancement of shareholder value."

It's easy to see why Lindner and other shareholders would feel frustrated. The company's shares at the time of the announcement were trading below where they were a decade ago. Even counting dividends shareholders have collected along the way, the stock has badly underperformed the overall market and many other grocers' stock.

And analysts say the outlook for markedly improved performance is bleak. They say the central Indiana grocery market, long considered one of the country's most competitive, is growing more so, as Arkansas-based Wal-Mart and Cincinnati-based Kroger add stores and gain market share.

On the same day Marsh announced it was exploring a sale, it said it lost $3.4 million in the second quarter, which ended Oct. 15. It also announced it was suspending its quarterly dividends, a move that will conserve more than $4 million in cash a year.

But a sale may not be a panacea for disappointed shareholders. In the days after Marsh's announcement, the company's shares slid, suggesting investors are skeptical the grocer will find a buyer, or at least one willing to pay an attractive price.

The Class A shares were trading Dec. 1 at $10.61, and the Class B shares were at $10.38. Both classes were down more than 11 percent since the announcement and down more than 25 percent since July.

Analysts say it's unclear how events will unfold. A major grocer, such as California-based Safeway Inc., could buy Marsh to enter the Indiana market, perhaps paying a premium to the company's $83 million stock market value. (That firm has no affiliation with the locally based seven-store Safeway chain.)

Or a private equity firm could swoop in as a buyer. Or demand could be tepid for the entire company, prompting Marsh to sell off its holdings in parts and shuttering groceries or Village Pantry convenience stores that fail to attract interest.

The outcome is sure to have a big impact on the community. Marsh is the sixthlargest employer in Indiana, with 14,900 workers. It's also a high-profile corporate citizen, supporting everything from pro sports teams to arts organizations.

Private equity boom

Analysts say the timing is right to attract interest from private equity firms. In recent years, the firms have raised billions of dollars from investors, and they're now scouring the globe for companies to buy. Among the biggest players are Kohlberg Kravis Roberts & Co., Warburg Pincus, Carlyle Group, Blackstone Group and Apollo Management.

Three groups of private equity firms, for instance, have put together bids for a much larger grocer now on the block, Idaho-based Albertson's Inc. It's expected to sell for more than $16 billion.

Marsh has some blemishes that could cool interest, however. For one, equity firms like to purchase companies through leveraged buyouts. The firms put in only a small amount of equity and ratchet up the debt of the company they're buying.

But Marsh already is $200 million in debt. In its most recent quarter, it had to devote $6.3 million to interest payments.

"It's detrimental for a private equity group that they're so leveraged," said Mitchell Corwin, an analyst with Morningstar Inc. who follows the company.

Marsh's diminished real estate holdings also could be a drawback. Private equity firms often look for assets they can readily sell to raise cash. After a private equity firm a year ago merged Kmart and Sears, for instance, it generated a hefty return by selling pricey real estate.

But Marsh in recent years has propped up its bottom line by selling land it doesn't need. The company earned $3.8 million selling excess real estate in 2005 and $3 million last year. It also has been raising cash by selling its grocery stores to landlords or other investors and leasing them back.

Marsh now owns 29 percent of its groceries and 27 percent of its convenience stores, according to a filing with the Securities and Exchange Commission.

Grocery suitors

It's more likely another grocer would buy Marsh, said Mark Foster, a money manager for Kirr Marbach & Co. in Columbus, Ind.

"There are probably some regional [chains] that want to add on a contiguous geography," he said.

Analysts say the good will surrounding Marsh's name might spur interest, and a buyer might even choose to keep that name.

It's anybody's guess, however, who the suitors might be. Less than 48 hours after the announcement, industry observers had rattled off the name of nearly every midsize to large grocer in the country as a potential buyer.

"[St. Louis-based] Schnuck's ... is the leading logical acquirer," said retail consultant Bill Bishop, president of Willard Bishop Consulting Ltd. He thought Pittsburgh-based Giant Eagle also would have interest because its market extends to neighboring Ohio.

William "Rusty" McKay, who formerly owned three Cub Foods stores in Indianapolis, said California's Safeway "could be a player." The company is the fifth-largest grocery chain in the country, with annual sales of $33.6 billion.

Yet he also cautioned that California Safeway has had difficulty integrating smaller chains it purchased in Chicago, Houston and Philadelphia.

Wal-Mart and Kroger also might be candidates, said Joseph A. Lackey, president of the Indiana Grocery and Convenience Store Association.

Either, however, surely wouldn't want the whole company, since many of their locations are within site of a Marsh. That could lead to the company's being sold piecemeal.

"It's unlikely that the entire chain will be sold to another supermarket operator," said Morningstar's Corwin, "but if it's broken up, there might be some interest."

Is bankruptcy an option?

Corwin thinks Marsh might ultimately land in bankruptcy court because its heavy debt will scare off suitors. Anyone buying the company for its current market value of $83 million also would be saddled with its $200 million debt load.

Marsh would be more attractive if it files for Chapter 11 protection and sheds debt through the restructuring process, observers said.

"Marsh is losing money on a quarterly basis at a fairly high rate," said Henry Efroymson, a partner and chairman of the bankruptcy group at Ice Miller, the state's largest law firm. "And although the company reportedly has sufficient cash availability now, if those losses continue ... it will have no choice but to consider alternatives to meet those needs."

But Foster thinks bankruptcy is a long shot. He said Marsh could raise cash by selling a division, such as its Village Pantry business.

Bankruptcies have become common in the grocery business, as general merchandisers like Wal-Mart and Target enter the industry and grab market share with low prices.

Florida-based Winn-Dixie filed for Chapter 11 protection early this year, blaming competition from Wal-Mart. In May, Jasper-based Buehler Foods filed for Chapter 11 protection, saying it overextended itself when it bought 17 Winn-Dixie locations in Louisville.
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