DBRS Downgrades Safeway Inc. Issuer Rating to BB (low) following Acquisition by Albertson’s

DBRS Limited (DBRS) has today downgraded the Issuer Rating of Safeway Inc. (Safeway) to BB (low) from BBB and its Senior Unsecured Debt rating to B from BBB with a recovery rating of RR6; the trends are Stable. DBRS has also changed the name of the rated security to Senior Secured Second-Lien Notes and discontinued Safeway’s commercial paper rating at Safeway’s request. These actions follow the Company’s announcement that it has all necessary regulatory approvals for and its shareholders have voted in favour of the proposed transaction under which Albertson’s Holdings LLC (Albertson’s or the Company), the direct owner of Albertsons LLC, will acquire all outstanding shares of Safeway.

DBRS has removed the ratings from Under Review with Negative Implications. On March 3, 2014, DBRS placed Safeway’s ratings Under Review with Negative Implications following the Company’s announcement that it was considering a possible transaction involving its sale.

Under the terms of the transaction, each outstanding common share of Safeway will be converted into $32.50 in cash and a pro rata portion of any net proceeds with respect to certain sales of Safeway’s interest in Casa Ley and Property Development Centers, LLC (PDC) if completed before the acquisition or value rights if the sales are not fully completed by the close of the acquisition. In addition, Safeway shareholders will receive a pro rata portion of after-tax amounts received by Safeway as dividends or distributions in respect of Casa Ley or that are paid from the operating earnings of PDC. Finally, shareholders will receive per-day payments until close if the acquisition closes after March 5, 2015. Debt financing arranged by Albertson’s includes a Senior Secured First-Lien Term Loan B-2 of approximately $1.4 billion, a Senior Secured First-Lien Term Loan B-3 of $950 million and a Senior Secured Term Loan B-4 of approximately $3.9 billion; an ABL facility with a limit of $3.000 billion; and $1.145 billion of Senior Secured Second-Lien Notes offered by the Company and Safeway as co-issuers. In addition, certain Safeway senior unsecured notes due 2016 and 2017 will be secured by a second lien on all assets ranking pari passu with the newly issued second-lien notes, and approximately $750 million of Safeway senior unsecured notes due 2027 and 2031 will be secured by a second lien on substantially all assets of Safeway.

In terms of operations, management is expected to leverage the Company’s improved size and scale and has stated that it believes it can achieve significant synergies in the $650 million range within four years. Anticipated synergies will be driven primarily by removing complexity and reducing redundant costs as well as other efficiency-improving initiatives, including the information technology (IT) conversion of Albertson’s stores to Safeway’s IT environment.

As a result of the organizational structure, the review of Safeway’s ratings is based primarily on an analysis of the combined entity, Albertson’s. DBRS focused its analysis on the following: (1) Albertson’s business risk profile, including potential benefits from enhanced scale and geographic diversification as well as risks associated with the integration and realization of potential synergies and (2) the financial risk profile and longer-term financial management intentions, including any deleveraging plans.

DBRS ANALYSIS
(1) Business Risk Profile
The combination of Safeway and Albertson’s results in the second-largest conventional supermarket in the United States (based on store count and sales) and the third-largest U.S. grocery retailer, offering a significant improvement in size and scale with pro forma revenue of approximately $45 billion and pro forma-adjusted EBITDA before synergies of approximately $1.8 billion. The business risk profile of the combined entity is further supported by its solid market positions, well-recognized brands, geographic diversification across 18 states in the Western and Southern parts of the United States and significant real estate ownership.

(2) Financial Risk Profile
In terms of financial profile, Albertson’s is expected to have balance sheet debt (including capital leases) of approximately $9.9 billion on a consolidated basis. Combined with pro forma earnings, DBRS estimates that the combined entity will have lease-adjusted debt-to-EBITDAR of approximately 5.64 times (x) and lease-adjusted EBITDA coverage of approximately 3.10x, credit metrics considered to be in the B range of ratings. That said, the combined entity should nevertheless generate meaningful levels of free cash flow (based on relatively stable operating cash flow as a food retailer and declining capex levels) and could deleverage significantly through a combination of mandatory and optional debt repayment as well as earnings growth.

DBRS believes that Safeway’s Issuer Rating is best positioned in the BB (low) rating category, with a Stable trend, reflecting both the material increase in leverage and the investment-grade characteristics of the combined entity’s business profile.

Pursuant to its announced plans and the change of control provisions contained in certain of Safeway’s senior unsecured notes maturing in 2019, 2020 and 2021, Safeway has made an offer to repurchase such outstanding senior unsecured debt (other than the 2016/2017 and 2027/2031 notes discussed above). Any of the notes maturing in 2019 which are not repurchased will be secured with the same collateral package as the 2016/2017 notes as described above and any of the 2020/2021 notes that are not repurchased will be secured with the same collateral package as the 2027/2031 notes as described above.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

The applicable methodologies is Rating Companies in the Merchandising Industry (January 2015), DBRS Criteria: Commercial Paper Liquidity Support for Non-Bank Issuers (February 2014) and DBRS Recovery Ratings for Non-Investment Grade Corporate Issuers (March 2014), which can be found on our website under Methodologies.

For more information on this credit or on this industry, visit www.dbrs.com or contact us at info@dbrs.com.