wholeI’ve had a love hate relationship with Whole Foods Markets, Inc.  I love what they provide for me, but I hate the crowds and the customer experience.   In my household we refer to it as “Whole Paycheck”.   I was lucky, in a sense, when I lived in New York, the first Whole Foods  went in just a few blocks from my apartment, providing a working guy an oasis of healthy food options, that stood in marked contrast to everything I could procure within a 10 block radius of my doorstep.   I moved to Seattle and, thankfully, Whole Foods was just a few exits up the freeway, and I was able to conveniently procure my produce, protein and staples that served as the basis of our healthy lifestyle.

I first learned about Whole Foods when I was a traveling management consultant at Price Waterhouse (pre-merger with Coopers & Lybrand).   Back in the early days of Fast Company (circa 1996), the magazine featured an article on the company (article here) calling it the future of democratic capitalism — decentralized team based work environment, financial transparency, and consensus hiring.  At the time, I thought it was interesting model (multi-functional teams were all the rage in the reeingeering world), completely counter cultural within the grocery industry, but I was fairly out of tune with the natural foods movement at the time.

As I graduated from consulting to investment banking, my proximity to Whole Foods became closer,  and not only as a consumer.   Perry Odak, who was a Gordian Group, LLC (my previous employer) relationship, from the Ben & Jerry’s deal, had been brought in to turnaround Wild Oats Markets, Inc., the second largest organic market chain in the country.  While we were never engaged, to my knowledge, we were routinely bouncing ideas off of Perry and providing him valuation insights.  It was clear that an M&A exit was in their future.  I spent more time understanding the industry and business model and walking the isles of Whole Foods.  By then I was pretty much living in the prepared foods section.

While Whole Foods enjoyed a healthy run, driven by expansion of the store footprint, accelerating consumer sentiment around natural and organic foods, and the strong economic environment, the run began to lose steam in late 2006.   With the stock trading at $65/share in November 2006, the company announced results which included a projected slowing of their growth rate.   Comps were off, margin compression was evident, and square footage ramp was below expectations.  The era of 20%+ annual growth for Whole Foods had sunseted many believed.  Applying more conservation price-to-earnings assumptions yielded implied stock prices nearly 50% the prevailing share price.  By January, the stock was trading at $43/share, or better than expected according to analysts.

In February 2007, the inevitable happened, Whole Foods offered to purchase Wild Oats via a tender offer for would turn out to be approximately $752 million ($586 million if you net out the stores sold to Smart & Final post close).  If you can’t build it any more, than buy it.  Given Wild Oats historical operating challenges and Whole Foods  execution acumen, it was thought that considerable value enhancement could and would occur.  Whole Foods has a strong track record of turning around under performing natural foods retailers, and  it appeared there were significant opportunity for both overhead cost savings and store-level productivity gains to be had at Wild Oats owned stores.   The analyst community believed the merger will be a significant earnings driver for Whole Foods over the next several years.

A funny thing happened on the way to the alter however — the Federal Trade Commission  (FTC) filed a lawsuit to block the proposed acquisition, taking a very narrow view of the antitrust market, given that nearly every grocery store now sells organic and natural products.  This had negative implications for the stock, as uncertainty now was a compounding factor on top of eroding performance in the core business caused by cannibalization, competition and price reductions.   At the very least management would be distracted and integration delayed.

Whole Foods did not sit on its hands and wait for the FTC to mess with its future.  Instead they took their case to court and received a preliminary injunction against the FTC, setting the stage for an imminent closing.  In the background, it came to light that Whole Foods CEO John Mackey had been posting negative comments  under an anagram of his wife’s name (Rahodeb, when unscrambled would be Deborah) about Wild Oats and glowing comments about his own organization on the Yahoo! Finance message board for seven years, referring to himself in the third person.  Additionally emails from Whole Foods executives expressing their disdain for Wild Oats and their desires to “crush them at any cost” came to light.   That notwithstanding, on August 27, 2007 the deal was finalized and the merger effected.

Case closed? Not so fast.

After closing the deal with Wild Oats, Whole Foods stock price continued to erode.  Earnings misses followed by failed integration milestones blurred in to an economic crisis where consumers were trading down and, ultimately, suspension of the dividend.   Facing both a confidence crisis and a liquidity crunch, Whole Foods took a $425 million investment from Leonard Green & Partners (LGP) through their Green Equity Partners Fund.   While very successful, LGP is not known for paying peak market multiples.

Then things started to get very strange…

On July 29th,  a three-judge panel ruled that a district court judge had erred when he refused to grant an FTC request for an injunction to block the merger of Whole Foods and Wild Oats.  On November 21st, Whole Foods lost a decision to have that ruling reviewed by a larger panel of judges.   Despite the fact that most Wild Oats stores have been closed or absorbed, the FTC is now moving to have the merger invalidated.  A hearing on the merger is scheduled for February 2009.  Whole Foods has launched a new suit, claiming their right to due process has been violated.

In an effort to make a compelling case that Whole Foods is not a monopoly they have subpoenaed the records of 93 competitors in the natural food space (note: the number quoted in the popular press is 96, but in a recent court motion, the number was stated as 93).  Their inquiry focuses on 29 markets in what is terms are the “premium organic retailing space”.   Parties were given until November 4th, 2008 to respond. Financial records, weekly sales figures, marketing plans, store opening schedule, inventory reports, and more.  Most of these entities are in fact private, making these records proprietary.  Amazingly, 50 of 93 entities have complied in whole or in part without a peep.  The squeaky wheel in the machine is New Seasons Markets, a nine store chain of natural markets located in Portland, Oregon.

New Seasons CEO Brian Rhoter naturally took issue with the subpoena and is taking his case to court.  In his blog Rhoter points out not only the burden complying with the order is having on his business financially, but also, aptly,  that the FTC motion does not, in his mind, provide for adequate protection of its information or remedies upon breach.  Basically, Rhoter is saying we don’t have a dog in this fight, so why are we unnecessarily being burdened and our business information being put at risk.   The fact that Whole Foods had fronted the argument that none of their employees would see the data, and then went to court to get it sent to their Austin headquarters, raises eyebrows.

While I feel for New Seasons and side with Rhoter on this issue, my sense is that Whole Foods will prevail in court.   Antitrust does not work without competitive information and Whole Foods is following the common protocol, at least at a high level.  What boggles my mind is that others being impacted by this legal morass are not lining up behind Rhoter, at least in an attempt to greatly narrow the scope.   And what of the 42 odd companies (sans New Seasons) who have made no production in this case?  What action is Whole Foods going to take against them?  It is possible if New Seasons would have quietly ignored the subpoena that they might be better off in the short run.  After all I don’t think Whole Foods has the necessary runway to successful compel “groupo 42” to produce and then internalize that response and incorporate it by February.

I can’t also help but let my mind wander, to the actions of Mackey and the emails of key employees that painted a win at all costs culture within the corporate center, and wonder if secretly Whole Foods is loving this part of the process.  Essentially this is antitrust as a business strategy.  I’m not saying that anything Whole Foods is not above board or that they have any intention of misusing anyone’s information, but the reality is you can’t see this information and then wipe the slate clean of it when making decisions.  Sure, pursuant to the protective order, key executives would never see this data but there are a cadre of individuals who will and invariably there will be data leakage, there always is.  Further, this case is central to the future of Whole Foods, its executives and board have to be exposed to  some of the information in order to make decisions on legal strategy.  Even if data reaches them in summary form, or at a high level, it is information they would otherwise not  have had access to in absence of this case.  This only leads me to be more sympathetic to Rhoter, as it points to a lack or organization among independent organic retailers.  If only they had known they would need their own lobby.

The last great example of a company that used antitrust as a business strategy was Gemstar-TV Guide International.   The fate of that entity and its executives was not so favorable.  That said, I value Whole Foods role in the market and I hope it prevails in its case against the FTC.  A break-up of the company would do more harm than good.   Organic food retail is a highly competitive market place once you consider how much of the product can be obtained in  mainstream supermarkets and club warehouses.  However, I wish Whole Foods approach to business was more indicative of its role as senior statesmen for the industry and consistent with what we might view as its mission.