The Kroger-Albertsons Merger Spotlights a Popular Private Equity Tactic

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Cerberus Capital Management, a big private equity firm, has long attracted controversy. In 2007, it took over Chrysler, but after two years of Cerberus ownership, the company needed a government bailout to stay in business. It spent years buying up companies that made guns — one of which was used by Adam Lanza in 2012 to kill 20 children and six teachers at Sandy Hook Elementary School in Newtown, Conn.

Now the firm, which has some $60 billion in assets, is trying to pull off a deal that is expected to face intense scrutiny from antitrust regulators. Cerberus is the largest investor in Albertsons, the country’s second-largest supermarket chain by revenue. In October, Kroger, which is nearly twice the size of Albertsons, announced it was going to buy its smaller rival for $24.6 billion. If the deal were to go through without any government-mandated divestitures, the combined company would own some 5,000 stores, making it by far the dominant grocery chain in the country. The two companies hope to complete the deal in early 2024, according to federal filings.

At a time when corporate consolidation has become a major concern in Washington, D.C., the proposed deal has already drawn a great deal of pushback. At a hearing on the merger held by the Senate antitrust subcommittee a few weeks ago, Amy Klobuchar, a Minnesota Democrat who leads the subcommittee, suggested that the merger would lessen competition and lead to price hikes. And Senator Mike Lee, Republican of Utah, complained that for all of their promises that the deal would be good for everyone, the two companies hadn’t explained “why the merger is necessary in the first place.”

But there is another aspect to this deal that may be even more contentious.

Albertsons, which Cerberus bought for $350 million in 2006, is planning to pay a $4 billion dividend to its investors — and to do it now, more than a year before the merger closes. Although Albertsons became a public company in 2020, Cerberus remains its largest shareholder, with a 30 percent stake. It also controls the Albertsons board. (Cerberus did not respond to an email requesting an interview.)

“In my opinion, the $4 billion special dividend is straightforward corporate raiding,” Sarah Miller, the founder of the American Economic Liberties Project, wrote in an email. Karl Racine, the attorney general of Washington, D.C., noting that the dividend was 57 times as much as any previous Albertsons’s dividend, called it “a cash grab.” He and others also pointed out that Albertsons did not have $4 billion in hand; it would have to borrow $1.5 billion, adding to its nearly $7.5 billion debt load.

Dividend recapitalizations — or dividend recaps, as they are called — have become a fairly common trick in the private equity playbook. Last year, according to a Bloomberg report, companies borrowed around $80 billion — a record — to pay out dividends to their private equity owners. Critics say that dividend recaps too often leave companies without enough capital to withstand a business downturn. For private equity firms, said Andrew Park, a policy analyst at Americans for Financial Reform, “it’s heads I win, tails you lose.”

Dividend recaps are usually under the radar, as private companies are not required to make the same level of financial disclosure as public companies. The Albertsons recap, however, was right there in the merger documents — and critics quickly pointed to it as a classic example of how private equity firms take care of themselves ahead of the companies they own.

“When you saddle a company with serious debt before a merger, what happens if it doesn’t go through?” asked Phil Weiser, Colorado’s attorney general who has also served in the Justice Department’s antitrust division. “This level of stripping a company of its assets is alarming.” (Albertsons says it will still have $3 billion in liquidity after the dividend is paid.)

Last month, a group of attorneys general, including Mr. Racine in Washington, D.C., and Bob Ferguson in Washington State, filed lawsuits against Kroger and Albertsons hoping to stop the dividend payment. In the suit filed by Washington State, Mr. Ferguson brought up other aspects of the deal that the attorneys general find troublesome, including the loss of competition if Kroger decides to shut down stores that are too close to one another, the potential for food prices to rise and the effect on unionized workers. (Each company owns some unionized stores and some nonunion stores. Union leaders fear that Kroger will close or spin off the unionized stores ahead of the nonunion stores. Kroger, however, has promised to protect workers’ jobs.)

But it is the dividend that is front and center in the legal pleadings. Mr. Ferguson argued that the dividend violated the state’s consumer protection laws because it would so badly weaken Albertsons. However, in a ruling in Washington State on Dec. 9, Judge Ken Schubert of King County Superior Court rejected that argument.

“It’s not like the two of them got together and said, ‘How can we screw the consumers of Washington State and the nation,’” he said from the bench, according to The Seattle Times. “Albertsons from the start wanted to get rid of this money.”

A restraining order was put in place to block the payout while Mr. Ferguson appeals Judge Schubert’s decision to the state’s Supreme Court. It was extended yesterday. Colorado has filed an amicus brief siding with Washington State.

If the dividend had been negotiated as part of the merger agreement, that would have been a violation of antitrust laws. But both Kroger and Albertsons say that was not the case — that the dividend was not part of the merger discussions — which means it is unclear whether Ferguson and his allies will ultimately prevail.

“This is an instance where the equitable powers of the court can stop the dividend even without a lot of direct legal precedent,” Mr. Weiser said. “We believe that Washington State has made a very compelling case.”

Even if the higher court rules against Washington State, and the dividend is paid, the scrutiny it has received suggests that government officials are no longer willing to shrug their shoulders at the excesses of private equity. Almost everyone I spoke to about Albertsons’s dividend mentioned the Toys “R” Us bankruptcy in 2017. The toy company’s debt rose to $5 billion from $100 million while under private equity ownership; in the end, that debt load sunk it. “Part of our concern with this special dividend is that it could lead to another Toys “R” Us situation,” said Jonathan Williams, the communications director for the union representing many of the grocery workers.

It is doubtful that the dividend recap will go away — not without some drastic change, like the passage of a new law — but thanks to Albertsons and Cerberus, it’s going to receive some long overdue attention.

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