Monday, October 8, 2007

Monday Morning Java

News, facts and information to start your week off with a jolt

UNFI-Millbrook Merger: More Natural~Specialty Foods Convergence
The announcement on Friday (October 5) that natural foods distributor United Natural Foods, Inc. (UNFI) and specialty foods/general merchandise distributor Millbrook Distribution Services are merging demonstrates the further convergence between the natural and specialty foods industries.

UNFI, the larger of the two distributors with 2006 sales of $2.4 billion, is the acquirer of Millbrook despite the use of the term merger to describe the deal. UNFI has set up a wholly-owned subsidiary called UNFI Merger Sub, Inc. which will acquire all of the outstanding shares of Distribution Holdings, Inc., which is a privately-held subsidiary of Millbrook Distribution Services. Millbrook had 2006 sales of about $300 million U.S. and distributes specialty and natural foods along with health & beauty care and general merchandise items to retailers in 48 states in the U.S. It's customers are supermarkets, mass merchandisers, drug chains and independent grocers.

The acquisition is a big win for UNFI in a number of ways. First, as we discuss often here, the natural and specialty foods industries are converging more and more across all classes of trade. Supermarkets and mass merchandisers are dramatically increasing their selections of natural and organic products (UNFI's niche) while natural foods grocers like Whole Foods Market, Inc. (UNFI's largest customer) and others are offering an increasing selection of specialty, gourmet and ethnic foods (Millbrook's niche) that fit their lifestyle retailing formats.

By acquiring Millbrook, UNFI not only brings a solid supermarket and mass merchandiser account base into its fold (Millbrook has about 9,000 retail customers) , it also gains an existing specialty foods infrastructure and product inventory. This gives UNFI a one-two-punch: The acquisition gets the distributor deeper into the supermarket and mass merchandiser retail segment than it currently is (and in a big way) while also giving it a ready-made product arsenal in the specialty foods category so it can service it's existing customers more fully in the specialty category.

Additionally, The acquisition better positions UNFI with its largest customer, Whole Foods Market, Inc. Whole Foods, which represents about 30% of UNFI's total gross sales, has become an upscale, lifestyle-oriented retailer which offers specialty and gourmet foods in its stores alongside its natural and organic offerings. Although UNFI distributed many specialty foods prior to the Millbrook acquisition it didn't have the depth of offerings to fully-service Whole Foods' stores in the category. Having the Millbrook infrastructure will allow UNFI to offer much more in the specialty foods category to Whole Foods' stores as the supernatural grocer's primary distributor. This is a big win for UNFI in terms of added sales and gross margin opportunities. It's also a win for Whole Foods in that it will allow the retailer to consolidate some specialty foods vendor purchases as well as likely achieve a reduction in its cost of goods under its contract with UNFI.

Lastly, the Millbrook acquisition gives UNFI a strategic buffer should its number one customer Whole Foods decide to become a self-distributing chain in the natural foods category. While this isn't likely anytime soon--NFFI currently has a multi-year contract--Whole Foods' rapid growth could result in the supernatural grocer seriously considering self distribution as a way to leverage its size and increase overall gross margins.
Unlike the conventional grocery industry, the natural foods industry distribution chain still puts a major focus on third-party distributors like UNFI and others. However, Whole Foods is an exception as a retailer due to its size and at some point it will seriously consider self-distribution of at least the top-selling natural foods categories. Therefore, by acquiring Millbrook, UNFI provides itself a strategic buffer if and when Whole Foods makes this decision by positioning itself deeper in the specialty foods category and increasing its overall business with supermarkets and mass merchandisers in both the specialty and natural products categories.

Industry wide, the acquisition will offer other UNFI customers increased opportunity on the specialty foods side as well. It also will give UNFI opportunities with supermarket and mass-merchandiser chains and independents it currently isn't serving. The natural-specialty foods convergence at retail has many chains and independents wanting to consolidate vendors as much as possible. As such those with the most "cross-over" potential stand to gain the most in the long run. This positions UNFI well as the leader in both segments if the distributor is able to integrate Millbrook into its operations smoothly. Such integration is where the synergies lie in the long run rather than in operating Millbrook as a stand-alone operation.

This seamless integration of Millbrook into UNFI is key. Other distributors like Tree of Life, Inc. have learned this lesson the hard way. Florida-based Tree of Life made a series of specialty foods distribution company acquisitions in the mid-1990's (Gourmet Award Foods, Hagemeyer, A-1 International Foods and others). Tree of Life struggled with these integrations and is only today beginning to integrate its natural and specialty foods distribution business nationally.

UNFI has a few things going for it in terms of integrating Millbrook that Tree of Life didn't have in the mid-1990's however.

First, Tree of Life acquired numerous independently-owned and operated specialty foods distributors in a short period of time which made it difficult to fully integrate those cultures and operations into one another properly. Second, UNFI has a much more substantial natural foods base (2.4 billion in sales) than Tree of Life had at the time. Third, UNFI has Whole Foods as a customer. The fast growing grocer provides UNFI with guaranteed organic growth while it focuses on integrating Millbrook and investing in growing its supermarket and mass merchandiser retail format business.

Lastly, UNFI is only integrating one company into its overall operations. Additionally it is doing so by first operating it as a wholly-owned subsidiary and keeping Millbrook's management team in place--at least for now. This will allow time for cultural and operations integration. Millbrook also already has a national distribution network in place so unlike the mid-1990's experience for Tree of Life--where the distributor was building a national network one piece at a time--UNFI merely needs to find the synergies between its exiting supply chain and Millbrook's rather than create them.

UNFI's acquisition of Millbrook points up how the natural and specialty foods convergence is occurring across all classes of trade--retail, manufacturing, distribution--in the natural and specialty foods industries. As the lines blur (Wal-Mart being a major organics player, Whole Foods being a lifestyle retailer, for example) we will continue to see similar mergers and acquisitions across the board. The changes at retail, where natural foods retailers are becoming more upscale and supermarkets are becoming more natural and organic oriented, are what is driving this convergence. Distributors and manufacturers should watch this closely as it portends how they will operate in the future.

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