Tuesday, July 29, 2008

Retail Memo: U.S. Federal Appeals Court Panel Orders Lower Court to Review Last Year's Decision to Approve of Whole Foods' Acquisition of Wild Oats

Natural~Specialty Foods Memo has been writing extensively about the U.S. Federal Trade Commission's (FTC) ongoing determination since last year to get a U.S. federal appeals court to overturn a lower court's ruling that gave Whole Foods Market, Inc. the green light to acquire and integrate Wild Oats Markets into its corporate culture and operations.

The FTC appealed last year's lower-court ruling once before. The federal appeals court upheld the lower court's ruling at that time. However, the FTC filed a second appeal, arguing as it has all along that the acquisition-merger of Wild Oats gives Whole Foods a monopolistic position in the supernatural (especially organic products) food retailing segment.

Natural~Specialty Foods Memo has disagreed with the FTC's argument all along, and have sighted extensive examples in various stories and analysis of how growing natural foods retail chains like Sunflower Farmers Market, Sprouts Farmers Market, Trader Joe's and numerous others, along with national and regional supermarket chains like Safeway (Lifestyle format), Publix, Wegmans, H.E.B., United Supermarkets (Market Street format), Raleys, SuperValu, Inc. (Bristol Farms and other formats) and numerous others are providing serious competition to Whole Foods in the upscale natural, specialty and fresh foods retailing segment in the U.S. We could mention dozens more regional chains and multi-store independents that are doing the same.

Today, a three-judge federal appeals court panel voted 2-1 in favor of sending the ruling that allowed Whole Foods to acquire Wild Oats back to the lower court for further consideration, which is not completely what the FTC wanted, (they wanted the lower-court decision reversed) but allows the regulatory agency to once again argue its case against the merger.

The decision also doesn't require Whole Foods to stop the integration of Wild Oats' stores into its operations and corporate culture, nor is it an overturning of the deal.

Below is a report (in italics) by the Associated Press on the federal appeals court panel's decision today to send the decision back to the lower court for review. Following the Associated Press report is an analysis of the appeal court panel's decision today, along with its ongoing category monopoly argument.

WASHINGTON (AP), July 29, 2008 -- Whole Foods' long-running effort to acquire its rival organic-supermarket chain Wild Oats isn't completely out of the legal woods yet.

A three-judge federal appeals court panel on Tuesday overturned a lower court ruling from last year that allowed Whole Foods Market Inc (WFMI, Fortune 500). to acquire Boulder, Colo.-based Wild Oats Markets Inc.

The 2-1 ruling sends the case back to the lower court for further consideration, but doesn't halt Austin, Texas-based Whole Foods' integration of the Wild Oats chain or require that the deal be undone.

However, if the district court ultimately rules in favor of the Federal Trade Commission (FTC), which sought last year to block the deal, it could disrupt efforts to combine the companies.

Whole Foods spokeswoman Kate Lowery said the company is disappointed with the decision and is "evaluating its legal options," which include asking all 10 judges on the appeals court to review the case.

Jeffrey Schmidt, director of the FTC's Bureau of Competition, said the agency was pleased by the ruling.

Competition conflict

The FTC argues that the transaction would stifle competition by combining the two leading organic-supermarket chains, which could result in higher prices.

Whole Foods contends that competition from conventional supermarkets such as Safeway Inc. (SWY, Fortune 500) and The Kroger Co. (KR, Fortune 500) - which are selling increasing amounts of organic food - would keep prices low.

The agency sought a preliminary injunction to temporarily block the deal so it could hold its own administrative proceedings to determine whether the transaction violated antitrust laws.

But Judge Paul Friedman of the U.S. District Court for the District of Columbia sided with Whole Foods in a ruling last August, and the companies then closed the acquisition.

FTC pushes its case

Regulators usually throw in the towel if they fail to secure a preliminary injunction, due to the difficulty of unwinding a deal once it's complete. What makes the Whole Foods case unusual is that the FTC has pressed its case, antitrust experts say.

FTC officials complain that the burden of proof imposed by Friedman was too high.

The appeals court ruled that the district court hadn't given enough weight to the FTC's evidence that conventional supermarkets aren't close competitors to the organic chains and therefore won't keep their prices low.

In order to secure the preliminary injunction, the FTC only needs to show that it likely would prove its case, the appeals court said.

The lower court "underestimated the FTC's likelihood of success," Judge Janice Rogers Brown wrote for the Court of Appeals for the D.C. Circuit.

Judge David Tatel, in a concurring opinion, said the case is "unique" because the lower court can no longer grant a preliminary injunction now that the two companies are combining operations.

Instead, the district court could halt further integration of the companies or take similar steps, Tatel wrote. But he and Rogers also wrote that the lower court should take into account that the acquisition has been closed.

Judge Brett Kavanaugh, in dissent, wrote that "the FTC's case is weak and seems a relic of a bygone era when antitrust law was divorced from basic economic principles."

Future transactions at stake

Veronica Kayne, a former FTC antitrust official and now an attorney at Haynes & Boone in Washington, said the appeals court's decision could make it easier for the government to obtain preliminary injunctions blocking future transactions.

Whole Foods, which operated 194 stores before the deal, purchased the 110-store Wild Oats for $565 million.

A lawyer for Whole Foods said in April that the company had already sold 35 of the Wild Oats stores and closed 12 more. Another third of the remaining Wild Oats stores have been converted to Whole Foods outlets.

Natural~Specialty Foods Memo Analysis

While today's 2-1 decision by the federal appeals court panel doesn't reverse the acquisition-merger nor do anything to stop the continued integration of the former Wild Oats stores into Whole Foods' corporate culture and operations, it does place somewhat of a legal cloud over the issue for Whole Foods.

On the one hand, the supernatural foods retailer might be hesitant to continue to spend significant sums of money and energy in its program of converting the remaining Wild Oats natural foods markets into the Whole Foods banner and merchandising program, knowing the possibility exists for the lower-court to ultimately reverse its original decision of approving the merger, although we doubt that will happen.

On the other hand, an argument can be made for Whole Foods to proceed even faster in integrating the Wild Oats stores and re-bannering them as Whole Foods since is our analysis the process has really already gone too far to make any reversal by the lower court either fair or practical.

Additionally, the more the integration process has moved forward by the time the lower court takes up the appeals court panel-ordered reconsideration, the more logical it will be for an argument that the integration has gone too far to reverse the previous decision to be made.

Today's decision is odd in that it prevents the lower court from completely reversing the merger. Howver it allows room for the court if it decides to to halt further integration of the Wild Oats stores into Whole Foods, which we assume if that is the decision means Whole Foods still owns Wild Oats but would have to sell the remaining non-integrated stores that exist at the time of that hypothetical court decision.

This would seem to argue for rapid integration of the remaining stores. Although, once could reasonably argue "all" the stores are already integrated since they are and have been operated by Whole Foods for sometime. After all, the current name on a store doesn't define "integrated." We don't expect the lower court to like what the appeals court panel has given it either way.

The appeals court panel has handed the lower court a can of all-natural worms in how it defined the case. We have a feeling the lower court may just decide to cut bait rather than take much court time to go fishing.

As we've argued all along, the FTC has no concept in our analysis of the current dynamic state of natural and organic products retailing in the U.S. If it did, it would drop its Whole Foods focus, which is a waste of money and valuable lawyer resources, unless of course it has other reasons for focusing on it so extensively, and get on with more important issues such as taking a look at the competitive nature of the oil and energy industries in the U.S.

It also might ask itself why if Whole Foods is in a monopolistic position thanks to its acquisition of Wild Oats, its stock price hasn't been doing so well of late?

The FTC also should ask itself if Whole Foods is such a dominant player now in natural and organic products retailing, why it recently had to come out with its "Real Deal" value pricing program?

We can answer that for the FTC. It's simple: not only isn't Whole Foods in a monopolistic position, it's actually struggling somewhat because of the poor U.S. economy, and struggling even more so in places like California where the economy is among the worse in the nation. Many consumers are trading down completely or buying organic products at discounters like Wal-Mart, Trader Joe's, Costco, Sprouts Farmers Market, Sunflower Farmers Market and others.

Does any reasonable and analytical-minded person really think Whole Foods Market, Inc. would be lowering prices--and its margins in some instances--if it were in a monopolistic position thanks to the Wild Oats deal? Doing so is the antithesis of what the FTC said Whole Foods would do in fact in its original argument. In that argument to the court the FTC said the acquisition of Wild oats would allow Whole Foods market, Inc. to raise prices bcause of its monopoly status.

Another observable fact of U.S. food retailing in 2008 that demonstrates the folly of the FTC's continued attempts to get the Whole Foods-Wild Oats deal overturned is the simple fact the "supernatural" food retailing category is today meaningless, even though we use it for illustrative purposes.

Major supermarket retailers like Safeway Stores, Inc., Kroger Co. and SuperValu, Inc .(the top three supermarket chains in the U.S.) have and continue to blur this category distinction by moving stronger and deeper into the sales of premium fresh, natural and organic products, which are Whole Foods' primary positions.

Add to these three Wal-Mart, Costco, Super Target, Trader Joe's and the many regional operators like H.E.B. (Texas) Wegmans (east cost), Raley's (California), Publix (Florida),, Fresh Market (southern U.S.) and numerous others (and don't forget the numerous multi and single- store independents), along with the emerging natural and organic foods category natural foods retailers Sprouts Farmers Market and Sunflower Farmers Market, and you get a picture of a highly competitive market in the natural and organic food and grocery categories in the U.S.

In fact, in some regional markets like Texas, California, Arizona, New York state, Pennsylvania and numerous others, Whole Foods is in danger of losing market share to major national and regional players like H.E.B, United Supermarkets (Market Street format) Sprouts, Sunflower Farmers Market in Texas; Wegmans and a number of others in New York and Pennsylvania; Publix in Florida (which now has its own organic foods format), Wal-Mart, Sprouts, Sunflower, Trader Joe's and Tesco's Fresh & Easy in Arizona; and retailers too numerous to mention in California.

We will be closely following today's decision by the federal appeals court panel to return the decision back to the lower court. Our analysis is that we would be very surprised if the lower court changes it original decision. However, courts often do surprise.

The fact is however that it's now been a year since Whole Foods and Wild Oats merged. In that year we've seen nothing to indicate a monopoly position in natural and organic foods retailing for the combined Whole Foods-Wild Oats.

What we have seen in that year though is increasing competition from all types formats being put on Whole Foods.

This increased competition includes the bold moves by Sunflower Farmers Market and Sprouts Farmers Market of opening the first of what will be many for both chains of their respective natural foods stores in Whole Foods' home market of Texas, the continuation of H.E.B's opening of 100,000 square foot upscale supermarkets in Texas that rival what Whole Foods is doing in the natural and organics categories, Wegmans doing the same in New York, and similar developments by both supermarket chains and independents and natural foods retailers throughout most U.S. markets.

In fact, rather than being in a position to solidify some mythic category monopolistic position, it's our analysis Whole Foods finds itself in a position of having to defend it current position as the leading natural and organic foods retailer nationally in the U.S.

That's a far cry from the FTC's argument. It's also far more accurate.

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