Monday, December 8, 2008

Retail Memo: Breaking News - Whole Foods Market, Inc. Files Lawsuit Against the FTC; Argues the Regulator Violated the Company's Due Process Rights

Analysis: Whole Foods Market, Inc. v. U.S. Federal Trade Commission

Whole Foods Market, Inc. and its powerhouse Washington, D.C. legal team, which is being led by former George W. Bush Administration U.S. Solicitor General Ted Olson (a Republican) and Lanny Davis, former legal council to President Bill Clinton and a chief advisor to Senator and soon to be Secretary of State Hillary Clinton, fired back hard today against the U.S. Federal Trade Commission (FTC), filing a rare lawsuit against the federal regulatory body saying the agency has violated its due process rights over its ongoing legal challenge to its friendly acquisition-merger of Wild Oats Market, Inc. in the summer of 2007.

Whole Foods Market, Inc. acquired Wild Oats Market, Inc. last summer for $565 million in a deal blessed by Wild Oats' board of directors and stockholders.

Shortly after the deal was announced, the FTC file a legal objection, arguing a combined Whole Foods-Wild Oats would constitute a monopoly in what the regulator defined as the "premium organic retailing segment." This definition isn't one formally recognized by the natural foods retailing industry. Essentially the FTC created it for its regulatory purposes in analyzing the merger.

Whole Foods filed its lawsuit against the FTC today in federal district court in Washington, D.C. The lawsuit says that the FTC is completely biased against Whole Foods, has already prejudged the outcome of the case and can't be expected to oversee an impartial administrative proceeding. The administrative proceeding referred to in the lawsuit is an administrative hearing/trial before an administrative law judge that the FTC has set for February 16, 2009.

The chief argument, in addition to the language above, in Whole Foods' lawsuit is that the FTC has violated the company's due process rights by setting a rapid schedule for the trial (February 16, 2009) that won't allow Whole Foods adequate time to prepare its defense.

In the lawsuit filed today, Whole Foods wants the federal court to require the FTC to terminate its February 16, 2009 hearing, or administrative trial. In its place, Whole Foods wants the merger case resolved "once and for all" in a U.S. federal court.

Attorneys for Whole Foods Market, Inc. are challenging what they call an "inherent flaw" in the way antitrust cases are handled in the U.S. That flaw involves the fact that when it comes to mergers and acquisitions in the U.S., companies fall under the oversight of the U.S. Justice Department or the FTC, depending on certain, somewhat arbitrary criteria. The companies though face much different scrutiny from the FTC compared to the Justice Department.

For example, when the U.S. Justice Department is opposed to a merger or acquisition involving companies that have come under its jurisdiction, they go through what is essentially called a "one-stop" process to stop the deals. They file a lawsuit asking a federal court to stop the deal. If the court rules against Justice and in favor of the acquiring or merging companies, the process is essentially over.

The FTC process, as we've seen play out with regard to Whole Foods' since the summer of 2007, is much more open and extensive. When it opposes a deal such as the Whole Foods-Wild Oats merger, the FTC can file a preliminary injunction, which it did, then even if a court rules against it, the agency can appeal in addition to opening a new administrative case against the company. Once it has opened that new administrative case, the agency can appeal to a federal court once again.

This is just what has happened regarding Whole Foods. A federal court approved the deal. A federal appeals court upheld that court's ruling in favor of Whole Foods. However, the FTC still opened a second administrative case against the merger. Recently a different appeals court made a ruling that allowed the FTC to then go forward once again, which has resulted in the administrative trial set for February 16, 2009.

In its lawsuit today, Whole Foods' attorneys argue that the FTC process is unfair. Whole Foods Market, Inc. says it has already spent $16.5 million working with the FTC on the case and could lose millions more if it drags on.

Natural~Specialty Foods Memo talked today with a senior staff member of a U.S. Senate Committee that deals with FTC-related issues and legal cases. This staffer, who has many of years of experience involving FTC cases and is a lawyer, said the Whole Foods lawsuit is unique and rare because it is attempting to challenge the way the regulatory agency does business, as well as offering the specific arguments in the suit. If successful he says the suit could possibly lead to fundamental changes in how the U.S. government deals with mergers and acquisitions.

Whole Foods' lawyers said today the lawsuit is the first of its kind in 50 years, agreeing with the Senate Committee staffer's observations about the nature of the lawsuit. The unique aspect of it is the way it challenges what the legal team refers to as the "inherent flaw" in the merger and acquisition regulatory system.

The lawsuit revealed that Whole Foods Market, Inc has spent $16.5 million thus far defending the company against the FTC case. The lawsuit also argues Whole Foods has nearly completed the integration of Wild Oats into the company and that overturning the merger now would result in loses to the company of many more millions.

As we written, the premise of the FTC's legal argument is that a combined Whole Foods-Wild Oats has resulted in Whole Foods Market, Inc. having a "monopolistic" position in what the FTC calls the "premium organic retailing segment" in about 18-29 markets in the U.S. The FTC argues this position allows Whole Foods to be able to exert an anti-competitive force in these markets, which includes being able to raise prices if it so desires.

Somehow the FTC doesn't realize consumers can now purchase natural and organic foods from such a wide-range of retail classes of trade -- from natural foods store competitors of Whole Foods, to Wal-Mart, Target, Costco, Trader Joe's, supermarkets, chain drug stores, and numerous other online stores, farmers markets and more -- that Whole Foods' ability to raise prices even in markets where it might hold a favorable position is today restricted by this explosion in retail formats and outlets that sell natural and organic food and grocery products -- a retail format and outlet explosion that continues to grow.

The consumer has nothing to fear from a combined Whole Foods-Wild Oats in terms of competitive pricing because today there are so many alternative retail outlets for natural and organic food and grocery products. In fact, that reality is why Whole Foods' sales are currently suffering.

The problem with the FTC's argument is that first, there have been no signs that Whole Foods holds any type of monopolistic position in any U.S. market post merger. In fact, since the merger the natural grocer has been struggling, in part because of the massive debt load of about $150 million it assumed from Wild Oats as part of the acquisition.

But that debt load is only part of the problem: Sales at Whole Foods stores are down sharply because of the economic recession. In the quarter before last Whole Foods Market, Inc. had a 40% drop in net income. Additionally, It's stock share price is down nearly 70% from its high after the Wild Oats acquisition. Further, It recently has fired at least 100 employees at its Austin, Texas headquarters to cut costs. Lastly, last week Whole Foods sold 17% of the company for $465 million to private equity firm Leonard Green & Partners in order to generate needed cash for ongoing operations (and based on the amount its spent to date on legal fees to fight the FTC for that too) and for the retailer's modest fiscal year 2009 growth plans which it has reduced in half.

These aren't the signs of a monopolist. Rather, they are the signs of a struggling food retailer in a bad economy in which consumers, even those in the so called "premium organic segment," are trading down to more inexpensive food stores not out of choice but out of need. They also are buying less organic food and grocery products overall.

Regarding Whole Foods' ability to raise prices in these 18-29 U.S. markets as the FTC argues it can as a monopolist, the opposite has actually been the case. Beginning towards the end of the first quarter of this year, and continuing to the present, Whole Foods has been lowering the everyday prices on numerous items in its stores as a way to better compete in the down economy. The natural foods retailer also has launched a value-based program in which it is heavily promoting price discounts in its stores and has even been offering coupons that give shoppers $5 off purchases of $25 or more, for the first time in the company's history. That amount to a 20% discount on purchases of $25. Would a monopolist do that?

If Whole Foods prevails in the lawsuit filed today, a federal court would stop the FTC's administrative trial set for February 16, 2009.

If Whole Foods doesn't get that ruling, or a court fails to rule on the lawsuit before February 16 and Whole Foods loses at the February 16 trial before an administrative law judge, the retailer still has the option of appealing that ruling to a federal appeals court, which we believe it most surely will do.

Of course that, on top of what it is already spending for high-priced legal talent like Ted Olsen, Lanny Davis and others, not to mention the new Washington, D.C. lobbying firm it has retained, means an even further drag on earnings, which means tough going for it's stock share value.

One must ask the question, with so many companies in so many industries looking for a bailout from the federal government, is not the FTC breaking one of the central codes of good government, which like in medicine is "First Do No Harm" in its pursuit to overturn the Whole Foods-Wild Oats merger.

We suggest it is; that the FTC's legal case against Whole Foods is frivolous and based on a faulty premise: the so called "premium organic retail segment" monopolistic argument. The empirical realities of the marketplace just don't demonstrate it's true.

As a former dedicated Whole Foods shopper and regular reader told us last week -- "I now buy most of my organic groceries online, as well as find lots of deals at the dollar stores and Wal-Mart, buying only what Whole Foods puts on special; get most of my organic produce at the farmers' market; am no longer am buying prepared foods at Whole Foods or elsewhere; and I shop around for natural and organic meats, buying a little at Whole Foods if the price is right. She's a "premium organic consumer" who's never heard of the "premium organic retailing segment," nor does she need to.

Reader Resources

Recent related stories from Natural~Specialty Foods Memo:

>December 7, 2008: Retail Memo: New Seasons Market CEO Brian Rohter and Whole Foods Market Co-President Walter Robb Discuss and Debate the Subpoena Issue Online

>December 7, 2008: Retail Memo: New Seasons Market CEO Brian Rohter Speaks Out Again Today on the Whole Foods Market, Inc. Subpoena of His Company's Data

>December 7, 2008: Retail Memo: Whole Foods Market Retains Top Washington D.C. lawyers and Politically-Connected Lobbyists to Plead its Case Against the FTC

>December 6, 2008: Retail Memo: Fast-Growing and Scrappy Sunflower Farmers Market Ventures Deep in the Heart of (Whole Foods Country) Texas

>December 6, 2008: Retail Memo: Fast-Growing NF Chain Sunflower Farmers Market Responds to Whole Foods Market, Inc. Subpoena For Sales, Financial and Related Information

>December 3, 2008: Retail Memo: More on the Whole Foods Market-New Seasons Market Subpoena Issue; FTC Holding Firm For February, 2009 Hearing

>December 2, 2008: Retail Memo: Whole Foods Market, Inc. Closes $425 Sale of Stock to Private Equity Firm; Adds Members of the Firm to its Board of Directors

>December 2, 2008: Retail Memo: Portland, Oregon-Based New Seasons Market CEO Brian Rohter Responds to Whole Foods Market's Paige Brady

>December 2, 2008: Retail Memo: Whole Foods' Paige Brady Responds to Yesterday's New Seasons Market Piece; Lots of E-Mails; Issue Heats Up On the New Seasons Market Blog

>December 1, 2008: Retail Memo: Whole Foods Wants A Court-Mandated Financial Records Dump from Portland-based New Seasons Market; it Says For its Battle Against the FTC

Additionally, we've been writing about the FTC-Whole Foods Market, Inc. issue since last year. You can read a selection of those stories here.


Annie said...

This is the best summary of the organic market trend that I've seen. The mainstream media's presentation of Mintel's data is sensationalized as "even organics are not recession-proof." But really, find us something that isn't recession-proof!

I also agree with the assessment of the spurious nature of the suit against WF -- at one time that might have been vaguely true, but my qualitative research shows shoppers in mainstream stores searching out organic brands more and more.

I've written about some of these issues on the In-Store and Retail Media Blog and appreciate this assessment.

Natural~Specialty Foods Memo said...

Thanks for the comment Annie. Did check out your post on the in-store Blog. Good work.

Hope you continue to contribute (comments) to Natural~Specialty Foods Memo. We like dialogue, variety of viewpoints.

Also feel free to let us know if you want to write something for the Blog. Our e-mail address is:

Would be interested in hearing more about your qualitiative research, for example.

Did you see our piece from yesterday on the organic category? Ties-in with what you are saying. It's near the top of the Blog currently.

What type of formats are you seeing shoppers go to for organics in your research?

Best Regards.

Anonymous said...

Agree, excellent summary.I do recall many years ago when Albertson's acquired then Lucky Stores in California that the California Atty General required Albertson's to divest of many Lucky stores. This should have been discussed by Whole Foods and the FTC at the outset. The big losers in this matter are Whole Foods stockholders and consumers.