Safeway Inc. (SWY): How Is This Company Selling a Business Unit for More Than Its Market Cap?

Divergent performance: Safeway’s U.S. assets vs. Canadian holdings

Assuming that this deal does go through, it will put both companies in an interesting spot. The deal values Safeway’s Canadian assets at roughly seven times the current book value of its U.S.-based assets. In other words, Empire may be overpaying by a significant amount. However, Safeway Inc. (NYSE:SWY)’s Canadian properties have represented the lone bright spot for a firm that has struggled with declining market share in its home market. In 2012, the portfolio took in $6.7 billion in revenue and posted a profit of nearly $430 million. Seasoned observers believe that the company accepted this deal in an effort to reduce its long-term debts and gain capital for long-delayed modernization projects.

For Empire’s part, this transaction will require a fantastic amount of debt. According to the company’s announcement, it will use a combination of traditional loans and note sales to raise $4 billion. Whether it can afford this leverage is an open question.

Will it work out?

Aside from the tremendous amount of debt that Empire will need to assume in the process of financing this purchase, the company could be in line to reap some serious benefits from the deal. Empire believes that its move will create $200 million in annual cost savings, and the potential synergies of such a scaling-up project should be obvious. As an added bonus, the value of the real estate on which these properties sit is likely to appreciate over time.

At the same time, Empire could be entering the western Canadian grocery space at a tricky time. U.S. big-box giants Walmart (WMT) and Target (TGT) have both revealed major expansion plans in the region. Given these companies’ cost-cutting reputations, they could put pressure on smaller grocery chains and independent retailers. Of course, it is too early to determine whether these moves will affect Empire’s new stores.

In sum, investors who believe in the economic fundamentals of the western Canadian grocery market would do well to look more closely at this deal. Although its move is not without its risks, Empire is gaining a significant foothold in a favored quarter of the country. On the other hand, this deal may finally turn Safeway Inc. (NYSE:SWY)’s fortunes around and make the U.S. firm attractive at its current levels. This is a rare deal that truly seems to offer something for everyone.

The article How Is This Company Selling a Business Unit for More Than Its Market Cap? originally appeared on Fool.com and is written by Mike Thiessen.

Mike Thiessen has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Mike is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.

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