Mega - Ofer Vaknin - May 30, 2012
A Mega supermarket outlet. Photo by Ofer Vaknin
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Highly leveraged holding companies in the public domain have been visibly rocked the past year by plummeting profitability and share values, constraints on pulling dividends, and inability to roll over their debts. Notable among these are Nochi Dankner's IDB pyramid group, Ilan Ben-Dov's chain of companies, Yossi Maiman's Ampal-American Israel Corp., and Mori Zisser's Elbit Imaging.

Privately owned concerns may be hidden from view but are no less vulnerable, and the public is nevertheless heavily exposed to their risk through debt held by pension funds. Among the largest of these is Alon Israel Oil Company, 53%-owned by David Weissman's and Shraga Biran's Bielsol Investments and 47% by the Mishkei HaKibbutzim cooperative group - represented by Yitzhak Bader who also serves as Alon group chairman, with over $8 billion in annual revenues split mainly between Israel and the U.S.

The group has a pervasive presence in both countries. In Israel it owns the Dor Alon chain of filling stations and Alonit convenience stores, the Mega and AM:PM grocery chains; the Vardinon, Sheshet, and Na'aman houseware store chains; fast-food outlets KFC and Pizza Hut; as well as substantial stakes in Diners Club, Highway 6 operator Derech Eretz, and the Tamar offshore natural gas field. Its major U.S. holdings include Alon USA gas stations and 7-Eleven convenience stores. With more than 12,000 employees, the group continues expanding into new areas with the launch of the virtual cell phone operator YouPhone and partnership in building a $100 million power plant.

Alon group has accumulated about NIS 3 billion in financial liabilities, NIS 700 million to NIS 800 million of which are bank loans, primarily from Bank Hapoalim, and the balance from bonds issued in Israel in early 2007 - when markets were at their peak - with trading limited to institutionals. On the other side of the ledger are assets cumulatively worth the same or several hundred million shekels less - depending on how share prices stand on any given day: A 67.2% stake in Alon USA worth about NIS 1.2 billion; a 77.26% ownership stake currently worth NIS 482 million in Alon Holdings Blue Square Israel; and NIS 502 million worth of stock from its 82.96% holdings in Alon Natural Gas Exploration Ltd.; along with NIS 650 million in cash resources. Other holdings just sufficiently cover the present value of Alon's overhead expenses.

The A- trapdoor

Fortunately for the group, it has a breathing spell of several years before most of the principal on its bonds become due, in eight equal annual NIS 225 million payments from January 2016 to January 2023. But there's a catch.

If the company's credit rating falls below A-, where it now stands, bondholders have the right to cash in unless the bonds - averaging 5.5 years in duration and bearing 5.35% annual interest - become listed for public trading. For bondholders - most of the country's major institutionals - there would really be no choice: They aren't permitted to invest in non-tradable assets rated less than A-.

In October 2010 S&P Maalot dropped Alon Blue Square bonds two notches to A-. In response the group stopped doing business with the rating agency, switching to rival Midroog. Nonetheless, the group's bonds are still rated by Maalot, which has recently initiated internal discussions on analyzing the group companies to determine whether the ranking needs to be reduced, according to information reaching TheMarker. Weissman and Biran might prefer pouring cash into the group to maintain its rating rather than putting the group's fortunes on public display.

"Weissman and Biran have deep pockets and strong reputations in the capital markets," says a knowledgeable institutional investment manager. "We saw how they didn't hesitate to cough up NIS 150 million the past two years to shore up their troubled Rosebud Real Estate. It's a fair assumption that they'd also come to the rescue of the Alon group if needed - but the numbers here are much greater."

"If Alon's bonds are registered for trading their yields will reach around 20%," claims the investment manager. "The company, however, has enough financial flexibility and cash cover overhead and financing costs for several years, even without significant dividends from subsidiaries."

As opposed to the group's bondholders who didn't bother asking for collateral, Bank Hapoalim's loan is backed by Blue Square shares acquired from 2003 to 2007 for between NIS 1.7 billion and NIS 2.2 billion, but now worth just a fraction of that. Alon will likely be asked to shore up Hapoalim's security with Alon USA stock or pay down part of the debt. The bank has reason to worry: Alon Blue Square shares have fallen 38% so far this year and 70% in the year and a half since the group was restructured. Since Alon embarked on its Blue Square investment along with Matthew Bronfman and Shalom Fisher in June 2003, the company has yielded a minus 43% return while the Tel Aviv Stock Exchange TA-100 index racked up 117% in gains.

Blue Square: Big challenges ahead

Much of Blue Square's drop in value is attributable to its retail operations, both its Mega Retail supermarket division and the BEE non-food division. For almost a year the former has been battered by fallout from the cost-of-living protests and mounting competition from discount food chains, resulting in weakened demand and deeper price cuts accompanied by rising payroll and leasing costs. A 5.3% decrease in supermarket revenues in the fourth quarter of 2011 compared with the same period the previous year, and a 6.9% drop in gross profits, led to operating profits of this sector falling 51% to just NIS 25.8 million. The company has needed to begin selling off money-losing branches and slashing costs to survive against Super-Sol and upstarts Rami Levi Hashikma Marketing, Victory Supermarket Chain, and Hatzi Hinam.

The non-food BEE division suffered a NIS 17.7 million operating loss in the fourth quarter, compared with a NIS 20.4 million operating loss in the last quarter of 2010. Poor results by the Kfar Hasha'ashuim toy stores and the Hakol B'Dollar five-and-dime chain weighed heavily on performance, and analysts the division to continue bleeding in 2012.

Neither has Blue Square's 78.4%-owned Dor Alon Energy filling station subsidiary generated any good news. Like its competitors, the company was hard hit by government decrees limiting the margin on retail gasoline sales, with first quarter operating profits falling 34% from the parallel period last year to NIS 33.4 million, and net income plunging 59% to just NIS 8.5 million. Since the restructuring in October 2010 the company's shares have tumbled 45.4%, cutting its market valuation to just NIS 431 million.

Blue Square's one ray of light is its Blue Square Real Estate subsidiary with a strong asset base in Israel and trading at a market value of NIS 900 million. The company's weak retail activities led to a NIS 59 million net loss attributable to shareholders in the fourth quarter of 2011 compared with a NIS 2 million net loss the same quarter in the previous year. Nonetheless, it distributed a NIS 75 million dividend in December.

Cracks in the American golden egg

Alon USA, considered the group's "golden egg" until 2008, has been paying the price of its billion dollar leveraged buying spree of refineries, gas stations, and convenience stores. Problems, including explosions, have since plagued its refineries. Accumulated losses exceeding $200 million in 2009 and 2010 and empty coffers have required the owners to pour tens of millions of dollars into the enterprise and bring in private equity funds as partners.

The group has pinned high hopes on Alon Natural Gas Exploration's 4% stake in the Tamar gas deposits, expecting an annual cash stream of $30 million to $50 million within a few years from the project. Alon's share in the cost of the project is estimated at $130 million.