Mega at a Crossroads: To Sell Off Part of the Supermarket Chain, or to Ask for the Court’s Protection From Creditors

Mega is expected to release poor financial reports later this week, and is running out of time to find a solution to prevent suppliers from abandoning it.

Ofer Vaknin

Facing a steep drop in sales and just before the release of its third-quarter financial results, Alon Blue Square, the owner of the Mega supermarket chain is at a crossroads – and will most likely have to decide which way to proceed as early as next week. Among the possibilities under consideration are closing down its discount chain brand You, selling the entire chain or turning to the courts for protection against its creditors. Retail food industry sources say the company is continuing in its efforts to sell You, or its Mega in the City (Mega Ba’Ir) line of supermarkets, in parts or together.

The question is whether it is too little, too late – or maybe a move that will be a lifesaver for the Mega supermarket chain and its thousands of employees. Four months after turning to the courts for a debt restructuring agreement, Alon Blue Square seems moving in the direction of closing down You or selling it.

The You discount brand was launched exactly two years ago with a major advertising and marketing campaign. But it opened its new branches slowly, and kept the branches of its previous discount brand Mega Bool operating. The selection of products in the stores was limited, and Mega changed the direction of its discount pricing policies regularly. As a result, You, which now has 22 stores, never took off – and caused heavy losses to Mega’s bottom line.

When Mega’s new management was appointed, led by Mega chairman and Alon Blue Square CEO Avigdor Kaplan, the company thought it was necessary to close You, along with Mega in the City and the Zol Be’Shefa (formerly Shefa Shuk) discount brand targeted at the ultra-Orthodox. But the union objected, and instead Mega announced a more limited plan for saving the company at the end of June. This plan included closing 32 stores of the You, Mega in the City and Zol Be’Shefa brands, as well as cutting 35 million shekels ($9 million) in wage costs. In return, management allocated 33% of the company’s stock to employees.

Months ago, many suppliers and others in the supermarket industry said that the rehabilitation plan was too limited, and would be inadequate to put Mega back on its feet, calling it only a Band-Aid that would not stop the bleeding and worsening of the situation. It turns out they were right. It seems that senior executives at Mega now agree, and realize there is no choice but to close – or sell – You.

No choice but to ask for court protection?

In the end Alon Blue Square will probably have no choice but to petition the court soon for a stay of proceedings and protection from creditors, say industry sources. If this scenario occurs, then Alon will try to come to court prepared with solutions, such as potential buyers for the various brands: the 114 Mega in the City stores, the 22 You stores and the 12 Zol Be’Shefa stores.

Kaplan has been leading attempts since last Thursday to sell off You, and other brands, say industry sources. It is likely that a number of You branches will be sold to some of the smaller, private supermarket chains.

The much harder problem will be what to do with the 114 Mega in the City stores located in urban areas. While this brand may be relatively successful, with good locations – and as opposed to You has not caused Mega major losses – it still seems it will be much harder to find a buyer for these stores among the rival private supermarket chains, who will find it difficult to handle such a large and complex merger. This leaves a sale to a major international corporation in the industry as a more likely choice.

If the company does go to court to ask for protection from its creditors, it is likely that Alon Blue Square will ask the court to make its creditors take a haircut, including writing off some of the debts owed to banks and suppliers.

Mega will release its third-quarter financial reports in the coming days, and they are expected to be bad. This could scare off both suppliers and buyers, with the suppliers deciding to cut back on their deliveries to Mega to cut their losses in case Mega files for court protection. In addition, Alon Blue Square provided some of the large suppliers with financial guarantees in order to keep them supplying the chain with products to keep the shelves filled during the Jewish holiday period in September, and some of these guarantees are set to expire soon – which could lead some of these suppliers to stop deliveries to Mega if they do not receive new guarantees.

Meanwhile, there is no plan to go to court to ask for protection, said a source close to Alon Blue Square. “For now, there is no decision leading in that direction. Management is working hard on how Mega can be made more efficient, improved and recover. The guarantees to suppliers will be renewed if there is a need to renew them. For now there is no decision whatsoever, and the chain is examining all options,” he said.

“Mega’s situation is not good since the suppliers slowed down their deliveries, and it is clear the chain for now is in an unbalanced and uncomfortable situation, but from this to a stay of proceedings there are a number of things along the way that must be considered and crystallized. There can also be other things along the way that could revive Mega without reaching a stay of proceedings,” he added, noting that the company is trying to fix things and continue to operate.

The source said Mega will make its regular weekly payment to suppliers this week on Friday of tens of millions of shekels.

Even if Alon Blue Square does shut down You, or sell it, in order to save Mega the controlling owners, Shraga Biran, David Weissman and the Kibbutz Movement purchasing organizations, will have to put up some 150 million shekels in new funding – in addition to what they have already invested. Whether they will do this is not at all clear, given their having created difficulties about such investments in the past.

Under the July debt restructuring agreement the owners were to have put 320 million shekels into the company: 240 million shekels in a rights offering and 80 million shekels from Alon Blue Square. In addition, Alon Blue Square was to take on itself 200 million shekels in debt that Mega owed the banks. So far the owners have put in some 160 million shekels, and provided suppliers with another 40 million shekels in financial guarantees so they will continue supplying Mega with products.

Mega has already used the money it received to pay suppliers, as well as using the money for the process of closing stores and paying severance to workers it laid off. The additional estimated 150 million shekels is critical in order to cover one-time payments for closing branches and paying severance, as well for working capital and managing inventory.

Also, if Mega decides to keep the Mega in the City stores it will have to invest large sums in renovating most of the stores, which have been neglected for years. The company will also have to launch an advertising and marketing campaign for the remaining stores.

Many in the industry have their doubts that Mega will succeed in its recovery program, even if it sells You and other stores. This is because the entire food retailing industry is in trouble, with a slowdown in consumer spending and eroding profit margins along with the problematic relations between Mega’s owners and its suppliers, which will make it difficult for the chain to continue to function.

Empty space on shelves

The relations between Mega and its suppliers are problematic and bad, mostly because the previous management, headed by the owners, never told the suppliers the truth about the scope of the enormous debts and even hid these figures in their financial reports. Only when the company went to court for its debt restructuring did it reveal the full extent of the debts: some 1.3 billion shekels, about half of which was owed to suppliers.

Since the debt restructuring agreement was reached, the new management at Mega, headed by CEO Raviv Brookmayer, has improved these relations with suppliers. Brookmayer has brought Mega to sales of some 80 million shekels a week, but a number of the larger suppliers are not delivering goods at all, or only partially.

The recovery plan has set a target of about 85 million shekels a week in sales, but a few weeks ago revenues started heading down once again, partly because problems between Alon and some of its bondholders helped ruin prospects of a sale. Also, the headlines warning of more trouble at Mega may have scared off suppliers, and as a result customers too, who are not interested in shopping in supermarkets with partly empty shelves.

Weekly sales have since fallen to about 70 million shekels, which puts the entire recovery plan in jeopardy. Last week sales were about 75 million shekels.

Smaller and mid-sized suppliers are not cutting back on their deliveries too these days, leaving more shelves with empty spaces. Suppliers, especially those without credit insurance, are worried because Mega management has asked them to go back to the credit terms they once supplied and stop paying in cash as they are now doing – or at least by providing financial guarantees.

Mega said it is “in the midst of implementing a recovery plan. In light of the slowdown in the supply of goods by certain suppliers, the board of directors and management of Mega is studying the implications stemming from this and the adaptations needed in order to meet the framework of the [debt restructuring] agreement and return to the required volume of sales. The management of Mega is doing everything in its ability and is acting with the suppliers in order to guarantee the supply of products and the regular availability of goods in the chain’s stores.”

As for appealing to the court for protection from its creditors, Mega said “the matter is not on the agenda.”