Financial Education Association

Case Study: The Management Buyout of White Hen Pantry, Inc.

Author(s): Jeffrey W. Allen and John J. McConnell
Source: Journal of Financial Education, Vol. 23 (FALL 1997), pp. 113-119
Published by: Financial Education Association
Stable URL: https://www.jstor.org/stable/41948271
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 Case Study
The Management Buyout off
White Hen Pantry, Inc.
Jeffrey W. Allen and John J. McConnell

Management of White Hen Pantry, a subsidiary of Jewel Stores, undertook a leveraged buyout
of the subsidiary in 1 985 with the assistance of PruCapital. The case focuses on the valuation of
the subsidiary and the structure of the financing of the transaction.

INTRODUCTION COMPANY HISTORY

In February 1985, management of White Hen PantryWHP was established in the greater Chicago area in
1965 to develop a convenience store division for Jewel.
(WHP), led by its President Bob Robertson, is consider-
ing buying the company from its parent, Jewel Compa-The operation was to address a growing void in conve-
nies, Inc., for $55 million. The management group hasnient neighborhood food shopping as supermarkets
formed a company named ROBODAKS for the pur-
became larger, fewer in number and further away from
poses of buying WHP. After the transaction, the com-many consumers. The concept established by WHP and
pany will retain the name of White Hen Pantry. The other stores is a modern version of the vanishing
leveraged buyout (LBO) is to be financed largely with
neighborhood grocery store that provides fill-in shop-
loans made by PruCapital, Inc., a financing unit ping
of between trips to the supermarket. In 1969, the
Prudential Insurance Company of America. The pri-company expanded its operations into New England,
mary representatives of PruCapital are Brandon WalshWisconsin and Central Illinois. These locations were

chosen because Jewel had significant existing opera-

and Kelvin Pennington. In analyzing the buyout, three
sides of the transaction should be considered: the tions there, which provided a wealth of data on cus-
buyout from the perspective of WHP management, tomertheshopping patterns and convenience store pros-
buyout from the perspective of PruCapital, and pects.
theManagement has periodically examined new
buyout from the perspective of the seller, American regions for expansion but has chosen to direct store
Stores Company. American Stores has retainedgrowth Lehman into the existing regions until WHP can more
Brothers, a major investment banking firm, to represent
fully capitalize on the significant growth potential that
remains.
it in the transaction. Among the issues to be considered
are the price of the company and the structure of the
financial agreement.
FRANCHISE ARRANGEMENT
American Stores acquired Jewel Cos. (Jewel) in
a hostile takeover in June of 1984 in a transaction
WHP operates a chain of 317 convenience stores, 302
valued at nearly $1.2 billion. This acquisition of
created
which are franchise stores and 15 of which are
the nation's third-largest drug and supermarket re-
operated by WHP. These stores average approximately
tailing chain. American Stores has decided to sell
2,500 square feet in size, offer up-front parking, and are
certain units of Jewel including WHP to reduce its debt
generally open 24 hours a day. WHP stores offer a broad
and to concentrate on drug store and supermarket
array of grocery items and high quality items in delica-
retailing.
tessen products, fresh baked goods and produce. Perish-
able products are emphasized, partly to project a
distinctive image of quality and freshness not often
Southern Methodist University, Dallas, TX 75275 and Purdue University, found in convenience stores. WHP is the only company
West Lafayette, IN 47907. among the industry's top 50 that does not sell gas.

Fall 1997 113

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 Exhibit A. Regional Analysis of Revenue (in $ Thousands)
Annual Growth

Chicago $ 11,324 $ 12,505 $ 14,414 $ 16,028 $ 18,969 13.8%

New England 2,345 2,674 3,052 3,729 4,766 19.4
Central Illinois 630 671 905 1,154 1,541 25.1
Wisconsin 1,222 1,256 1,239 1,306 1,364 2.8

Total

lable expenses such as payroll. About six franchisees

Management st
a were provided income underqual
higher the guarantee during
group 1984.
of custom
prefer Exhibit Ashoppin
shows the region-by-region growth of WHP
gas, and as
sales. WHP has either regional or area managers for m
proportion
each of its four regions. They are responsible for all of
competition.
aspects of convenience store operations in their terri- T
femaletory. Reporting to them are 26 store counselors who
shoppe
male work closely with franchisees regarding all matters of
counterp
WHP store operations. Services provided
and Jewby WHP to the
franchisees include business counseling, assistance in
development o
chise the selection of products offered, suggested retail prices,
system. F
level promotional programs,
of motivadvertising, accounting, audit-
rior ing, administrative, payroll preparation, tax advice,
service thr and
while vendor information.
concurr
recognition, The franchisees are not required to purchase prod-st
practices. ucts from any particular source. WHP It does not own a a
control distribution center
growtor warehouse, but does provide the
ing requiremefranchisees with a recommended list of vendors with
actively purchasing andinvolve
product recommendations. About 90%
and does of the franchisees' purchases not are from the recom- p
has worked mended vendors. Franchisees benefit from ext using these
which vendors is by obtaining lowerevideprices through volume
and long discounts. wait
operators. The company's accounting and control systems are
The franchise
considered among the best in the industry. The franchi-
and is sees are conditio
required to deposit weekly all cash receipts into
WHP owns the store and the franchisee owns the a store bank account effectively controlled by WHP.
WHP controls all checks drawn on the store bank
inventory and has the right to use the store premises,
fixtures and equipment. The franchisee has no owner-
account using blank checks pre-endorsed by the franchi-
see. Weekly reports are sent to WHP regarding cash,
ship interest in the physical property. The franchisee
has total authority to manage the store with respect sales, vendor
to receipts, and payroll. From this informa-
purchasing, pricing, hiring, firing and other store tion, WHP is able to determine weekly sales, franchise
opera-
tion matters provided he or she adheres to the fees owed, payroll expenses, taxes, amounts due pre-
compa-
approved vendors and other payments for services
ny's strict quality standards. Each franchisee is required
to maintain a certain minimum sales level. rendered. The franchisee is entitled to a weekly draw
A franchise fee is paid to WHP on all store sales from
to the business based on a percentage of sales or
cover rent expense and all services it provides. The some
fee stated minimum. Profits are distributed quarterly.
was increased in 1984 from 13% to 13 1/2% for all new Franchisees have an incentive to under-report sales,
since the franchise fee is calculated as a percentage of
franchisees. It is expected to be increased to 13 1/2%
for all franchisees in January, 1986. After paying sales.
the Under-reported sales normally become reflected
in lower gross profit margins. From the different reports
franchise fee, the franchisee retains all profits from the
store operation. WHP does guarantee the franchisee a WHP receives, it is able to determine the appropri-
that
ate gross profit margins for each store. A store sus-
minimum store profit of about $35,000 before control-

114 J our nal of Financial Education

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 Exhibit B. Balance Sheet as of November S, 1984 (in $ Thousands)
Assets Liabilities and Equity
Adjusted Actual Adjusted Actual
Cash $ 183 $ 183 Accounts Payable and Accruals $ 3,669 $ 3,669
Receivables 1,718 1,718
Inventories 472 472
Prepaid Expenses 422 422
Other Current Assets 202 202

Current Assets 2,997 2,997 Current Liabilities 3,669 3,669

Net Plant 51,456 26,456 Revolving Loan 16,399 1,399
Other Assets 901 901 Senior Notes 18,500
Excess of Cost Over Book Value 5,714 - Subordinated Notes 16,200 -
Preferred Stock 4,500 -
Common Stock 8c Surplus 1,800 -
Total Assets $ 61,068 $ 30,354 Retained Earnings - 25,286
Total Liabilities & Equity $ 61,068 $ 30,354

young professionals or dual income families. This con-

pected of not fully reporting sales receives additional
scrutiny through surprise cash and inventory audits trasts
and with several competitors who attempt to target a
other control checks. Under the agreement, WHP larger
can customer base. WHP management feels that the
latter approach results in doing many things poorly
terminate the agreement if the franchisee fails to report
rather than a few things superbly. This strategy enables
sales, fails to pay debts owed to WHP on a timely basis,
vacates the premises, is convicted of a felony, orthe be-company to fulfill a broad array of fill-in shopping
comes insolvent. needs for basic food staples between trips to supermar-
Franchisee store income is perhaps the most crucialkets rather than simply providing the characteristic
factor determining turnover and the overall financialcigarettes, milk, and bread typically purchased at a
convenience store.
quality of WHP. Average franchisee earnings increased
from $35,000 in 1979 to approximately $50,000 in 1984.
WHP's average franchisee earnings level compare very
FINANCES AND OPERATIONS
favorably to the average earnings of about $30,000 for a
franchisee at Southland Corporation or $40,000 at
Convenient Food Mart. Exhibit B gives a condensed balance sheet as of
November 3, 1984. Both an actual and an adjusted
balance sheet are shown. The adjusted balance sheet is
SALES AND MARKETING revised upward to reflect the write-up of assets that will
occur as a result of the buyout by ROBODAKS.
WHP management has developed a high quality As shown in Exhibit B, the company's working capital
needs are minimal. The investment in inventory is
image for the company by emphasizing a broad line of
perishable food and grocery products, convenient store primarily for the WHP-operated stores since the franchi-
locations, extended shopping hours, fast check-out, andsees are responsible for their own inventory. About 50
a high level of customer service. A typical WHP cus-percent of receivables represent amounts due from
tomer shops in the store 2-3 times per week. WHP is thefranchisees and are generally collected within 14 days
leading convenience store chain in the greater Chicago from franchisee.

area, which represents nearly 75% of White Hen's The company does not have any significant trade
revenues, and is the third largest chain in Boston andpayables since it acts primarily as paying agent for
Milwaukee. The company's average weekly store salesfranchisees and makes inventory purchases only for
are $12,600, or 46% greater than the industry average corporate stores. Trade payables were only $301,000 as
of about $8,800. The very high per store sales level of November 3, 1984.
reflects a dramatic difference in average weekly cus- WHP's minimal working capital requirements are a
tomer traffic (5,500 WHP vs. 4,300 competitors) and distinctive
a advantage over other nonfranchised conve-
somewhat higher average ticket per sale ($2.30 WHP vs.nience store organizations. Other organizations must
$2.05 competitors). commit about 20% to 30% of incremental sales rev-
Management has focused its marketing efforts on the enues to support increased working capital needs. In
customer segment of 25-44 year-olds that are eithercontrast, as WHP grows, it can devote its cash flow

Fall 1997 115

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 Exhibit C. Historical Income Statements (in $ Thousands)

Franchise Sales $ 153,368 $ 128,624 $ 168,866 $ 147,543 $ 129,035 $118,261 $ 104,065

Corporate Sales 6,359 6,735 8,176 10,525 8,430 4,812 3,365
Total Store Sales 159,727 135,359 177,042 158,068 137,465 123,073 107,430
WHP Fee 19,803 16,656 21,846 19,186 16,783 15,378 13,531
Store Earnings 347 353 371 422 323 143 196
Other Revenue 402 436 646 512 397 437 415

Total Net Revenue 20,552 17,445 22,863 20,120 17,503 15,958 14,142
Store Rent and Operating Costs 9,539 8,033 10,299 9,428 8,208 7,467 6,936
Selling Expense 1,266 1,061 1,596 1,449 1,202 1,196 1,040
Gen. & Admin. 1,446 1,299 1,560 1,460 1,227 1,192 973
Operating Profit Before Depr. 8,301 7,052 9,408 7,783 6,866 6,103 5,193
Depreciation Expense 1,824 1,525 2,183 1,746 1,586 1,285 1,091
Adjusted EBIT 6,477 5,527 7,225 6,037 5,280 4,818 4,102
Jewel Asset Charge 397 365 487 306 167 144 134
Actual EBIT

mainly to reducing debt There were a net total

rather of 86 storesreinvesting
than opened between it t
support higher working 1979 and 1983. Sixty requirements.
capital of the new stores were opened in
Exhibit C presents WHPs
the Chicagohistorical income
area, 15 in Boston, and 11 in Central state
ments. Over 95 percent Illinois.
of No stores company's
the were added in Wisconsin revenues
because a
derived from franchise fees. Total franchise fees as a
management focused its expansion efforts in faster
percentage of total WHP revenues decreased fromgrowing 1979 markets. The company's only expenditure for a
through 1982 as the company added corporate oper- new store is for fixtures and equipment, which currently
ated stores. WHP-operated stores are less profitable cost about $100,000. Management of WHP originally
than franchised stores because these stores are often
planned, under Jewel ownership, to add 30-40 stores
used for testing new programs, training, or are operated
annually for several years and expand the company's
on an interim basis until a franchisee takes over.
organizational staffing levels accordingly. This strategy
Operating expenses have historically been very stable.changed when WHP was put up for sale. Under the
Store rent and operating expenses increased in 1979buyout proposal, management plans to add only 15 new
principally because of the initiation of a performance
stores annually. A reduction in the number of new
bonus program which provides additional compensa-
stores within the constraint of capital availability is
tion of about $6,500 for retiring franchisees with over
appealing because the company can focus on market
five years of service. An accrual of $278,000 was made in
penetration with the existing store base and still provide
1979 for all franchisees with over five years of service.
meaningful incremental growth.
Store rent and operating expense as a percentage of
Roughly one-third of the company's stores were
total store sales declined somewhat in 1983 due to a
opened since 1978 and about 80 percent are new since
slower growth in rent expenses (8 of the 29 new stores
1970. On average, WHP stores are significantly newer
were purchased instead of leased) and greater efficien-
cies from operating personnel. Selling expense thanasthose
a of the competition. The company maintains
the image
percentage of total store sales declined in 1981 and has of new, clean stores with a distinctly unique
remained flat since. G&A expenses as a percentage policy
ofof redecorating each store every fourth year and
total store sales increased in 1980 when the company completely remodeling each store every twelfth year.
started a program development department to promote Redecorating a store costs about $10,000, while a major
new ideeis and programs to increase store traffic and remodeling costs $100,000-$125,000. Store refurbish-
sales. ment is a constant requirement within the convenience
Operating profit before depreciation as a percentagestore industry. Southland Corporation and other indus-
of sales has also been very stable. Adjusted EBIT shown try leaders have devoted many millions of dollars in
in Exhibit C excludes the Jewel corporate asset charge recent years to renovate stores. WHPs management's
which would not continue in the future, hence, ad- priorities are to allocate its limited capital first to the
justed EBIT more appropriately reflects WHPs histori-store refurbishment program and then to opening new
cal earnings. stores. However, both programs can be deferred if

116 Journal of Financial Education

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 Tf1 tom »o io io
GM 1> O CO 1- "t »-H CO economic circumstances require it. Histor
o> o co ^ ©
2 ^ *n cc jected capital expenditures are given in
m
Because a large fraction of WHP's stores w
oo © m co m o
the early to mid-1 970's, a large fraction
h Ci CO CM lO H CM
CD 00 TJH J> undergone complete remodeling the mid
2 co irT explains the relatively small number of st
m
ings projected for the late 1980's. Th
m x> io i>
o CM r- I r- I LO r- I i-H
uo o remodelings in the early 1990's is due to
a! oo Th cm new stores in the early 1980's.
2 H w
m

m © m © m CM
CT> rf< © © H
WHP MANAGEMENT
oo J> oo Tt< ©
Cl l-H CO

The management of WHP comprise the shareholders

of ROBODAKS. Management will all remain in place
l> © © I> IO Tf
00 X 0C1 co H following the buyout and the top five officers will each

I
00 (û oo CO O»
2 ^ CM participate in the LBO as shown below.
m m
The company has about 175 full-time employees, 146
i CM © © CM iO CO
i> CM 00 CM CM H
located at the corporate headquarters and 24 at the
4Ä- oo to oo ^ a> company-operated stores. There are also about 147
2ì ^ CM
.a, m m part-time employees at these stores. WHP has had very
little attrition among employees. Instead, several employ-
© © © © m oo ees have switched to become successful franchisees for
ço CO © © «O 1- I H
00 XC l-H Tf ©
the company.
•ū 2 H" ^
ROBODAKS has approached PruCapital, Inc. to

Í
4*1= m
u
.ü assist in the buyout of the company. American Stores
P © ifìm o m 'T)
n . >n O CO l-H i- i CM has agreed to sell the WHP operation to WHP manage-
oO ^ ^

I C* r-H t-H CO
^ 4**
ment for a total purchase price of $55,000,000 plus
$1,000,000 in closing costs and fees. ROBODAKS will
"3
also assume about $1,400,000 in existing debt and will
'I a> íd oo uo a>
Tíh õ Cl O Ifi H 1-H
X *> ^ co a> issue $55,700,000 of securities as shown in Exhibit E.
u
-d 2 ,-r i- r cm io Also as shown in Exhibit E, the proposed financing
I arrangement allocates 33% of the stock to WHP manage-
ment and 67% to Prudential.
I rH CO i-H lO O CM
00 Oï 1-H Gi Gi CM CM
oo ifì o © WHP management plans to open 15 stores annually
O* co irT
Q
■W
and increase average store sales by 7.1 percent per year.
Total sales are projected to increase by 11.5 percent per
i X
Tf co co co co Ci
CM CO 00 CM I> ^h
co CM g
year. These increases compare with historical five-year
average increases for store growth, growth in sales per
2 CM CO g
13 «» ^ & store, and total sales growth of 6.6 percent, 6.5 percent
3 X
u ü and 13.3 percent, respectively. Management expects
< co ir> oo © oo
r-H © rHrHCOCM r-i S WHP's future revenues to reflect an increase in the
X © 00 CO 1-H ^
Cl CM co" "O
»-H O franchise fee charge from 13 percent to 13.5 percent in
^ g
0 1986 for all franchisees. Expenditures for normal store
CM xfi©l>CO CM fi 5 maintenance, redecorating, and mzyor remodeling are
o 1-1 lil 50 Ol H COcťn
00 CO Ū1 H CO hr ¿J expected to continue.
2 - ■§•£
m m g Já
o Jí
o; O
' T5 g PRUCAPITAL
X <L> qj
.22 5/3 - U U

'S
<*> b O r -ri o G b O - 'S -û 'S ^
S"2 c -ri -o ¿ ü ^ o °From the perspective of PruCapital, in order for the
PřS^JS
yí K C V5K < Já
c/3 13 T3T3 WHP investment to be attractive, the purchase price
'? <D V V - V5 <u c/3 <D O 3 3
?, 06« o S 22 ï
2 2ccï g T3Õ must be at or below market prices, cash flow must be
Zc/3 <Hc/5c/d ^ ST1 sufficient to significantly reduce debt and provide Pru-

Fall 1997 117

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 Years with Years in the
Name Position Investment Ownership Age WHP Industry
Robert G. Robertson President $ 300,000 30% 46 20 30
Allen S. Davis Vice President - Operations 200,000 20 43 15 25
George S. Bovis Vice President - Market Development 200,000 20 44 13 22
& Growth
Robert B. Knight Vice President - Administration 200,000 20 42 16 19
8c Controller
Robert C. Smith Vice President - Secretary 8c 100,000 10 38 7 7
General Counsel

Total

Exhibit E.
13%
6-Year 11-Year 10-Year Redeemable
Revolving Fixed Rate Fixed Rate Preferred Common
Credit Senior Notes Subord. Notes Stock Stock

PruCapital, Inc. 21,000 9,250 8,100 2,250 400 41,000

Prudential - 9,250 8,100 2,250 400 20,000
Management - - - - 1,000 1,000

Total

Note A: The $
are priced at
Note B: Annu
Interest rate
Note C: Annu
treasury rate o
Note D: PruCa
Note E: Com
33% by ROBO

Capitalization : Redeemable Preferred Stock 4,500

Revolving Credit Agreement, due 1991 $15,000 Common Stock 1,800
Working Capital Loan 6,000 ™ ^ . * - onA
Senior Notes, due 1995 18,500 Total ™ ^ Equity . $ * 6,300 - onA
Miscellaneous Debt 1,399 Consolidated Capitalization $63,399
Subordinated Notes, due 1997 16,200
Total Debt $57,099

Capital with an appropriate

per storereturn on inve
to increase at t
$56 million gross purchase
percent, price
while(includin
new sto
of closing costs and $4 the
15 in million
firstof tax
year,
represents about 6.9x trailing
thereafter, 12-month
for a average
trailing 12-month EBIT and Depreciation,
percent per year. Tot 1
12-month net income, and 2.2x
increase book
at an valu
averag
million tax recapture is excluded,
Franchise fees the
are EBI
no
drops to 6.4x. future. Capital expen
In order to provide a benchmark
same for thei
as those under m
Walsh and Pennington have compiled info
WHP's competitors. Data for these compa
ing their market values and comparative m
multiples as of ASSIGNMENT
February 11, 1985 are given in
PruCapital believes1 . that
What are the risks to ROBODAKS?
management's pr
are too aggressive. PruCapital estimates av
2. What are the risks to PruCapital?

118 J our nal of Financial Education

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 Exhibit F. Industry Market Valuation (in $ Thousands)
Market Funded Market Latest
Stores in Value of Debt and Value of 12 Mo. EBIT
Company Fiscal Sales Operation Common Preferred Company EBIT Multiple
Southland 8,772,000 7,500 1,318,800 993,600 2,312,400 300,970 7.7
Circle K 1,029,000 2,620 361,680 326,500 688,180 71,780 9.6
National Convenience 819,000 1,090 321,168 189,791 510,959 44,927 11.4
ConnaCorp. 414,000 405 7,882 17,600 25,482 2,688 9.5
Mumford Inc. 395,800 845 81,500 22,400 103,900 14,296 7.3
Sunshine Jr. 169,270 345 22,126 1,800 23,926 3,390 7.1
WHP

3. Wher
investment bankers have created a dispute concern-
for ing management's ROfraction of ownership in WHP.
4. Is th
Given the projections of management, they be-
Approac
lieve their equity ownership of the company should
cashbe greater than 33 percent.
flo Under the projections
of PruCapital, however, the ownership position of
analysis
F. WHPs management is appropriate. Given that the
How d
5. Given
creditors of the firm (primarily PruCapital) would
like to see the company attain solid earnings levels
above, co
and repay the outstanding
tive of debt, what incentives
could PruCapital offer management
sions can to rectify this
6. dispute? Show how you would structure these o
The
vis-à-vis the more conservative estimates of the incentives over time.

You're Invited to Join Us

SOUTHERN FINANCE ASSOCIATION

November 19-21, 1998

Marco Island, Florida

Join us in beautiful Marco Island, Florida for our annual meeting. Research papers
on all major areas of finance will be presented and discussed. Select panel
discussions and tutorials will be included in the program. Academicians,
practitioners, and government employees interested in financial research are
encouraged to attend the SFA meetings.

For more information, please contact:

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Southern Finance Association
Crummer Graduate School of Business
Rollins College
1000 Holt Avenue -2722
Winter Park, FL 32789-4499
Phone: 407-646-1512
Fax: 407-646-1550

Fall 1997 119

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