Shares of SUPERVALU Are in Special Situation Territory

We have the opportunity to invest in a simple retail business that is misunderstood by the market. We recommend going long the stock, ABS bonds and ASC bonds as yield to event will offer a nice return.

The situation and events are as follows: SVU has approximately 40% short interest as of 8/31/12. Rating agencies downgraded to Caa1/B- with negative watch. On July 11, 2012, SVU suspended guidance on EPS but will provide annual FCF, debt reduction and CapEx guidance; cut the dividend and announced the hiring of Goldman Sachs and Greenhill & Co for a strategic review.

CEO, Craig Heckert, was replaced by Wayne Sales the former CEO of Canadian Tire and Board Member. President of the UFCW is commenting in the press that he is preparing his union members to expect Chapter 11 filing and restructuring similar to A&P/Pathmark. In addition to the high short interest, bond market pricing shows YTM from 8-15% and rumors of bankruptcy. How does a company file if there are no covenants?

Our view is that SVU is very similar to Ahold restructuring story, where SVU should be back on track to investment grade rating. They own 40% of their real estate; alot of their banners are either #1 or #2 in market share; and their assets are in high demand. The difference here is there is no fraud (at least we hope not) compared to Ahold.

We believe the catalysts to unlock value was announced in July through the hiring of GS and Greenhill. Basic valuation on their businesses b/w 5-6x EBITDA gets us to a $7.86 to $24.64 stock price. If you look back in history, SVU had a stock price of $40ish after their acquisition of ABS. (We can only dream) Based on M&A multiples can also see a scenario in the following manner: Supermarkets implied enterprise value of $5.6BN to $8BN; Save-A-Lot implied EV of $1.7BN to $3.4BN and Distribution business implied EV of $1.4BN to $4.4BN.

Given recent press coverage, many buyers are coming to the plate and looking at the different assets. We believe the pricing of SVU's assets will surprise the market. The credit markets especially the high yield market and the bank debt markets like simple businesses like SVU. We don't believe financing is an issue; note that SVU just redid their bank deal in August. Underwritten by Wells Fargo, US Bank, Barclays, CSFB, Rabobank and BMO, SVU will not have problems finding a banker looking for more financing fees!

We read about many sum of the parts valuation stories. The only time this can be realized in our favor is when a strategic review is in process or an activist is involved. Fortunately we have the former with a like minded CEO. We recommend going long the stock and the bonds. The bonds will appreciate and pay you a coupon while waiting for the event.

Overall, there is a lot of noise and rumors, but take a hard look at the assets, the financing market, and what you want to own. We think much of the negativity is priced in.

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