Battle Of Safeway: Squeezing KKR At Both Ends

If the SEC makes the new rules for nominating directors retroactive when it likely unveils its revised recommendations in May, Safeway Inc. could become the first test case.

Last week, a group of powerful pension funds said they plan to withhold their votes from the CEO of Safeway Inc., and two of its directors. They also said they will try to recruit other investors for their efforts.

The pension funds were the Connecticut Retirement Plans and Trust Funds, New York State Common Retirement Fund, New York City Employees’ Retirement System and the Illinois Board of Investment.

The California Public Employees’ Retirement System, the country’s largest pension fund, also said it will withhold their votes from the three individuals.

The Disney Strategy

The five funds combined own 2 percent of Safeway’s shares.

"What we're doing here is similar in strategy to Disney," said New York State Comptroller Alan Hevesi at a news conference in Washington, D.C. "I hope it will indicate how serious we are" to commence a process to improve the governance and performance of the company.

The pension funds could also emulate the strategy of the pension funds—including the New York State Common Retirement Fund and CalPERS—that threatened binding shareholder resolution that could have eventually led to outsiders nominating their own slate of directors at Marsh & McLennan Co.’s annual meeting. However, both parties recently reached a compromise whereby the insurance and money management giant agreed to nominate a former federal prosecutor the dissident group recommended (see related story from Mar. 16 edition).

"We always hope to end up in a dialogue," acknowledges John Chartier, spokesman for New York State comptroller Alan Hevesi.

The object of their ire: Safeway CEO Steven Burd and board members William Tauscher and Robert MacDonnell, the only Safeway board members that will be on the ballot at the company’s May 20 annual meeting since the grocery giant has a staggered board of directors.

The pension funds complained that several efforts to meet with management and the board were spurned. They insist that eight of the nine current board members are not truly independent.

"Pervasive Conflicts"

For example, the funds claimed that Tauscher and businesses he operated received more than $3 million from Safeway since he joined the company's board in 1998.

They also complained that Safeway’s stock has fallen 60 percent in the past five years and have asserted that under Burd’s leadership, Safeway invested billions of dollars on unsuccessful and costly stock buyouts, lost four of its top executives in little more than a year, and has pursued a confrontational labor strategy that has caused long-term damage to its relations with both customers and employees.

In response, Safeway Vice President Brian Dowling said in a statement that the pension funds’ actions are an attempt—at the behest of union leadership—to pressure a company that has taken decisive action in labor issues and moved to restructure its labor costs.

"The fact that the attack is shrouded in the language of corporate governance issues may help garner press coverage, but it can't create legitimacy where there is none," he added.

He claimed the company has improved its governance practices and increased investment in its stores. He also defended the independence of the company’s board members.

"Safeway has been and continues to be committed to the highest corporate governance standards," he stated. "We have enacted director independence guidelines more restrictive than the NYSE/SEC rules, and have properly applied them to our board members."

The Road Through KKR

Although Safeway seemed strident and combative in its response to the pension funds’ announcement, Bill Atwood, spokesman for the Illinois Board of Investment is undeterred.

This is because he believes he believes there is a better chance of reaching a more amicable solution with the buyout firm Kohlberg Kravis Roberts.

One of his group’s biggest criticisms is that four of Safeway’s nine directors—James Greene Jr., Paul Hazen, Robert MacDonnell and George Roberts—are affiliated with KKR, which completed a $5.7 billion leveraged buyout of Safeway in 1986. It took Safeway public in 1990 and sold its remaining Safeway shares in 2000.

But Atwood points out that four of the five pension funds that appeared in the press release announcing their plans for withholding their director votes at Safeway are also investors in KKR’s buyout funds. Only the New York City Employees’ Retirement Fund does not currently have money with KKR.

Atwood is hoping this intriguing position will provide the group strong leverage when it tries to negotiate a possible settlement with the four directors from the buyout fund.

"We have a long-term business relationship with KKR," explains Atwood, acknowledging that his pension fund has invested with the buyout giant since the 1980s. And although it has not placed new assets with KKR since 1996, KKR still accounts for 20 percent of the Illinois Board’s private equity portfolio.

"In an ideal situation, this relationship can be levered to positive change," Atwood elaborates. "Why would KKR put itself between Safeway and KKR investors?"

Of course, there is no guarantee that KKR will buckle under the pension funds’ demands. But, Atwood acknowledges it will be interesting to see how this relationship is played out.

"It can either facilitate a solution or exacerbate the situation," he adds.

How this intriguing sideshow plays out could also set a precedent for many future governance battles.

After all, many of the pension funds that have invested in the large, multi-billion-dollar leveraged buyout funds are also shareholders of the funds' portfolio holdings.