Long-simmering tensions between Save A Lot’s private owners and its independent licensees—an issue that has intensified as the discounter nears a financial crisis—were revealed in an explosive lawsuit that alleges the company’s owners induced a group of military veterans to open Save A Lot stores behind bad data, then doomed them to failure through indifferent and at times hostile management.

The suit, filed late last week in U.S. Eastern District of Missouri, alleges that Onex Corp., an affiliated investor, and two Onex partners who are also Save A Lot directors, had a “secret plan” to transform the company from a licensee-based system to a corporate-owned store model it could then flip to a competitor such as Aldi or Lidl—wiping out approximately $1 billion of Save A Lot’s value, and all its equity, in only three years. Along the way, it punished licensees such as the veteran group, which said its stores were beset by uncompetitive wholesale prices and frequent out-of-stocks, performed considerably worse than company-provided data suggested they would, and were eventually abandoned once tensions arose between the groups, leading to millions in losses for the veterans.

Onex Corp., the Toronto-based investment company that took over Save A Lot in a $1.365-billion leveraged buyout in 2016, was not immediately available for comment.

The plaintiffs are a group of store owners composed of U.S. Navy and Marine veterans who invested in Save A Lot stores in 2015 in part to support a “mission” of bringing grocery stores to underserved trade areas. Onex Corp., a limited partnership that invested in the acquisition called Onex Partners IV, and two Onex employees who are also Save A Lot board members, Matthew Ross, the board chairman, and Anthony Munk, are named as defendants. The suit does not name Save A Lot nor its current management as a defendant.

The suit has seven separate counts, including alleged violations of the federal Racketeer Influenced and Corrupt Organizations Act, known as RICO, fraud, and conspiracy to breach contracts, and demands a jury trial and damages to be determined.

The veterans group opened 10 Save A Lot stores from 2015 to 2017, which they ran as a system, including seven after Onex acquired the chain from previous owner Supervalu, but closed them all by the end of last year. The stores were located in Aiken, S.C.; Columbia, S.C.; Tulsa, Okla.; Winfield, Kan.; Danville, Va.; Wichita, Kan.; Mooresville, N.C.; Oklahoma City; and Altus, Okla.

The veterans are not the only licensees who say they’ve been burned since Onex acquired Save A Lot, sources told WGB. Others have been scrambling to find support from wholesalers or other partners to buy themselves out as a member-owned co-op. A separate group of concerned owners founded an owners group in part to better communicate with management through the National Franchise Association. Big Save A Lot owners such as Houchens Industries, which at one time operated about 200 Save A Lot locations, has converted dozens of them to a cost-plus format in partnership with wholesaler AWG Inc.

Save A Lot, in the meantime, appears nearly certain to be hurtling toward a financial crisis.

Lack of Uniformity

St. Louis-based Save A Lot, the second-largest U.S. discounter behind Aldi, is currently seeking strategic alternatives because a turnaround plan has failed to gain traction amid increased competition—including multibillion-dollar investments by Walmart, Aldi, Lidl and Kroger—and also longstanding tension with licensees, who as of Oct. 31 operated 698 of the company’s 1,115 stores. Peter J. Solomon has been Save A Lot’s investment banker since May, seeking a sale or partnership, sources said. More recently, Save A Lot has retained FTI Consulting to do what sources described was “operational” work, primarily finding efficiencies.

A Save A Lot spokeswoman declined comment.

The company’s most recent initiatives, including previously reported actions to cut prices, repackage private brands and roll out a new store design, were designed to improve sales and profits but have not gained traction in part because licensees over the past two years have become reluctant to buy into them, with many seeking to source from alternative suppliers, sources said. That also has contributed to rapidly declining systemwide performance with same-store sales this year down by more than 5%, according to Mickey Chadha, a VP with Moody’s rating agency.

In an interview with WGB, Chadha said a “lack of uniformity” was among the chain’s central challenges. “It’s a model that can work only if the goals of the licensees and the corporate stores are aligned,” he said.

“The issue there is that in the past, there has been very little controls over licensees,” Chadha said. “So if corporate decides we’re going to lower pricing to get traction, the licensees have not really followed through on that, for many reasons. Maybe they don’t want to lower pricing because they feel their profitability will be lower.”

Licensees, however, say the pricing program and other turnaround initiatives have come far too late in the game. And the nature of the limited-assortment concept leaves operators especially sensitive to price, promotional and assortment disruption, because they typically have fewer means to offset margin changes that may accompany them. “It’s chaos in St. Louis,” one licensee told WGB.

For example, the lawsuit describes a massive restructuring in the early months of Onex’s ownership, including the elimination of scores of corporate employees who supported licensees and the legacy supply chain. When the company—now under management of Lidl U.S. veterans Kenneth McGrath and Kevin Proctor—experienced early sales struggles, the suit alleges, licensees faced higher wholesale charges for groceries and experienced multiple supply-chain interruptions, accelerating a sales decline at the same time that competitors were engaging in price wars.

Save A Lot prices were so high, the lawsuit alleges, that “at times, it was cheaper for plaintiffs to purchase inventory from their local competitors across the street at retail, than to purchase the inventory from [Save A Lot] at purportedly ‘bona fide wholesale prices.’

“In short, Save A Lot became noncompetitive with its major competitors,” the complaint continued. “This killed the major competitive advantage Save A Lot was supposed to have over its competition: dramatically lower prices.”

The veterans allege that the defendants were aware of what they were doing, saying the higher prices in effect was “simply a ruse to mask a hidden franchise fee.”

Similarly, the suit contends, Save A Lot encouraged investment from licensees for new stores using reports on sales projections and other data it knew to be inaccurate.

Central to the case is a contention that Save A Lot’s owners had little use for independently owned stores, intending through its investment in the chain to sell corporate-owned units only to fast-growing discount competitors: “Defendants had done their market research. They knew that both Lidl and Aldi had realized explosive growth—each now has over 10,000 locations worldwide. And all their stores are corporate-owned. Also, defendants knew that Lidl and Aldi would be potential purchasers of [Save A Lot] and aligning SAL’s operations (which was primarily dependent upon independent stores) to Lidl and Aldi’s operations (which were corporate-owned stores) would make SAL a more attractive acquisition.”

Men on a Mission

The plaintiffs are veterans of the U.S. Navy and Marine Corps centered around graduates of the U.S. Naval Academy Class of 2006 and include veterans of overseas conflicts. The group founded Honor Capital LLC in 2014 to support a “mission” to combat U.S. food deserts and run its stores as a cooperative “system.” The group at one time was featured in a Save A Lot marketing materials, and according to the suit they were solidly behind the “America’s Choice” strategy of McGrath’s predecessor, Eric Claus. The suit describes high enthusiasm around the mission, investing behind ideas such as a mobile food unit to deliver food from its stores to outlying communities, and establishment of a program meant to encourage other veterans to also become Save A Lot owners. In this sense, the dispute represents a stunning waste of potential goodwill.

The “America’s Choice” plan, enacted in the final months of Save A Lot’s ownership by Supervalu, was to be built around the acquired America’s Choice private label. That initiative appeared to have been abandoned shortly after Onex took control; it was not until earlier this year that Save A Lot debuted new packaging on private labels.

According to the complaint, the veteran’s group continued investing in new stores as Onex took control without realizing that the company at that time was “gutting” the corporate and field offices and “dismantling” its supply chain. Save A Lot “regularly failed to deliver inventory that the Veterans ordered for the stores, which meant the veterans’ stores often did not have basic staples on the shelves, such as ground beef or paper products,” or featured items in weekly ads, the suit alleged. This resulted in stores spending advertising dollars that ultimately drove customers away.

Deeply Distressed

Save A Lot’s acquisition was funded by $660 million in equity between Onex and its associated Onex IV fund, and by a $728 million term loan against the company.

Reshmi Basu, a restructuring editor at Debtwire, said Onex officials had warned investors while syndicating the loan that the process of turning around Save A Lot could be challenging—but they were more right than they knew. Its term loan is currently trading at “deeply distressed” levels, Basu told WGB, with trading as of late last week showing a 35/38 bid/ask vs. 50/52 at the beginning of the year. The loan does not mature until 2023, although covenant violations on borrowing limits before then could trigger a renegotiation, sources said.

Profitability at the chain has plummeted precipitously since Onex took control, with LTM EBITDA (earnings before interest, taxes, depreciation and amortization on a trailing 12-month basis) falling from $200 million in the fourth quarter of 2016 to just $13 million in the most recently reported third quarter of 2019.

Debtwire first reported that Save A Lot had engaged FTI, a Boston-based consultant that has worked with numerous food retailers in financial distress. But Basu said she didn’t see its engagement as a signal a crisis was any more likely.

“It acknowledges there is work to do given how leveraged the structure is,” she said. “I think FTI being there is a positive, because they can clean up some inefficiencies.”

A spokesman for FTI declined comment.

Burt P. Flickinger, managing director of Strategic Resource Group, said Peter J. Solomon has been crafting scenarios for potential buyers, citing Grocery Outlet’s success as a potential model for what Save A Lot could be given the right investment: A discounter finding growth opportunity through independently owned, price-focused food stores. It is not known whether Lidl or Aldi have interest in corporate stores, although both are rapidly expanding in the U.S.

“The idea is if Grocery Outlet could go from inconsistent success a decade ago to a strong IPO and a strong stock today, why couldn’t another extreme value retailer?” Flickinger told WGB.

A Solomon representative did not respond to a request for comment.

In the meantime, Save A Lot appears destined for a balance sheet restructuring that can conform to its new level of profitability and its debt obligations. “Once you start pricing down, the margins take a huge hit and unless you can offset that decline through increased traffic, you’re in for trouble,” Chadha said. “There is no way of growing out of this. To grow out of this is next to impossible in today's pricing environment for food.”

A ‘Stunning Admission’

The lawsuit points out that struggles in 2017 and 2018 were not limited only to the veterans group. “In fact,” it said, “most if not all of Save A Lot stores were experiencing significant problems.”

The veterans described meeting with company officials in March 2018, during which they relayed its stores were on pace of losing $1 million annually due to lower-than-expected sales.

In the face of assurances that McGrath’s new management team by then had developed a plan to revitalize the stores, the veterans in May 2018 offered to sell their units back to the company but were rebuffed, “a stunning admission that Save A Lot literally would not buy what they were selling,” the suit said.

The relationship between the parties deteriorated further when Save A Lot declined to make financial accommodations for actions that in the veteran’s opinion harmed their business.

Downgrades in Save A Lot’s term loan, in the meantime, prompted the veterans’ financial backer to withdraw support, leading to a decision to close their most troubled stores. The suit claims that when Save A Lot understood the group was considering legal action, it withdrew advertising support, and in October 2018 moved them to “cash-on-delivery” demands that, according to the suit, left the veterans with little choice but to close all their stores.