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JP Foodservice has appetite for rivals

THE BALTIMORE SUN

Is this a case of the purloined playbook, or simply the sincerest form of flattery?

Only Jim Miller knows for sure. The 46-year-old chairman of JP Foodservice Inc. of Columbia is out to make some noise with the state's quietest billion-dollar company. After years of stumbling under the debt load of a 1989 leveraged buyout, JP Foodservice shook off much of the debt by going public in November, announced big gains in sales and operating earnings last week, and is winning backers for its plan to begin growing again.

That plan calls for boosting profits by snapping up smaller competitors in the highly fragmented restaurant supply business an industry in which no one has 10 percent market share.

It calls for getting about 3 percent more sales every year out of the existing business plus another 3 percent sales gain from the acquisitions, and forcing most of that to the bottom line through upgraded information systems and service. The plan, analysts say, will let earnings rise 10 percent a year or more in a mature business.

One more thing: The plan also happens very much to resemble the long-term behavior of Sysco Corp., the Houston-based industry leader that used to employ Jim Miller.

"Sysco has very high goals and expectations," he allows. "We are setting the same kind of high goals and high expectations for our company."

Wall Street sees JP Foodservice as having a chance to become the next Sysco, and it likes the idea a lot. For now, however, there are both a lot of similarities and a lot of differences.

Both companies sell food to restaurants, institutions, hotels and the like. JP sells hot dogs to the food service vendors at Fenway Park and Oriole Park at Camden Yards, hamburgers to Ruby Tuesday's and Perkins, and lunch meats to Subway. About 44 percent of its sales are to chain customers but most of the rest are to small, often mom-and-pop operations. JP's 2,300 employees, about 400 of them in Maryland, fill orders from nine warehouses spread from Severn to Boston to Minneapolis, enough to make JP the sixth-biggest broad line food distributor in America.

But Sysco is three times bigger than industry runner-up Kraft Foodservice Inc., and its $10 billion in sales dwarfs JP Foodservice's $1 billion. While JP's operating profit margins are above the industry average, Sysco's are nearly 20 percent higher. And Sysco makes about two and a half times as much on the bottom line, after JP makes the payments on its $155 million debt.

But JP's push to make its profits climb toward the rarefied zone Sysco occupies is under way. JP's debt load got a lot smaller in November, when it partially cashed out the 1989 LBO with an $11-a-share initial public offering that raised $80 million. The company also replaced debt that paid interest rates of up to 14 percent with investment-grade bonds that pushed their average interest rate below 8 percent. The result: annual interest payments cut by $18 million.

"They're basically taking a page out of Sysco's playbook," said ,, Mark Allen, an analyst at Robinson Humphrey Co. in Atlanta, a co-manager of JP's initial public offering. "They have been very successful with that strategy for 20 years."

Formed in 1989

JP Foodservice has never been an investor's darling before. The company was formed in 1989, when Mr. Miller and a group of managers and investors bought its predecessor from Sara Lee Corp. in a leveraged buyout. For $317 million, about $303 million of it borrowed, Mr. Miller and other managers got 11 percent of the company while Sara Lee kept 47 percent and institutional players bought 41 percent.

Sara Lee currently owns 38 percent of its stock.

"Sara Lee is a conglomerate," Mr. Miller said. "You could not get the same type of returns as a Hanes or Champion [which were also units of Sara Lee]. . . . It was a situation where we had certain problems with obtaining funds. If you could get 50 or 60 percent returns, you are not going to fund a 20 percent return business."

Mr. Miller insists, to the skepticism of many, that the LBO was successful. The company always lost money while it was privately held because of its debt load. But it did what LBOs are supposed to force companies to do: It made JP clean up its operation, dump nearly a quarter of its sales as too unprofitable to be kept around, and doubled its earnings before interest payments. What it did not do was raise the value of the stock.

"It worked. It was a very successful LBO," Mr. Miller said. "We were showing a net loss, but every LBO would show that until they were able to do a public offering. You have to retire your debt. . . . The whole objective was to take the company public in five years."

But even by the standards of 1980s leveraged buyouts, this one was overheated. People who did LBOs for a living typically financed up to 90 percent of their deals. This one was 95.6 percent debt.

JP makes only 3 cents' profit on every dollar of sales now, after five years of wringing out fat and building what Mr. Miller says is the lowest cost structure in the industry, and that's before interest payments. It didn't have room for mistakes, because the distribution business works on tight margins even in good times, and when the economy turned soft in 1990 it couldn't support its debt and still make money.

Even today, JP doesn't pay a dividend, and its stock is trading in the range of its initial price.

Add to that the fact that the investors paid more for the company in 1989 than its current stock price today, and you have the idea of why the LBO isn't considered a success, said Charles hTC Ronson, who publishes the IPO Value Monitor in New York.

"They paid too much," Mr. Ronson said. "It's not a business where you are going to have unique or idiosyncratic strategies. . . . It's very much a blocking and tackling business."

Even its status as the sixth-biggest U.S. food distributor gives JP only 1 percent of the national market. The next biggest player in Maryland is Baltimore-based Continental Foods, whose $85.5 million in sales was good for 72nd place nationally in a 1994 trade magazine survey.

"It's our intention to stay east of the Mississippi," Mr. Miller said. "You look at Ohio, New York State, Virginia -- those all make wonderful geographic sense for us."

Goldman Sachs analyst Jordan R. Alliger said in a Jan. 5 report that the top 50 distributors control only 32 percent of the market, and the next 150 only 7 percent more. Goldman Sachs, another " co-manager of JP's stock offering, said the many small companies won't be able to keep up with JP as it grows.

Smith Barney Inc., a third co-manager of JP's IPO, estimates JP can boost these companies' earnings up to 60 percent by serving their accounts with its own fleet of trucks, its sales force and its warehouses. JP has not yet begun its hoped-for acquisition campaign, but its existing business is living up to its part of the growth plan. The company on Thursday announced its first quarterly earnings since going public, which showed sales rising 9 percent to $272.4 million for the quarter and operating profits up 13 percent. Restructuring charges produced net loss of $1.9 million, but the company earned nearly $4.9 million before the special charges, after results were adjusted to account for the company's new debt structure.

The company is moving to catch up to industry trends to make the business it has more profitable. Especially, JP is expanding its own brands, confident that it can make more money on them than on many name brands and also control the products' quality standards, Mr. Miller said. It is also using its size to push into restaurant consulting, helping owners with menu planning and other services. Ultimately, these services as well as products will give big companies like JP an edge over the boutique firms from which they hope to take market share.

"You have to be able to grow and to bring value-added services to customers to survive in this business," Mr. Miller said.

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