Overview of the deal
Estimated value: £10bn
Announcement date: April 2018
Advisors: Morgan Stanley, UBS
The supermarket industry is experiencing a bout of toughening competition driven by the expansion of German, low-cost supermarket chains Lidl and Aldi, Tesco’s £4bn acquisition of wholesale business Booker Group, and most prominently Amazon’s entrance into the industry through their £10.4bn acquisition of Whole Foods, which generates fear that they will disrupt the industry through technological innovation. This merger is a defensive strategic move to allow both Sainsbury’s and Asda to maintain competitiveness in the wake of this unprecedented market shake-up.
The purchase will be paid for with a mix of equity and cash where Asda’s parent company, Walmart, will receive £3bn in cash and a 42% stake in the combined business, but has vowed to hold less than 29.9% of the combined entity’s voting rights. The deal is the textbook example of a horizontal merger with the merged entity holding a 31.1% market share.
The NewCo will operate a “dual-brand strategy”, and will so retain both the Sainsbury’s and Asda brand as they are today. Sainsbury’s have stated that economies of scale will allow for price decreases of 10% on everyday essentials. Overall, this would allow both firms to weather the increasing competition as a more efficient, powerful, single entity.
“Alongside Tesco, Sainsbury/Asda would mean two companies controlling almost two thirds of Britain’s food sales. Small suppliers would face an intensified squeeze. No amount of store sale “remedies” would make a significant impact on this dominance. [...] Above all, this is another test of whether UK authorities are serious about competition.” -Neil Collins, Financial Times
Company details (J Sainsbury)
Sainsbury’s is the second largest supermarket chain in the UK. It currently holds a 15.8% market share.
- Founded in 1869, headquartered in London
- President and CEO: Mike Coupe
- Number of employees: 181,900
- Market Cap: £7.14bn - EV: £6.23bn
- LTM Revenue: £28.46bn - LTM EBITDA: £1.21bn
- LTM EV/Revenue: 0.22x - LTM EV/EBITDA: 5.5x
Company details (Asda Stores Ltd)
Currently the third largest supermarket chain in the UK. Asda is a subsidiary of Walmart after a takeover in 1999. It currently holds a 15.3% market share.
- Founded in 1965, headquartered in Leeds
- President and CEO: Roger Burnley
- Number of employees: 165,000
- Market Cap: N/A* - EV: N/A*
- LTM Revenue: £22.22bn - LTM EBITDA: £1.18bn
- LTM EV/Revenue: N/A* - LTM EV/EBITDA: N/A*
*Not available because of Asda’s private ownership
Projections and assumptions
The most immediate consequences of the deal do not necessarily lie in the internal details of the Sainsbury-Asda entity, but perhaps in the industry response to their move. Paradoxically, it seems like this defensive merger might contribute towards even tougher competition in the supermarket industry, since, in July, Tesco announced a “strategic alliance” with mainland Europe supermarket giant Carrefour which could be seen as a response to the Sainsbury's-Asda deal. Tesco and Carrefour have had informal talks for two years but have been spurred to action by this deal. A future merger between Tesco and Carrefour, while purely speculative at this stage, would potentially diminish the competitive upside Sainsbury’s and Asda currently expect as a result of their merger.
Both companies have stated that they do not foresee having to close any of their stores, keeping the same regional coverage, however as the Competition and Markets Authority (CMA) has been involved that is looking less likely. Furthermore, there are certain areas in the UK where the two companies previously competed but where they might now enjoy a regional monopoly. These will turn out to either be profit-making victories for the company, or, perhaps much more likely, losses as the CMA moves to shut down stores.
Among the NewCo’s first steps will be to modernise their stores with click & collect and same-day delivery services - infrastructure that Sainsbury’s secured through gaining ownership of Argos when it acquired the Home Retail Group in 2016.
The long-term upside to this deal does not necessarily manifest in significant future gains in market share beyond the simple sum of Sainsbury’s and Asda’s separate market shares, or even in large profit margin improvements. Though the deal will allow the merged company to compete effectively with their 31.1% market share, and so it might increase their profit margins in the very short run as economies of scale help lower their COGS. However, with their stated aim to compete through lowering their prices, partnered with tough competition, any sustained profit margin increases look unlikely. Instead, as already mentioned, the benefit of this deal lies in the protection it offers to the NewCo’s market share because of various synergies and market power gains.
The deal will also create financial synergies, helping the combined entity to raise capital while also increasing their cash flows and thus supporting their ability to take new investment initiatives. Furthermore, they have stated that they will be able to freely exchange knowledge and technological developments with Walmart. This will gear the group towards competing through innovative market solutions, something that Sainsbury’s have already demonstrated to be a part of their strategy through their Argos acquisition, setting them up to compete through the same modern services, i.e. click & collect and same-day delivery, that Amazon has used to great effect in the online shopping space. So it is likely that they will attempt to leverage this deal for similar purposes in the future, quite possibly through future acquisitions.
Risks and uncertainties
The primary risk lies in the uncertainty of CMA approval, or in any potential conditions the CMA might place on the NewCo. Despite Sainsbury’s and Asda’s claims that they will not have to close any of their current stores, it has been met with skepticism from local MPs, and this is worsened by the speculated creation of “monopoly towns” - towns where, until now, Sainsbury’s and Asda have been the largest supermarkets. Furthermore, any consolidation of market power in the food industry becomes a sensitive issue because it affects necessity goods, and considering the apparent acceleration of this consolidation, the risk continually increases that the CMA will look to put down their foot before, in their view, it goes too far. Lastly, as the CMA approved Tesco’s acquisition of the Booker group without any conditions, a sense of overconfidence may have afflicted management in respect to this deal, leaving them vulnerable to the opposite outcome.
As has been mentioned previously, Tesco and Carrefour announced a strategic alliance as a response to Sainsbury’s and Asda’s move, representing another step-up in the industry’s competitiveness. This, combined with the threat posed by Amazon and their potential ability to introduce disruptive technology, could result in an environment where this merger is not enough of a defensive measure to retain the two companies’ market share.
Lastly, Sainsbury’s will take on £3.5bn in debt through syndicated loans to finance the acquisition, an amount that is two times larger than their current net debt. This puts the new entity in a more vulnerable position, threatening future cash flows and earnings.
“Waiting in a studio for a TV interview on April 30th, Mike Coupe, the boss of Sainsbury’s supermarket, was caught on camera quietly singing “We’re in the money” to himself. Having just announced the biggest deal in the grocery business for over a decade, it is easy to see why the tune might have come to mind. [...] he had to apologise quickly for appearing rather smug…” -The Economist
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