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'Are we missing something?' Shock Sainsbury's bid panned
Analysts argue a Sainsbury's takeover of Home Retail would leave it with too many stores, too much debt and distract management from its existing business.
Shares in the embattled supermarket, which like its rivals has been struggling to counter the threat posed by discount stores Aldi and Lidl, are down 5.2% since it revealed a bid for Home Retail, owner of the Argos and Homebase chains, had been rejected.
A share price slide on news of a potential acquisition is common, as investors fret the acquirer will overpay for their target. But what's striking with the Sainsbury's approach is how much analysts are struggling to piece together a convincing rationale.
Sainsbury's did its best yesterday to reassure on that front, outlining five reasons for the deal in its statement to the market. Broadly, these relate to brand power, cross-selling, better use of space, financial services capabilities and revenue and cost synergies.
'No strategic business sense'
Tony Shiret, analyst at Haitong Securities, delivered the bluntest assessment of the potential deal. In a note entitled 'Are we missing something?', he argued the deal made 'no strategic business sense'.
He questioned the stock Sainsbury's placed in the combined brand of the two companies, lauded in the supermarket's statement as a potential 'non-food retailer of choice for customers, building on the strong heritages of both businesses whose brands are renowned for trust, quality, value and customer service'.
Shiret said that statement 'appears to have flowed from the pen of an investment banker who has not been in Argos for a while/ever'. 'We do not believe that Home Retail has any brand attributes; that is one reason why it is in trouble,' he added.
The supermarket's faith in the potential for cross-selling is likely to stem from the existing link-up with Argos, with Sainsbury's having trialled 10 of the retailer's concessions in its stores over the last year.
'In theory therefore, Sainsbury's should be well placed to know the Home Retail business and – it seems reasonable to assume – must be pleased with what it has seen from the Argos concession trials,' said James Anstead, analyst at Barclays.
But Shiret argued this was too short a period on which to base the rationale of a deal. 'It is... a little surprising that Sainsbury's would be confident enough to want to acquire Home Retail on the basis of such a limited period of shared experience in so few stores, without even the benefit of knowing how they traded in the peak season,' he said.
The real estate element of the deal is the aspect that has really foxed analysts. Just over a year ago, Sainsbury's was mothballing new shop plans, and yet it is now trying to buy a company that has its own problems with excess locations.
Anstead pointed to Sainsbury's own estimates of, at best, 6% of 'surplus' retail space, that it could be assumed would be used as a new home for the Argos brand.
Nor does the other side of the equation, using spare Home Retail capacity to house Sainsbury's stores, appear compelling, he argued.
'We believe that most of the Argos stores have planning consent that would allow food retail use,' he said. 'However, that does not mean that they are easily capable of being transformed into convenience stores. Many may be the wrong size, shape, configuration or location.
'Indeed, if many of these sites were ideal convenience stores then we are surprised that more were not sold to the space-hungry supermarkets in recent years.'
Home Retail's real estate also raises debt implications for Sainsbury's in the event of a deal going through. Barclays has calculated that, on 2016/17 earnings estimates, the supermarket has a debt-to-earnings ratio of four times.
If Sainsbury's wanted to stick to that debt level, which many shareholders believe is already high enough, a deal looks difficult. Home Retail's lease liabilities of £2.2 billion, taken with £100 million of pension liabilities but offset by £250 million in cash, brings total debt to £2.05 billion, according to Barclays.
With forecast Home Retail earnings of £600 million, that means Sainsbury's, with earnings of £1.9 billion, can afford to take on an extra £2.4 billion in debt. But that leaves only £350 million for a bid – well below Home Retail's £1 billion market capitalisation after yesterday's share surge. Sainsbury's will therefore need to rely on its shares making up a big chunk of any potential future offer, or hope the expected synergies come through pretty quickly.
And Sainsbury's also has the issue of Homebase to resolve. Anstead highlighted that Homebase was not even mentioned in the supermarket's statement, and given Sainsbury's sold the DIY chain in 2000, to Home Retail predecessor GUS, it could be assumed it does not factor in its plans.
At a time when rivals Tesco (TSCO) and Morrisons (MRW) are ridding themselves of peripheral businesses and concentrating on core operations, Sainsbury's is going against the grain and, according to Shiret, risks a distraction from turning its existing business around.
Maybe management is just too worried about precisely that business. 'There is little that Sainsbury's can add in terms of expertise in non-food multi-channel offerings, and as a result the potential acquisition of what is largely viewed as a structurally challenged business will raise some eyebrows,' said James Grzinic, analyst at Jefferies.
'We expect many to read into this a certain amount of concern by Sainsbury's management on the prospects of the core business.'
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- J Sainsbury PLC (SBRY.L)
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by David Kempton on May 24, 2016 at 17:15