The leak on Saturday lunchtime that Sainsbury’s and Asda were in advanced merger talks shocked the UK retail sector, but now the dust has settled a bit it is possible to clarify the key issues and implications of a possible deal.
The shock £13bn merger news would have been unthinkable a few years ago, but the bizarre decision last year by the much maligned regulator, the Competition and Markets Authority, to give the Tesco/Booker merger the go-ahead without any divestments inevitably paved the way for more supermarket sector consolidation.
Back in 2015 the CMA had given Poundland a very hard time over its bid for discount chain rival 99p Stores because of the number of store location overlaps, a saga that helped cement its reputation for being picky about local market share dominance.
So when Tesco announced its plan at the beginning of last year to buy the food wholesaler Booker, it seemed inevitable that the CMA would be equally worried about the huge overlap in their respective convenience store operations – although the management were always confident that the deal would get regulatory clearance. At the very least Tesco seemed likely to have to divest its One Stop convenience store chain, but the CMA swallowed the argument that a merger would not force up prices for consumers. And after a lengthy inquiry, the regulator concluded at the end of last year that the deal did not raise any competition concerns.
No doubt the pace of discussions between the management teams of Sainsbury’s and Asda accelerated after the CMA Tesco/Booker decision, but, astonishingly, it appears that the merger talks had already been underway for over a year.
Although Walmart International boss Judith McKenna took part in yesterday’s Sainsbury/Asda merger presentation to City analysts and the press, along with the Asda CEO Roger Burnley, it was striking that Sainsbury’s CEO Mike Coupe singled out her predecessor Dave Cheesewright for special thanks, as the main architect of the deal from the Walmart side. When Cheesewright stepped down as Walmart International boss in January this year, the company said he wanted to step back from a full-time role, but would continue to work for the company on “special projects”.
It is therefore pretty clear that mighty Walmart have been working on a way of easing themselves out of their UK exposure for some time, even though McKenna gushed about the firm’s new approach to international partnerships and said they would be very happy to own 42% of the combined business.
The fact is that Asda has been struggling for many years against a background of rising competition from discounters Aldi and Lidl and the growing online grocery market. All boats float on the same tide and even Asda has been able to report some modest like-for-like (LFL) sales growth recently on the back of the big rise in food price inflation. But through much of 2016 and 2017 Asda suffered big falls in LFL sales, despite the well-publicised problems of market leader Tesco.
The collapse in Asda’s trading performance in 2016 and 2017 doubtless concentrated minds back in Walmart HQ in Bentonville, Arkansas and it is ironic that they reached out to Sainsbury’s for help by recruiting one of its senior executives, Roger Burnley, to rejoin the company where he used to work, first as Asda COO and then CEO.
As an aside, it is an odd, if comforting, aspect of the Sainsbury’s and Asda merger plan that so many of the key players know each other well and have worked together. Earlier in his career Mike Coupe worked at Asda and knew both Judith McKenna (who became Asda’s finance director) and Dave Cheesewright , whilst Roger Burnley clearly knows both Sainsbury’s and Asda very well.
This meeting of minds clearly concluded that low prices and Walmart’s buying power alone were not going to help Asda take on the fast-growing discounters and that something else was needed: perhaps an injection of store design and food ranging nous from Sainsbury’s…
So Roger Burnley was sent in to stop the collapse in Asda’s sales and profits and stabilise the business, while his bosses (and their advisers) cooked up a clever plan on how to structure a merger, once Sainsbury’s had finished integrating Argos, which it bought in autumn 2016.
One problem was that Asda was actually the bigger player. In the weekend’s hastily arranged deal, Asda was valued at more than Sainsbury’s then market capitalisation of £5.9bn, at £7.3bn debt-free (about 10 times its expected 2017 operating profits), but Walmart is cashing out £3bn of that and will be left with only 42% of the combined business (c30% in voting shares and 12% in non-voting shares), so that Sainsbury’s can remain a UK listed business. And the PR spin is that “Walmart will be a long-term shareholder and partner and will leverage its global scale and investment to support the combined business”.
The Asda brand will be retained, along with its Leeds HQ, so there is little in the way of cost-cutting envisaged. But Mike Coupe is still confident of delivering at least £500m of synergies, mostly in buying scale economies (squeezing suppliers), but also through inserting Argos concessions into Asda stores.
Coupe made clear that the promised synergies made some allowance for store disposals to placate the CMA. No figure was mentioned, but Sainsbury’s said they had done a huge amount of work on the subject of store overlaps, including examining precedent deals like Ladbrokes/Coral, and they were confident the eventual store disposal figure would be much less than the hundreds that some observers fear.
Too many store disposals and the deal won’t be worth doing, too few store disposals and the CMA will look toothless…but the City expects there to be a “Goldilocks” scenario that is just right for Sainsbury’s/Asda.
It has been calculated that there are 75 Asda stores in the same postcode “sector” as a Sainsbury supermarket/superstore. Take South Ruislip in west London. Sainsbury’s used to have the place tied up, but a 40,000 sq ft Asda opened nearby last year, while Aldi and Lidl have also recently set up shop, so it looks to now be quite a competitive catchment. The “pointy-heads” at the CMA will doubtless have a lot of fun deciding whether Sainsbury’s/Asda will have a dangerous monopoly of South Ruislip (amongst many other areas).
Of course, if the CMA does insist that Sainsbury’s/Asda sell, say, 75 stores, then it remains to be seen who would be able to buy the. The only major supermarket player with the money and the appetite is Morrisons, but non-food discount chains like B&M and Home Bargains will be interested in some sites.
With the merger not expected to complete until the autumn of 2019 there is a lot of water to flow under the bridge, but at this stage it looks as if the CMA will not ultimately want to block the creation of a major new rival group to Tesco. Sainsbury’s is clearly a very willing buyer of Asda, given the huge synergies it can achieve to protect itself in a highly competitive market, and it turns out that Walmart is a pretty willing seller.
