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Price wars

15 March 2016 By John Foley

Sales at J Sainsbury have turned a corner – the UK retailer on March 15 recorded its first like-for-like quarterly revenue growth in two years. But the market is still mired in a damaging price war. A potential bid for rival Home Retail Group, which Sainsbury must decide to make or not by March 18, is a decent coping strategy – even at a higher price.

The case for buying the owner of the Argos chain is solid. Some 6 percent of Sainsbury’s space, much of it in big out-of-town stores, is less productive than it should be. Transplanting Argos high-street stores into that profitability twilight zone should help boost sales per square foot and create savings with a net present value of 900 million pounds.

Two things stand in Sainsbury’s way: its current cash-and-shares offer, worth 1.73 pounds per share or 1.4 billion pounds, is too low. And a rival bidder, South African retail conglomerate Steinhoff, is dangling slightly more in cash. Fortunately, a simplified calculation suggests Sainsbury can go further.

Right now the offer leaves Sainsbury’s investors better off. Take the companies’ pre-bid values on Jan. 4, add the value of synergies, and net off 280 million pounds of related costs. Next, shave off the 675 million pounds of cash that will be paid out to Home Retail and add the extra 100 million pounds or so of net cash that Home Retail effectively found in its back pocket earlier this month. Result: the new company is worth 5.8 billion pounds.

Sainsbury investors keep 88 percent of that under the terms of the offer – leaving them roughly 200 million pounds better off than they were before the bid was outed, based on their own market capitalisation on Jan. 4. In theory, they could pay that amount out to Home Retail investors, implying a notional per-share offer of 1.90 pounds, without destroying value. If synergies are higher, which is highly likely, the deal will still be a positive.

What happened next would depend on Steinhoff. Beyond 1.90 pounds, Sainsbury would need to do more convincing. Walk away, and it needs to find a plan for that excess space. Either way it has room to go one more round.


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