Introduction
When Sainsbury made a declaration of interest in Argos and Home Base, many critics were sceptical and wondered the logic behind it. However, Sainsbury looked determined to acquire the home retail group, offering a £1.3billion to acquire the group. This move was seen either as a desperation move or a bold move to expand its market base. Joining forces with the home retail group would help them in many ways and having trailed Argos in a number of its supermarkets, this was definitely a move to counter the opposition. Furthermore, the supermarket store had claimed to have many complimentary products with the home retailers. Critics also argued it would help to improve the ‘click and collect’ service offered by Sainsbury. However, these same critics also recalled that Sainsbury originally co-founded the home based chain stores and later sold it in 2000 for £969 million in total. This only raised the suspicions for the move to acquire Argos.
Motives to acquire Argos
Argos, a chain store previously known for it’s childlike, and Christmas wish list booklets had for sometimes been slowly transforming itself to an iPad-style terminal. Through such changes announced in 2012, the home retailers had reinvented itself as a digital retail leader. This made the company a pace setter in selling and delivering goods on time, as put by investment banker Morgan Stanley, Argos was Amazon with stores. Argos had the ability to sell goods at any given time and delivered them on time, within a few hours. Therefore, the move by Sainsbury was logical as it offered these delivery channels, a resource they never possessed. By acquiring Argos, they argued that, they would be able to grow their sales, increase their delivery networks and also be able to sell products to each other’s customers. Moreover, the supermarket said over half of Argos stores had their leases up for renewal in a five year time period. This presented a favourable time to shut the stores and move to nearby Sainsbury stores. Sainsbury had even identified over 150 stores that could carry out this procedure.
At the central point of this acquisition was chief executive Mike Coupe, whose entire rationale of the acquisition was to serve the customer whenever they wanted to be served. However, one basic principle was behind the acquisition by Sainsbury, the change in customer behaviour. In this age of social media, online shopping and reviews, customers are no longer impressed by big stores, with big banners. Today’s customers expect to shop quickly and smoothly, this was the main reason Sainsbury wanted to acquire Argos. To them, shoppers expect to shop at a store or even online with their hand held devices and have their goods delivered to their door steps immediately. Argos had already proved to be the frontier in the business of click and collect, so, this was a rational decision.
To further explain the compatibility between the two retail giants, Coupe referred to his 78 year old mother, who constantly shopped at the supermarket. Just like many elderly folks, she made trips to the supermarket on a constant basis. On the other hand, his youngest daughter solely shopped online using her mobile phone. This made practical sense to have a smart phone, in order to shop online. However, he noted the millions of shoppers who still prefered to visit the supermarket for their shopping needs. Therefore, a merger by the two companies would see them cater for both types of customers.
Since 2012 when Argos reinvented themselves as a digital retail store, it had invested millions in their retail website and delivery services. One of the most efficient delivery system that could deliver same day orders to the highly demanding customers, a highly needed resource in Sainsbury’s delivery services. However, Coupe did acknowledge the concern by many customers and critics who viewed the move as a distraction to supermarket business. He assured the customers of his commitment to improve the services offered by the company regardless of where they shopped, online or in the supermarkets.
Valuation and payment structure of the Acquisition
Sainsbury agreed on a £1.3 billion deal to take over Argos who also happened to be the owners of the Home Retails Group. Under this deal, all the Home retail group shareholders would receive a 0.321 Sainsbury shares. Note, this shares would be inclusive of the combined stake of Sainsbury and Argos’s share. Hence the 0.321 stake of shares would be of the new Sainsbury shares. This would also see the shareholders receive a 55p for each share they owned. To compensate the Home Retail shareholders for the final dividend, they would also receive a 2.8p share of the combined company. Furthermore a 25p per share was offered to the shareholders for the cash return made from selling Homebase, the sister store to the acquired company.
From this base offer, the implied value of Argos was estimated to be £1.1 billion, but Sainsbury was generous enough to up the payment to reach a value of the agreed sum of £1.3 billion. This was very interesting as noted by several critics who valued the entire shareholders amount to a mere 161.3p per share. An inclusive amount of the 25p for the Homebase returns.
In general, all Home Retail shareholders would end up receiving a 12% share of the new company. This represented a 63% premium (161.3p) over the closing price of the Home Retail shares, a value obtained in January 4th 2016. Although during the acquisition process, several media outlets such as The Telegraph, reported that Sainsbury was trying to make an offer that would raise the share amount to 165p.
Original Offer
Mike Coupe highlighted the importance of this deal, to him, a combined effort of the two companies would see them ‘bake a bigger cake’ than they would individually do. Though Sainsbury was determined to make the deal, they had initially proposed a very weak deal of 150p per share. This original offer was rejected by the Home Retail Group who were pushing for a 170p per share deal. However, after revaluating their desire to offer customers better choices and faster delivery options, they agreed on the deal indicated above.
Final Deal
After many months, the merger was finalised. This merger would cost £140 million, a cost set to spread over the next three years with an additional amount of £140 million. This second amount would be used to refit the Sainsbury store in order to accommodate Argos infrastructure together with the click and collect counters within the stores. With this in place, the combined group was believed to target a double digit profit increase, by the third year of the merger. By this time the overall annual saving cost would be an average amount of £120 million[7]. While the board of Home retail Group was sceptical of the deal and still believed in the prospect of Standalone Company. The deal did help them recognise the possibility it had of offering the shareholders an attractive compensation, by giving a full valuation of their shares value. They would also participate in the creation of a combined group with a higher transaction rate.
Sainsbury deal was also boosted by Home Retail Group previous acquisition deal, where they had sold Homebase to Australian group Wesfarmers. A deal that had been valued at a value of £340 million. However, from an analytical point of view, this deal was seen to be cheap one. According to Sainsbury’s finance boss John Rogers, the supermarket store was buying Argos for a lower price of £240 million. That was quite a contradiction, having stated the takeover amount to be £1.3 billion. So, why the low amount?
Following a clever analysis process, the company had stuck to its principle of not overpaying for any product. Let’s examine the reason for this low figure. To begin with, the takeover amount was just the original £1.1 billion, the excess amount added to this value (£0.2) was as a result of the shareholders pay. Hence, this value of £200 million was as a result of the proceedings of the sale of Homebase. This earlier acquisition deal had produced shares that were worth 25p a share with an additional 2.8p a share handed to the investors of Home Retail as dividend.
In addition to this amount, the remaining £1.1billion was paid in cash, a value that had produced a 55p a share for the shareholders with a 0.321 stake in the combined company. This gave the Home Retail investors a 12% stake in the new Sainsbury Company. In the third step of the takeover, Sainsbury was transferring Argo’s loan book to its own bank. It was then going to use the bank’s customer’s deposits to pay for the loan book, which was valued at £600 million. To abide by the banking core tier-1 capital requirement, Sainsbury was injecting a £100 million cash amount. However, with only £250 million Home Retail balance to tap into, the grocer company was paying a reduced amount of the original price. All these strategic plans left Sainsbury with a mere £750 million on its balance sheet. When all is done, the grocer company would only have to pay an amount in the range of £300 million, just to pay off its debt. However, they also had to pay a £440 million cash element for the takeover.
Sainsbury strongly believed it could raise £120 million in synergies within three years after closing all Argos high street stores. Because of this reason, the deal was viewed as a cheap attempt to acquire Argos.
Risk involved in the acquisition
After Sainsbury revealed their intentions to secretly approach Home Retail Group, analyst and investors were concerned by one chief issue, customer mix. There was very little overlap between the customers of the two companies, with Argos appealing to the working class customers, while Sainsbury appealing to the middle class. Therefore this deal would risk the possibility of losing one major class of customers in an effort to satisfy the other. However, these remarks were downplayed by Sainsbury who presented statistics showing over 40% of UK householders had shopped in both companies in the past year. Nevertheless they also had to deal with the threat posed by rival supermarket franchises Lidl and Aldi, who had sparked a brutal price war by introducing budget prices on their products. This had resulted in a stagnant market state on all British food markets, where no economic growth had been observed. Sainsbury and Argos risked the possibility of losing both companies if this stalemate continued, as both companies would fall into recession, due to lack of operating funds.
In the introductory section of this report we saw Sainsbury as the original cofounders of the Homebase chain stores. This merger was a huge risk taken by Argos, who would have to deal with the possibility of being sold again to a second bidder. In fact, many critics saw the move as an attempt to acquire the non-food company in an effort to sell it to the highest bidder. This was a huge risk that Argos had to take and one they will have to deal with in the months to come.
However, according to Katies Hopes, the biggest threat facing this acquisition is the online store giant Amazon. In her review of the acquisition she highlights the effect Amazon will have in coming years. To her, amazon influence will drive major supermarkets such as; Sainsbury, Asda, Tesco and Morrisons to invest heavily in online delivery. Reason being, Amazon will eventually invade the tuff owned by these four major supermarkets. Amazon currently offers delivery services to household essentials, which is effective as they are easy to handle. However, many analyst believe, Amazon is a forerunner in establishing a full on grocery delivery service that include fresh products, a threat to these companies.
Amazon has already established some of these grocery delivery services in some parts of the United States and will eventually set them up in the UK. Jon Copestake highlighted the advantage Amazon has with its evolving proposition that many retailers cannot defeat. To him, Amazon offers a wide range of products from Amazon TV to next day delivery, a complete package that many retailers cannot meet. Because many retailers have a focused offer (specialised offer e.g. groceries), these retailers cannot counter the threat presented by Amazon. This is a huge risk Sainsbury and Argos must consider in their merger.
Another minor risk the two companies have to deal with, is that presented by the Competition and markets authority (CMA). According to its initial assessment, an inquiry was in progress to determine whether the acquisition deal done by Sainsbury was legitimate. July 25th 2016 was the date set to determine whether the case warranted a probe. Regardless of the outcome, analyst saw the move as a likely delay to Sainsbury’s time line to complete the deal by the end of summer. On its behalf, CMA was conducting an investigation to determine if the move by Sainsbury would lessen the competition within the markets of the UK (CMA, 2016).
Conclusion
This merger presented a unique opportunity for Sainsbury to venture into the non-food market. A move they had previously tried to make by venturing into the Tu clothing range and selling home ware. This move was highly welcomed, especially by its stakeholder, bearing in mind non-food market have higher profit margins as compared to the food market. Furthermore, a trial had been done by Sainsbury by using 10 Argos concessions in their supermarkets stores. It was a fruitful affair as it had the potential to sell more than 20,000 general merchandise products. In their acquisition proposal, Mike Coupe had presented a plan that was set to create a £6 billion company, a value that would surpass UK’s favourite general merchandise company John Lewis, valued at £4.4billion.
However, there are critics who still view the move as a step in the wrong direction as it presents Sainsbury with unforeseeable challenges. Independent retail veteran Richard Hyman believes Sainsbury should stick to its core business of food. To him, the product is the most important aspect of business, despite how boring it may seem. The delivery system used by this products is only a support facility to boost productivity. He further states that, no customer will ever pay for the delivery system, instead they are more interested in the product delivered. If it fails to meet the minimum requirements, the source company is set to fail.
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