Sainsbury s offer No 1 raises roof on Home Retail shares

Sainsbury’s is turning out to be something of a retail sector dark horse.

News that it made a surprising tentative offer for struggling Argos owner, Home Retail Group seemed left-field on the surface.

However, I suspect that given the growing lead between Sainsbury’s and its ‘Big 4’ supermarket rivals, bolstering trust in management under Mike Coupe, City dissent to a bid on Home would initially be muted.

Its tentative offer in November was rejected, Sainsbury’s said on Tuesday, adding that it was considering its next step.

With Home Retail shares closing 41% higher, buyers seem to have assumed a deal has been all but signed sealed and delivered.

It hasn’t.

At the very least though, the margin of institutional money in that run-up may nod to a view that Sainsbury’s will ‘consider its next steps’, and then go ahead and raise its undisclosed offer.

Sainsbury’s juices marginal advantages

In a still highly straitened environment for retailing across the board—on Tuesday underscored by off-colour Christmas sales from Next Plc.—Sainsbury’s has had a number of advantages.

These have been not so much accretive as implied till recent months, but there nonetheless.

Then, latterly, Sainsbury’s has been the only established supermarket chain to grow sales across all channels (supermarkets, online, convenience).

It did this for three months in a row, according to early December data from market researcher Kantar Worldpanel.

The higher prevalence of its stores in London and the South East than competitors—with only Tesco coming close—is an edge Sainsbury’s has capitalised on with a variety of, apparently, fine-tuned mixes and formats.

These even included trials, begun last year, of Argos concessions.

More ‘seasoned investors’ (shall we say) will immediately recall further Sainsbury’s-Home Retail connections over the years.

• DIY chain Homebase was of course founded by the supermarket before it was sold to the previous incarnation of Milton Keynes-headquartered Home Retail in 2006, for a total consideration of almost £1bn
• David Tyler, Sainsbury’s chairman since 2009, was FD of GUS Plc., previous owner of Argos Retail Group, before the latter’s 2006 demerger and transition to Home Retail

The partly shared timeline could give a fillip to integration, should a transaction take place, though we’re getting ahead of ourselves.

This would not be 21st Century ‘Big Retail’ if the path to a deal was not strewn with sticking points.

For one thing, whilst Sainsbury’s hasn’t disclosed how much it offered to HRG, save to say the proposal was in ‘cash and shares’, Sainsbury’s previous £1bn disposal price of Homebase sets a de facto floor.

A modest acquisition price could of course be justified given poor Home Retail performances in recent years.

But the supermarket has still made an offer despite presumably assessing that the scenario was fraught with risks.

That suggests some ‘determination’ (more impolitely, ‘desperation’), arguing against anything like a ‘bargain’ valuation.

Secondly, recent transactions in this space saw similar assets fetch just short of the equivalent of 9 times Ebitda.

I’m thinking of Tesco’s disposal of Homeplus, South Korea’s biggest general retailer, last year for £4bn.

The Korean group posted ‘clean’ Ebitda in February 2015 of £466m, meaning the disposal multiple was 8.6 times.

Home Retail’s last annual Ebitda of £386.1m suggests a price close to £3.5bn would therefore not be unreasonable.

On the other hand, if HRG’s 2015 core earnings have been correctly forecast at £244m, down almost 37%, the 9-times-Ebitda formula would beget a more modest c. £2.2bn.

But that would probably be too modest for Home’s shareholders and board.

In that event, support from investors in Sainsbury’s, the marginal outperformer of rivals, might cool.

After all, it was not so long ago that the newly re-crowned UK No.2, which sustainably retook that spot from Asda last summer, was, like rivals Tesco and Morrisons, verging on grave troubles.

Sainsbury’s current progress above the fierce supermarket melee amounts to a growth rate of little more than 1% per quarter, judging by Kantar.

The transparent aspects of SBRY’s rationale suggest diversification is a major aim.

Its investors will seek something more compelling.

Especially if separate predatory manoeuvring around Home Retail Group heard before Christmas triggers a bid battle.