1.0 Introduction

On 30th April 2018, J Sainsbury plc (“Sainsbury’s”) and Walmart Inc. announced the combination of Sainsbury’s and Asda Group Limited (“Asda”). Sainsbury’s predicted that the groups after combination would be UK’s leading groups in grocery retail. This report analyzes the grocery retail industry over the past 3-5 years and its trends towards consolidation. The factors which lead up to the merger and about subsequent business integration are also considered. Then the report calculates Asda’s value by four various models and assesses whether the transaction price is appropriate. At last, the report explains the regulatory regime about CMA and describes the current risk environment.

2.0 Sectoral Activity

In the past few years, the brexit had fundamentally affected the development of UK grocery retail industry while inflation kept at a high level. The UK grocery market had fallen into decline for the first time in 2016 because the performance of all four major supermarkets worsened (Butler, 2016). The companies found they need to spend more money in buying products because of the devaluation of pound.

At the same time, food margins fell because of the increase in costs. It hit the discounters and supported the repositioning of their models (Dresser, 2017). In addition, imports cost more, but some inflation would just be another way for the market to get out of it. In 2017, the dairy products hit record lows while the price of butter had fallen to 82p in some cases. The market has adjusted and these lines are now picking up. So while there are currency weakness and broader inflation through brexit, in some cases, the grocery retail industry is swinging in the other direction (Dresser, 2017).

2018 was a challenging year with pressure mounting on retailers (Deloitte, 2018). Consumer confidence rose, but spending growth slowed. Inflation had fallen as expected, but so had wage growth, meaning consumers were not letting up. In the first three months of 2018, snow and freezing temperatures reached ridership at the shopping site, and supply chain disruptions also caused empty shelves. Improved weather in the second quarter, coupled with the World Cup and royal weddings, gave UK retail a necessary support. Supermarkets were benefited from increased sales of food and drinks as consumers grill and celebrated the start of summer. In the end of 2018, retail sales proved strong in 2018 due to strong performance in the food, beverage sector and continued growth in e-commerce which accounted for almost 20% of retail sales.

In conclusion, although the grocery retail industry faced some difficulties over the past years, the prospect has started improving. IGD (2018) predicted that UK grocery market will grow 14.8% by £28.2 billion by 2023. The market provides a positive environment for the merger between Sainsbury’s and Asda.

5.0 Regulatory Regime

The competition and Markets Authority (CMA) is the main competition authority in the UK market (National Audit Office, 2016). It is an independent non-ministerial department which works for promoting competition for the benefit of consumers (CMA, 2018).

Its main responsibilities are investigating mergers, managing market studies and investigations about competition and consumer problems, enforcing the legislation to protect consumers, encourage sector regulators to use their competition powers and considering appeals and regulatory references (CMA, 2018).

In this case, CMA had finished Phase 1 in September and started Phase 2.

In the first phase, CMA assessed detailedly how the merger between Sainsbury’s and Asda would affect competition for UK consumers (CMA, 2018). The investigation considered whether the merger would lead to reduce choice, cause higher prices or worse quality services and products. In addition, CMA also assessed whether the merged company would squeeze suppliers by its increased buyer power and whether this could have potential effects for consumers.

In the second phase, CMA is further investigating the issues in Phase 1 (CMA, 2018). At the same time, it is also investigating some other issues it raised like fuel, groceries and other general merchandise. Furthermore, some emerging retailers’ potential impact of competition is also included. CMA needs to consider whether the supermarkets could make their commercial decisions more easily and reduce vigorous competition after the merger. In this phase, CMA needs to gather evidence to analyze, scrutinise both Sainsbury’s and Asda’s internal information and seeks the opinions of rival retailers and suppliers.

The investigations are still under way and the statutory deadline is 5th March 2019 (CMA, 2018). According to some early cases like the merger between Tesco and bookers, the merger between Sainsbury’s and Asda might be approved soon. CMA might ask Sainsbury’s and Asda to take some actions to keep the market competition. For example, it might ask them to sell some stores to keep the balance with other retailers. The consequence will still be positive as long as Sainsbury’s and Asda make some remedies to meet CMA’s requirements.

6.0 Current Risk Environment

In the previous situation, Sainsbury’s and Asda faced the pressure from other competitors. Sainsbury’s claimed that two stores would have 10% discount for their products, this decision exists business risks that affecting product sales and costs. After they set a lower price, they would have more opportunities to against the competitors in the inexpensive product market. However, the result of the price reduction would apparently increase the demand for these products. That means the producers need to raise their yield of products but earn less profit. In addition, the unemployment risks also exist. Some stores might be closed because Sainsbury’s and Asda have many overlapping regions.

Once Sainsbury’s and Asda merge successfully, they should also focus on protecting the environment because their merge will increase the demand and bring more stress and pollution to the limited resources. Fortunately, Simms (1992, p. 36) pointed out that “The impression is that Asda has been active on environmental issues for some time” and Sainsbury’s also makes effort in “green activity and promotion appear intelligent and coordinated”. It shows they could keep the balance between production and environmental protection. Yang (2007, p. 89) had summarized there are three types of risk during the process of enterprise merge. They are “merge fail, the loss of competitive advantage and the management of enterprise out of control”. In this case, the merger is still under way and the prospect is positive. The price reduction will make two companies maintain their competitive advantage. However, they might face operational risks. These two companies might have some difficulties in the process of resources integration. As a family business which lasts for 150 years, Sainsbury’s has enough experience to manage the company. Furthermore, Asda also has a mature logistics service and cutting-edge technology center. It is obvious that both companies could manage the operational risks under the control.

In conclusion, their merger is an optimistic decision in the current environment. However, the environment of the market changes constantly and is difficult to predict. Sainsbury’s and Asda should focus on making good use of two companies’ flexibility to avoid and control the current risks.  

7.0 Conclusion

The merger of Sainsbury’s and Asda is to get rid of the economic inflation brought about by Brexit and to combat the sales pressures brought by online e-commerce platforms like Amazon and low-cost supermarkets like Lidi. In a short time, it will stimulate their company’s share price, and it can complement each other in commodities or other aspects. The merger will have a deep influence on the UK supermarket retail industry.

References

ASDA Group Limited. (2010). Reports and Financial Statements 31 December 2009. Leeds: ASDA Group Limited.

ASDA Group Limited. (2017). Reports and Financial Statements 31 December 2016. Leeds: ASDA Group Limited.

ASDA Group Limited. (2018). Reports and Financial Statements 31 December 2017. Leeds: ASDA Group Limited.

CMA. (2018). About us. Retrieved from https://www.gov.uk/government/organisations/competition-and-markets-authority/about

CMA. (2018). Administrative timetable. Retrieved from https://assets.publishing.service.gov.uk/media/5c1228e540f0b60bc4029c59/full_administrative_timetable.pdf

CMA. (2018). CMA launches Sainsbury’s / Asda merger investigation. Retrieved from https://www.gov.uk/government/news/cma-launches-sainsburys-asda-merger-investigation

CMA. (2018). CMA sets out scope of Sainsbury’s / Asda merger investigation. Retrieved from https://www.gov.uk/government/news/cma-sets-out-scope-of-sainsburys-asda-merger-investigation

CMA. (2018). J Sainsbury PLC / Asda Group Ltd merger inquiry. Retrieved from https://www.gov.uk/cma-cases/j-sainsbury-plc-asda-group-ltd-merger-inquiry

CMA. (2018). Sainsbury’s / Asda merger referred for in-depth investigation. Retrieved from https://www.gov.uk/government/news/sainsburys-asda-merger-referred-for-in-depth-investigation

Deloitte. (2018). Retail Trends 2018. Retrieved from https://www2.deloitte.com/uk/en/pages/consumer-business/articles/retail-trends.html#

Dresser, S. (2017). Food Retail / Consumer Trends for 2017. Retrieved from https://www.groceryinsight.com/blog/2017/01/retail-trends-2017/

IGD. (2018). UK food and grocery market to grow 14.8% by £28.2bn by 2023. Retrieved from https://www.igd.com/about-us/media/press-releases/press-release/t/uk-food-and-grocery-market-to-grow-148-by-282bn-by-2023/i/19052.

J Sainsbury plc. (2018). Proposed combination of J Sainsbury plc and Asda Group Limited. Retrieved from https://www.about.sainsburys.co.uk/~/media/Files/S/Sainsburys/documents/reports-and-presentations/2018/combination-of-j-sainsbury-and-asada-group-ltd.PDF

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Leyland, A., & Quinn, I. (2018). Sainsbury’s Asda £51bn combination play: what we know and what it means. Retrieved from https://www.thegrocer.co.uk/home/topics/sainsburys-asda-merger/sainsburys-and-asda-mega-merger-what-we-know-and-what-it-means/566476.article

Butler, S. (2016). UK’s major supermarkets decline for first time this year. Retrieved from https://www.theguardian.com/business/2016/jun/28/aldi-lidl-asda-supermarket-sector

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Yang, C. (2007). Study on the risk decision for enterprise merge and acquisition based on AHP [J]. Journal of Central University of Finance & Economics, 2007(8), 88-92.

Appendix I

Asda’s balance sheet in 2017

Non-current assets:

Book value(£m)

Adjustment rate

Value after adjustment(£m)

Property, plants and equipment

8,970.0

80%

7176.0

Intangible assets

709.6

80%

567.7

Opertaing lease preparements

44.6

100%

44.6

Deferred tax assets

57.1

100%

57.1

Total Non-current assets

9781.3

7845.4

Current assets:

Inventories

1,147.1

70%

802.9

Trade and other receivables

223.6

90%

201.2

Intercompany receivables

3,126.7

90%

2814.0

Cash and cash equivalents

2,171.7

100%

2,171.7

Operating lease Prepayments

1.3

100%

1.3

Total current assets

6,670.4

5991.1

Total aseets

16,451.7

13,836.5

Liabilities

(7,732.2)

100%

(7,732.2)

Value (assets – libilities)

8719.5

6104.3

The asset based valuations assume the Asda’s value when it breaks up.

Most of Asda’s property, plants and equipment are freehold properties which could relatively hold the value, so we assume its adjustment rate is 80%.

Although the intangible assets are uncertain, most of Asda’s intangible assets are its goodwill. We assume its adjustment rate is 80% because Asda is one of the biggest market retailers in UK.

Asda’s inventories are very complicated. Some of them could hold the value, but some of them will lose their value quickly. For this reason, we assume its adjustment rate is 70%.

Considered Asda’s market share in UK, we assumed it has a high percent of possibility to receive the fund. We assume intercompany receivables, trade and other receivables are 90%.

We assume that all of Asda’s liabilities need to be paid.

Based on these assumptions, Asda’s value after adjustment is £6104.3 million

Appendix II

Asda’s dividends proposed and paid in 2016

Asda’s share in 2016

Asda’s dividend propsed and paid in 2009

Asda’s share in 2009

The last time Asda paid dividends was in 2016. It paid £450 million. However, “an exercise was performed to simplify the group structure through the restructuring of certain holding companies” (ASDA, 2016, p.53) in January. The share price reductions were included “under section 641(1)(a)” (ASDA, 2016, p.53). For this reason, it reduced its ordinary share and bonus share that it decreased its share capital to £1 and share premium to £nil. In 2016, the dividend per share was £112.5 million per share (£450m/4=£112.5m).

The time before last time Asda paid dividends was in 2009. It paid £160 million. In that time, there were 3,135,705,000 ordinary shares. In 2009, the dividend per share was 5.1p per share (£160m/3,135.705m=£0.051).

Po = D0(1+g)/(r-g)

If we use the data to calculate, the “g is” 20.62.

(112,500,000/0.051)^(1/7) -1=2062%

The “g” which is calculated by Asda’s dividend per share of 2016 and 2009 does not make sense because of its special situation in 2016, so dividend valuation models could not be applied in this case.

Appendix III

Asda’s income statement in 2017

Tesco’s EPS in 2017 annual report

Tesco’s share price on 23th February (There was no share price on 24th Februry)

Asda has earnings of £666,000,000

A similar listed company Tesco has a P/E ratio of 17.290

205.4p/11.88p=17.290

P=E * P/E= £666,000,000 * 17.290 = £11,514,000,000

The quoted company (Tesco) is safer and less risky, so Asda’s price needs to be reduced because it is an unquoted company.

 £11,514,000,000 – (£11,514,000,000 * 30%) = £8,059,800,000

Asda’s value is £8,059.8 million in the Income/Earnings Based Models.

Appendix IV

Asda’s cash flow in 2017

UK Ten-year Treasury yields

Profit after tax

£666.0 million

Depreciation and amortization:

Depreciation of property, plant and equipment

£415.3 million

Amortisation of intangible assets

£32.8 million

Impairment of property, plant and equipment

£6.6 million

£1120.7 million

Capital expenditure:

Purchase of property, plant and equipment

(£355.2 million)

Purchase of intangible assets

(£53.5 million)

Shareholders earnings

£712 million

We assume UK Ten-year Treasury yields as UK risk-free interest rate.

£712m/1.192%=£59,731.544m

Asda’s value is £59,731.544 million in the discounted future cash flow.