July 16 (Bloomberg) -- Co-operative Group Ltd., the owner of about 2,200 U.K. food stores, agreed to buy rival Somerfield Plc for 1.57 billion pounds ($3.2 billion), creating a tougher competitor for Britain's four biggest supermarket chains.

The combined company will have more than 3,000 outlets and annual sales of about 8 billion pounds, giving it approximately 8 percent of the U.K. grocery market, Manchester, England-based Co-op said today. Market leader Tesco Plc, Wal-Mart Stores Inc.'s Asda, J Sainsbury Plc and William Morrison Supermarkets Plc together control about three-quarters of the market.

Bristol, England-based Somerfield was sold 2 1/2 years after investors including Robert Tchenguiz took the retailer private. An auction of the company, which started this year, drew offers below the asking price as slumping consumer confidence weighed on retail sales and the credit crunch hindered private equity bidders. Co-op was the only suitor to identify itself publicly.

``I would say it's a fair price given where the market is at,'' said Stephen Pope, chief global strategist at Cantor Fitzgerald in London. Co-op, which is the largest U.K. company owned by customer members, will probably benefit as shoppers ``start drifting to whichever store is closer to them,'' because of rising fuel prices, Pope said.

Competition Concerns

The 880 Somerfield stores will be rebranded as Co-op under the deal, which is expected to be completed ``in the next few months,'' Co-op Chief Executive Officer Peter Marks told journalists on a conference call. Co-op expects to have to sell on some of the sites to other retailers because of competition concerns, he said, without giving further information.

``All the main players will be interested in opportunities that are presented,'' Marks said on the call. ``We will have to work closely with the Office of Fair Trading on the analysis of which stores we have to dispose of.''

Somerfield's sites, which include neighborhood convenience stores and outlets located at gas stations, should benefit from growth in the convenience-food industry, which is faster than that of the overall grocery market, the CEO said.

Somerfield has a market share of about 3.7 percent, while Co-op's is at 4.2 percent, according to Taylor Nelson Sofres Plc.

Sales at Co-op grocery stores open at least a year rose 4.7 percent in the 26 weeks to July 12, the company said in today's statement. Somerfield had revenue of 4.2 billion pounds in the year ended April 26, and same-store sales growth was ``very similar'' to that of Co-op, Marks said on the call.

Fewer Takeovers

Sainsbury reported a 3.4 percent gain in same-store sales for the three months to mid-June, while Tesco's revenue rose 3.5 percent on that basis in the 13 weeks ended May 24.

``From the point of view of the main food retailers, I don't see them quaking in their boots at Co-op owning the Somerfield stores,'' said Justin Scarborough, an analyst at ABN Amro in London. ``The company is run as a good business, but it's not a Tesco, Asda or Morrison.''

The purchase price is lower than the potential value of 2 billion pounds reported by the Financial Times in April. The value of announced mergers and acquisitions fell to $656.2 billion in the first quarter from $971 billion a year earlier, according to data compiled by Bloomberg, after the collapse of the U.S. subprime mortgage market set off a global credit crunch that made financing takeovers more difficult.

`Good Deal'

``The price that we have got is significantly below that number,'' Marks said, referring to the value reported earlier this year. ``We think we've got a very good deal. It's a good deal for Somerfield in the current climate.'' Co-op's lead adviser on the deal was Credit Suisse.

Price competition between supermarkets is intensifying in the U.K. as higher living expenses leave consumers with less money to spend. Last month, Tesco and nearest rival Asda cut some prices to lure shoppers into their stores.

Higher fuel costs are encouraging customers to shop locally as the cost of filling their cars increases, Marks said.

Co-op has roots going back to 1844 and took its current form after merging with United Co-operatives last year.

The company generated net sales of 8.3 billion pounds in the year to Jan. 12 through units ranging from retailers of food and electrical goods to a chain of funeral homes. Co-op also has financial-services, travel-agency, pharmacy and legal divisions.

Somerfield was put up for sale in an auction run by Citigroup Inc. Tchenguiz, Barclays Capital and private-equity firm Apax Partners Worldwide LLP paid 1.08 billion pounds for the food retailer in October 2005.

Somerfield agreed to the 2005 takeover after struggling to compete with rivals whose larger scale enabled them to charge lower prices. The grocer was the least profitable of the four main chains listed in London at the time it was taken private. Somerfield originated with the founding of a family-run food retailer in Bristol in 1875 and went public in 1996.

To contact the reporter on this story: Louisa Nesbitt in Dublin at lnesbitt@bloomberg.net.

Last Updated: July 16, 2008 07:32 EDT