Consumer

Andrea Felsted is a Bloomberg Gadfly columnist covering the consumer and retail industries. She previously worked at the Financial Times.

Brooke Sutherland is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

Sainsbury is trawling the January sales. The British supermarket chain revealed on Tuesday it's considering an offer for Home Retail Group, the struggling owner of Argos and Homebase, after an approach in November was rejected. 

Sainsbury's timing looks spot on. Home Retail had a market value of about 2 billion pounds ($2.9 billion) five years ago. But as Argos has struggled under the weight of competition from web behemoth Amazon, Home Retail's market value has shrunk to about 1 billion pounds. The company is due to update the market on its Christmas sales on Jan. 14.

Home Retail's Slide
Source: Bloomberg

Home Retail Group trades on about 13 times trailing 12-month earnings, compared with 17 times for the FTSE 350 index of general retailers. Even after jumping 41 percent on Tuesday, the stock trades for less than half its book value, suggesting Sainsbury could simply break up Home Retail Group -- and still make a profit.

Should Sainsbury offer, say, 160 pence a share a deal would still add 0.5 percent to 2016 earnings per share and 1.5 percent to 2017 EPS as long as it pays for at least a quarter of the purchase price in cash, according to Bloomberg data. That's before accounting for revenue and cost synergies that Sainsbury has yet to spell out. Exane BNP analysts estimate those could come to as much as 150 million pounds.

The purchase would help Sainsbury fill excess space on its store floors. Chief Executive Officer Mike Coupe has said that over the next five years, 25 per cent of its stores will have some surplus space. It has been trialling Argos concessions in some stores, and must have liked what it saw.

The big question is what Sainsbury does with Argos's more than 800 stores on Britain's high streets. Home Retail has been too slow to close Argos stores, instead using them as click-and-collect hubs. While Sainsbury could convert some Argos stores into its successful convenience store format, Britain's arcane zoning rules make that difficult. Sainsbury has talked about cutting costs by property rationalisation, a sign Argos store closures are likely.

Sainsbury may yet struggle to bag its bargain. Home Retail is putting up a fight, saying the offer undervalued the company. As Gadfly columnist James Boxell has argued, Home Retails's 200 million pounds of annual operating operating cashflow and scope to widen margins will make it attractive to private equity firms. (Equally Sainsbury could offload Homebase to a private equity firm as part of the deal.)

The supermarket chain will need to move fast. There's the risk that if it fails, Sainsbury could end up putting itself in play. Margins are already being squeezed by a price war as German no-frills discounters Aldi and Lidl encroach into its middle class heartland. Sainsbury would do well to remember what happened when Asda tried (and failed) to tie up with Kingfisher in 1999 -- the British supermarket fell into the arms of Walmart.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the authors of this story:
Andrea Felsted in London at afelsted@bloomberg.net
Brooke Sutherland in New York at bsutherland7@bloomberg.net

To contact the editor responsible for this story:
Edward Evans at eevans3@bloomberg.net