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.

J Sainsbury should leave Home Retail Group on the shelf.

Britain's second-biggest supermarket by market share had a decent Christmas with like-for-like sales in its fiscal third quarter down 0.4 per cent. That's slightly better than expected, but it's not shooting the lights out. Sainsbury usually outperforms at Christmas anyway as customers traditionally trade up from more down-market competitors.

Forced Circumstance
Ebitda performance shows challenges for both companies

Sainsbury also used Wednesday's trading update to set out its own catalog of reasons why the deal for Argos-owner Home Retail made sense, and there were some interesting nuggets. More than half of the 800 or so Argos stores have less than five years to run on their leases, thus easing the burden on Sainsbury of having to shut many of them.

As well as filling excess space in Sainsbury's stores, a big focus of the combined group would be click-and-collect -- the ability to pick up goods ordered online in stores -- something Sainsbury believes Amazon can't match. But all this won't come cheap.

There are some chunky cost savings to be made in a Home Retail-Sainsbury combination. Analysts estimate as much as 150 million pounds ($217 million), so there are ways to make the takeover math work even at a high bid price.

Even if Sainsbury offers the inflated 200 pence a share some investors are demanding -- according to weekend press reports -- and pays for a quarter of the takeover in cash, the synergies help salvage the deal from earnings dilution, according to data compiled by Bloomberg.

A 200 pence per share bid is about double Home Retail's average price in the days before news of a deal broke, so you'd be forgiven for feeling skeptical. But even that inflated price would value Home Retail at only about 0.25 times its revenue in the last year. So it doesn't sound as crazy when compared with similar-sized European retail targets, which have commanded a median multiple of about 1 times sales recently. 

Bid Bounce

That said, Sainsbury doesn't have too much financial flexibility. Net debt of 1.47 billion pounds is a relatively undemanding 1.2 times last year's ebitda, but when you add in the rent it has to pay on stores that rises to 4.1 times, according to the company. It would, however, get 309 million pounds of cash from Home Retail.

CEO Mike Coupe and finance director John Rogers were at pains to insist they wouldn't overpay. That's good news for Sainsbury's shareholders.

But even if you buy the financial logic, there are compelling strategic reasons why Sainsbury should walk away.

The supermarket's strength has been sticking to what it knows best: selling food and some complementary non-food items. Coupe has focused on cutting prices, but also investing in quality such as finding just the right level of ripeness for avocados. That's what its mainly southeast England based customers want.

It's already dabbling with discount retailing through its Netto stores. That might be useful in helping counter the threat from the German discounters, but it’s already a diversion from Sainsbury's core supermarkets. Home Retail would be another one.

Rival Morrison is quietly stemming its decline in sales by implementing some good old-fashioned shopkeeping, and there are signs that Tesco is finally regrouping. Meanwhile, the discounters are showing no sign of slowing. In fact they're pushing further upmarket -- right into Sainsbury's southern heartland.

Integrating Argos, and probably selling off the home improvement chain Homebase that comes with it, is a distraction Sainsbury can do without.

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
Brooke Sutherland in New York at

To contact the editor responsible for this story:
James Boxell at