Tesco Plc is at risk of seeing its Booker prize slip through its fingers.
The paltry premium the supermarket chain included in its 3.9 billion-pound ($4.9 billion) offer for the food wholesaler, together with the potential for a lengthy antitrust review, leaves the door open to a rival bid.
The deal looks very good for Tesco shareholders. They gain access to Booker Group Plc's revenue growth in the fast-expanding catering market as well as its impressive cash generation.
For this, Booker shareholders will receive just a 12 percent premium to Thursday's closing price. They will own just 16 percent of the combined group, so most of the benefits of adding Booker will go to Tesco's investors.
Charles Wilson, Booker's CEO, is this week meeting with his shareholders to try to convince them to back the deal.
He clearly believes in it. He has good reason to: in return for his 6.1 percent stake in Booker he will receive a 1 percent shareholding in the combined company -- although he has pledged not to sell that holding for at least five years. He's also become the favorite to succeed Dave Lewis as Tesco CEO.
For Booker's other shareholders, the benefits aren't so obvious.
Long-term investors would have been looking for much more than a 12 percent gain from a stand-alone Booker. A lot of their expected return comes from the wholesaler's generous dividend policy: over the past three years, the payout has increased 43 percent, according to Bloomberg data. Although Tesco will resume dividends, income won't be such a big feature of the combined company.
Booker shareholders are also being forced into a completely different investment story, which will leave them exposed to all the big supermarket problems -- too much space, ferocious competition -- that they had been seeking to avoid by holding the wholesaler.
They're not being offered an enticing premium, either. At about 600 million pounds, it comes to about about half the financial benefits Tesco expects to reap from the deal. The supermarket plans to cut 175 million pounds of costs annually. Taxed at 17 percent, capitalized at 10 times and discounted for the time it takes to achieve them, this amounts to about 1.2 billion pounds of value that could be unlocked by the deal. But the surge in Tesco's share price suggests the market believes the savings will be far greater.
Some investors will want a bigger premium for cashing out now, or a larger chunk of the consideration in cash. That's something a rival bidder could exploit.
A combination of Booker and Wm Morrison Supermarkets Plc would make sense. Morrison is building up its own wholesale arm, enabled by the manufacturing facilities that produce about a quarter of the food its sells. Under Morrison's previous management, the two companies held talks that came to nothing. But there's a new management team in place now, with a renewed focus on wholesale.
A combination with Morrison would also be more evenly balanced. Even with no premium, Booker shareholders would own around 37 percent of the business. They would get a bigger share of any merger benefits and their growth story wouldn't be totally overwhelmed. The snag is that the merger benefits may be smaller than with Tesco, and Booker shareholders might have to settle for less cash.
Morrison probably wouldn't face much other domestic competition. Walmart would be better off selling its Asda chain and J Sainsbury Plc is busy integrating Argos.
Germany's Metro AG is about to spin off its cash and carry and hypermarkets business into a new entity. That will happen before the Tesco deal is completed, and Booker would be an attractive target for the German wholesale and hypermarket business.
Then there's Amazon.com Inc., which is seeking to build an online food business in Britain. A private equity firm, too, could easily gear up Booker's balance sheet: the company is forecast to have 150 million pounds of net cash at the end of this financial year.
For Tesco, this was clearly a difficult deal to get agreed after six months of talks. It may be just as tricky to complete.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
To contact the editor responsible for this story:
Edward Evans at email@example.com