Every Little Helps

Supermarket Shareholders Revolt

A little diplomacy would go a long way to quelling concerns about its Booker takeover.

Just as Tesco Plc puts one crisis behind it, another erupts.

The British supermarket agreed on Tuesday to pay 214 million pounds ($269 million) to settle a probe into a three-year-old accounting scandal.

But Tesco now faces a new problem: two of its biggest shareholders, Schroders and Artisan Partners, have opposed its 3.7 billion-pound acquisition of food wholesaler Booker Group Plc.

Tesco's response should be to promote the deal harder -- and more diplomatically.


Tesco has under-performed the FTSE 100 index since announcing the Booker deal

Source: Bloomberg

Buying Booker is a strategic departure, taking Tesco into the fast-growing catering market. Given it was paying a skinny 12 percent premium, the acquisition looked better for investors in the supermarket rather than Booker. So it's surprising that the opposition comes from the Tesco side.

Can't Be Ignored

Deal skeptics Schroders and Artisan are major investors in Tesco

Source: Bloomberg

The skeptics' objection? Tesco is overpaying, and the deal risks distracting CEO Dave Lewis from the more important goal of turning around his existing business. If he can increase margins to 4 percent -- almost twice their current level -- the company's market value might rise by about two-thirds, or 10 billion pounds.

Something has gone badly wrong for Tesco to get into this pickle. Dissenters don't feel listened to. The company needs a new approach.

True, the takeover values Booker at an expensive-sounding 26 times forward earnings. But that's mainly because the company was highly valued to start -- with reason. Booker has an impressive record of profit growth and a strong balance sheet. Its well-regarded CEO Charles Wilson also comes as part of the package.

No Turnaround Necessary

Booker's operating profit has been expanding steadily

Source, Bloomberg, HSBC

2017 and 2018 are Bloomberg forecasts. 2019 is HSBC forecast

Despite the high multiple, the acquisition covers its cost of capital within two years, Tesco says. Based on the 175 million pounds of expected cost synergies and Booker's forecast operating profit in 2019, that stacks up.

Several questions remain: are the financial benefits really that big, and might all the benefits go to customers instead of shareholders? Is the payback good enough given the risk of distraction?

On the first, comfort comes from the fact the synergies are probably even greater than Tesco is letting on. It touts just 25 million pounds of additional profit from revenue gains -- absurdly low given its 55 billion pounds of sales.

On the second, it has a capable U.K. CEO in Matt Davies. He should be able to keep the core business on track while Lewis and Wilson get on with the merger integration. This deal isn't about eliminating overlap; it's more about buying power. 

Tesco needs to open a proper debate around these points rather than try and close down the discussion by declaring itself committed to the deal. Lewis says he has spent six hours with one of the dissenting investors. More chit-chats may be needed. With a competition probe ahead, there's time.

Chairman John Allan can't let the rebellion escalate. Sure, if Tesco really can't carry a clear majority of its investors with it, the deal should be pulled -- and without drama, so Lewis can stay in his job. Booker is a nice-to-have not a must-have.

But with a bit more diplomacy, another damaging Tesco crisis should be avoidable.

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
    Chris Hughes in London at chughes89@bloomberg.net

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

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