Time to wheel out a rights issue?

Tesco Is Worth Less Than Its Debts

Mark Gilbert is a Bloomberg View columnist and writes editorials on economics, finance and politics. He was London bureau chief for Bloomberg News and is the author of “Complicit: How Greed and Collusion Made the Credit Crisis Unstoppable.”
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Yesterday, Dave Lewis, chief executive of the British grocery chain Tesco, said he isn't working on a rights offering to boost the company's equity base. But his follow-on comment -- "you never say never" -- is the one investors should focus on, because the collapse in the company's share price means it's now worth less than it owes its creditors in the bond market.

Tesco's fall from grace has been spectacular: The company is now worth less than half what it was a year ago:

Today's share price of about 168 pence values the company at roughly 13.65 billion pounds ($22 billion). But Tesco owes its bondholders a bit more than 13.95 billion pounds, according to data compiled by Bloomberg. Excluding banks, it's the only member of the FT-SE 100 Index of the biggest U.K. companies with that uncomfortable debt-to-equity ratio.

WM Morrison Supermarkets, in comparison, is worth 3.57 billion pounds, and has bonds outstanding worth 2.05 billion pounds. J Sainsbury's market value of 4.5 billion pounds compares with bond market debts of just 733 million pounds.

Tesco's financial situation only seems to get worse. It reported a 41 percent collapse in first-half profit yesterday, and its chairman has quit after a black hole in its accounts -- opened when the company booked revenues too early and costs too late -- turned out to be 13 million pounds greater than the 250 million pounds initially estimated. Eight executives have been suspended, and the company is now being investigated by the U.K. Financial Reporting Council.

It's hard to see how Tesco can avoid passing the begging bowl to its investors by launching a rights issue. It's also hard to know whether the share price has fallen almost 14 percent in the past month because investors expect such a move.

If he does plan to raise capital, however, Lewis will have to move soon. Yesterday, Moody's cut Tesco's credit rating to Baa3, and left it on review for a further downgrade; one more drop would remove the company's investment-grade status. Raising equity when your market share is shrinking and you're being investigated for fraud isn't easy; selling stock when you've been downgraded to junk will be even tougher.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Mark Gilbert at magilbert@bloomberg.net

To contact the editor on this story:
Mary Duenwald at mduenwald@bloomberg.net