Sainsbury Plus Asda Equals Bond Market Love

(Bloomberg) -- The joys of being No. 1 on the high street can be a real benefit on Wall Street. The planned merger between J Sainsbury Plc and Walmart Inc.’s Asda not only promises improved buying power but also financing oomph. And that may create a permanent competitive advantage.

Megamergers need to be financed, and Walmart will be due a 3 billion pound ($4.1 billion) cash payment. This will be temporarily covered by short-term bank loans, but after the deal closes the new entity will want to lock in long-term funding. When it does, it will probably clinch some very competitive interest rates. The company says the new entity will earn an investment-grade credit rating, and it's probably right.

It's not just that it's dodged a bullet on having to take on Asda's 900 million pounds of legacy pension obligations, or that it looks capable of achieving the 500 million pounds of annual cost synergies it has pledged.

Asda owns 75 percent of its square footage outright, but Sainsbury owns just 50 percent. The regulator will have to rule on how many stores need to be shed, but hopefully the amount the new group owns outright will be higher than what Sainsbury has now.

Were things to work out happily here, the new group would be much better protected from the strain of rental increases. And there will be all the more assets to back the original Sainsbury's final-salary pension plan.

There could also be a serious benefit once the group reintroduces itself to sterling corporate bond investors (it's now largely absent from the debt market).  Pension and life-insurer funds have a particular love for assets backed by property.

The new megagrocer will likely consider very-long dated issuance, which would be a boon for this set, who are always on the hunt for long-dated assets to match their liabilities. It's an oddity of the gilt market that for years the yield curve has inverted at the long end. This makes underlying borrowing costs for ultra-long issuance even lower than for 20-30 year securities. All of this points to Sainsbury having maximum flexibility and a non-painful cost of financing once it taps capital markets.  

Another benefit is that Sainsbury has been fortunate in its choice of relatives. Walmart, rated AA, will retain a 42 percent stake in the combined entity. The behemoth of Bentonville, Arkansas, has pledged to involve itself in future financing and other arrangements, though the companies haven't yet made clear what this will involve. The presence of a high-rated partner may lift Sainsbury's estimation in the eyes of credit-rating companies. And investors will like the idea of a wealthy giant lurking in the background as a bodyguard against financial calamity.

This all might seem academic, given that the merger won't complete unit late 2019. The drop in Sainsbury's credit default swap pricing suggests it may not be. Investors are already rewarding the company for this deal, and it may want to take advantage by issuing debt before the transaction completes. The prospect that U.K. interest rates will — at some point — rise should only encourage the company.

Were it to come with a straightforward senior-unsecured corporate bond, it may well pay less than the average of its peers, according to Bloomberg Opinion calculations.

Issuing debt backed by its original real estate portfolio, or any one of a number of other cash flows, could be another way forward, and here rates may be even lower.

Now spare a thought for Tesco. It's been suffering from higher rents and so has been buying back some of its debt backed by the sale and leaseback of its property portfolio. Even worse, it now may face some tricky decisions on how hard it can push to regain an investment-grade credit rating, when it faces the cost of competing for market share with its beefed-up rival. 

Sainsbury's CDS hasn't fallen below that of Tesco yet, but could well do so on any positive signal from the CMA.

These advantages aren't a one-off benefit. They give Sainsbury a permanent edge as it competes against Tesco, the German discounters and Amazon.com Inc. — provided the deal goes through.

  1. Sainsbury has two convertible bonds, which will probably convert to equity, and a perpetual security that it will likely call in

©2018 Bloomberg L.P.

Bloomberg
Stay Updated With OnWeb News On BloombergQuint