Amazon Should Be Circling Britain’s Grocers

(Bloomberg) -- Britain’s supermarket industry is in upheaval. And the planet’s retail giant may yet make its mark.

Amazon.com Inc. tried to open talks to buy Waitrose last year, according to the Sunday Times. The John Lewis Partnership, which owns the grocer known for its posh clientele, denied that an approach had been made, while Amazon declined to comment.

This odd couple has a lot going for it. Like Whole Foods, which Amazon acquired last year for $13.7 billion, Waitrose has a strong brand associated with quality food. And as with Whole Foods, there will be a sizable overlap between the would-be target’s customers and Amazon Prime.

Even though the overtures may have happened last year, this is more than an academic issue. If Amazon wants to get serious about cracking online grocery in the U.K., it will probably have to buy a supermarket. With J Sainsbury Plc’s 7 billion pound ($9.5 billion) bid for Asda, and before it, Tesco Plc’s 4 billion pound takeover of Booker, all the British grocers are jostling for position.

Waitrose has a store network with some decent locations, particularly in London and the south east. But after a stellar few years, its sales growth has slowed. So offloading the supermarket or selling a significant stake might rid the partnership of what has become a problem child.

Waitrose had revenue of 6.35 billion pounds in the year to Jan. 27, and operating profit of 172 million. Using the trailing sales and operating profit multiples commanded by Sainsbury just before its Asda deal indicate it may be worth about 1.7 billion pounds ($2.3 billion) on a debt-free basis. But it offers access to premium customers and may therefore command a higher valuation. Add a takeover topup and the price could get comfortably over 2 billion pounds.

There are a few hurdles. The John Lewis Partnership also had net debt of 215.6 million pounds, and a pension deficit of 623.1 million pounds. A portion of this would have to be attributed to Waitrose.

But the biggest complication is that the John Lewis Partnership is an employee-owned organization. The unique structure makes disentangling Waitrose more difficult than separating a unit of a listed company. It might not be impossible, but it would certainly be time-consuming and complex.

John Lewis seems to be resisting any advances from Amazon. The group doesn’t have any shareholders to push it to reconsider its position as a listed company would. Still, things can change, particularly given the fact that Waitrose’s competition is ratcheting up. Tesco’s U.K. arm has a fresh lease of life, given the arrival of new chief executive Charles Wilson; Sainsbury’s Asda purchase could see the brand taken upmarket. Meanwhile, Marks and Spencer Group Plc Chairman Archie Norman is overhauling the company.

But if John Lewis is serious about holding onto Waitrose, and Amazon about cracking U.K. grocery, then the latter must look elsewhere.

It has already missed out on Booker, which I argued it should have acquired. Unless it gatecrashes “Sasda” then Sainsbury will have also slipped away, unless Amazon picks up individual stores that the competition authorities force the new group to offload.

Given the surprising combinations so far, even a purchase of Tesco shouldn’t be ruled out. Although it is big — it has a market capitalization of 23.3 billion pounds — that is a fraction of Amazon’s value.

A more digestible chunk would be Wm Morrison Supermarkets Plc, which already supplies products to Amazon.

But M&S is a real wildcard. It has a similar upmarket food business to Waitrose, as well as a large clothing arm. While M&S has struggled to get its womenswear right, the retailer offers Amazon the chance to gain some scale and credibility in its apparel efforts. It has stores in trophy locations. And it would be a nice example of history nearly repeating itself — Norman sold Asda to Walmart in 1999.

So Waitrose is far from the only English rose in the garden. And given its particular ownership structure, another British supermarket may have fewer thorns.

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