Walmart's Plan B for Britain

(Bloomberg Opinion) -- When J. Sainsbury Plc announced its 7.3 billion-pound ($9.5 billion) acquisition of rival Asda in April, it looked like the British grocer had beaten the mighty Walmart Inc. But if the takeover falls apart, it is the U.S. retailer that will emerge from the wreckage the least damaged.

The Competition and Markets Authority is expected to rule on the transaction in the coming days. If the watchdog blocks it – or gives the go-ahead but with onerous penalties – Walmart may just persuade private equity to be its Plan B.

When we argued two-and-a-half years ago that the U.S. retailer should consider selling Asda, it wasn’t clear that Walmart was prepared to part with the British supermarket chain. Now it is.

What’s more, under the terms of the Sainsbury-Asda merger, Walmart has agreed to keep a stake in the combined business. Doing the same in any Asda buyout would make the target that bit more easily digestible. It would also allow the purchaser to keep hold of the U.S. giant’s substantial buying power.

The supermarket would be an affordable, if large, bite for a financial sponsor. In the absence of another bidder, the valuation might fall to, say, 6 billion pounds. Then assume that half the deal could be funded in debt. If Walmart kept a minority stake, the equity the buyout firm would need to put up could be as little as 1.5 billion pounds.

This could prove tempting – if a buyout firm could satisfy itself that getting out of the investment would be as easy as getting in. With antitrust regulators likely to block a sale to another grocer, the exit would have to be through an initial public offering once the company was in better shape.

To generate an internal rate of return of roughly 15 percent over five years would require the buyout firm to grow the equity value to 6 billion pounds. Assume debt stayed steady as spare cash was reinvested in the business (it needs it). Asda would then have to attain an enterprise value of 9 billion pounds to deliver the desired gains.

Asda's margins are already wide. So the strategy would have to focus on getting sales up. CEO Roger Burnley has delivered the beginnings of a turnaround, growing sales by 2.6 percent in 2017. That would need to be sustained over the lifetime of the investment. The company would need to poach customers from big grocers Sainsbury and Tesco Plc, most likely by undercutting them on price, and from discounters Aldi and Lidl by convincing them to pay a little more for the convenience of a full range.

Sure, it would still be tough to get an Asda deal past any private equity firm’s investment committee. But a buyout wouldn’t be Walmart’s only option. It could combine Asda with another retailer, such as B&M European Value Retail SA – both serve the same price-conscious shoppers.

So at least Walmart has options. That isn’t the case with Sainsbury. CEO Mike Coupe could try to strike a deal with Wm Morrison Supermarkets Plc instead of Asda – but that could face similar regulatory constraints. Or he could stick with a standalone strategy. But that won't generate anything like the value promised by the Asda tie-up. What’s more, the company’s performance has recently deteriorated. A private equity bid for the supermarket might be possible, but it would be less than straightforward.

If the Asda deal falls apart at the checkout, Sainsbury will be left with the advice of one of its own marketing slogans: love your leftovers.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Andrea Felsted is a Bloomberg Opinion columnist covering the consumer and retail industries. She previously worked at the Financial Times.

Chris Hughes is a Bloomberg Opinion columnist covering deals. He previously worked for Reuters Breakingviews, as well as the Financial Times and the Independent newspaper.

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