The stories behind a surge in UK corporate activity
The FTSE 100 is seeing unprecedented levels of corporate activity and the deals keep on coming. J Sainsbury (SBRY), Shire (SHP), Sky (SKY) and Whitbread (WTB) are the latest blue chip companies at the centre of M&A and demerger activity and this article will look at the key points behind their respective deals.
Before we get to that commentary, it is worth noting that takeover appetite previously fueled by overseas buyers capitalising on the cheap pound hasn’t waned as the currency regains strength.
The continuing availability of cheap credit and solid global economic growth is helping to drive a wave of M&A activity both on the London stock market and overseas.
According to the latest data from Thomson Reuters deal-making worldwide is up 56% year-on-year to $1.55tn. By region, the UK has been the most popular target nation for cross-border M&A; with the value of deals targeting UK companies up 570%.
Numerous deals have been struck since those figures were published, including Sainsbury’s mooted merger with Asda, and overseas we’ve had Marathon offering $23.3bn to buy rival oil refiner Andeavor, plus T-Mobile agreeing a $26bn merger with Sprint.
Some of the more recent deals have either been flagged by some investors as being too cheap or are dogged by uncertainty over whether they will go through.
Other deals are surrounding by complex terms, so it’s no wonder that a lot of people have been left confused as to what’s really going on.
We’ll now discuss the aforementioned four stocks from the FTSE 100 as their deals have raised as many questions as answers.
SAINSBURY’S TO MERGE WITH ASDA
The merger of J Sainsbury (SBRY) and Asda will see US retail giant Walmart become the biggest shareholder in the business, initially at 42% with scope to sell down to a minimum of 29.9% in the two to four years post completion.
The business combination will see the group overtake Tesco (TSCO) in UK market share terms.
Interestingly, shares in Tesco and WM Morrison Supermarkets (MRW) didn’t stay low for long after the Sainsbury’s news. Tesco traded less than 1% down by the end of the day (30 April) and Morrison went from a 4% decline in early trading to finish the day 1% ahead. Sainsbury’s traded 15% higher.
There is speculation that Morrison may be able to buy some cheap stores from Sainsbury’s and Asda, and that it would be better placed to buy them than Tesco as the latter may encounter greater competition concerns.
Latest figures show that Tesco has a 25% share of the grocery market, while Sainsbury’s has 13.8% and Asda has 12.9%; so the combined share of the latter two is 26.7%.
Walmart will get £2.975bn in cash as part of the merger deal, roughly 41% of the value of Asda.
Sainsbury’s largest shareholder, the Qatar Investment Authority, says it will support the deal.
WHEN WILL IT HAPPEN?
All shareholders in Sainsbury’s will have to wait at least a year for the transaction to complete. Sainsbury’s believes the deal will be all wrapped up in the second half of 2019.
That all depends on the Competition and Markets Authority approving the transaction, which could be tricky given the dominance of the proposed enlarged business.
You would have expected a number of store closures in order to help achieve cost savings and appease the competition commission; however the merger announcement states there are no such plans. Many analysts think the companies will have no choice but to offload some of their estate.
WHAT ARE THE KEY POINTS TO THE MERGER?
– Both the Sainsbury’s and Asda brands will continue to exist.
– Argos (owned by Sainsbury’s) will be introduced to Asda stores, expanding its reach.
– Central to the deal is the proposed cost savings by combining strengths, in particular on the buying side.
Sainsbury’s says it could achieve £350m of net EBITDA (earnings before interest, tax, depreciation and amortisation) synergies from ‘access to better harmonised buying terms’.
Essentially that poses a major risk to suppliers that they will have to cut selling prices further.
Suppliers on the stock market who serve either Sainsbury’s and/or Asda include fresh prepared foods group Bakkavor (BAKK), meat supplier Cranswick (CWK), sandwiches specialist Greencore (GNC) and cosmetics group Warpaint (W7L:AIM).
Further synergies eyed from the tie-up of Sainsbury’s and Asda include £75m on the property side and the same amount from operational cost efficiencies.
The enlarged group will incur £150m one-off operating costs to achieve the identified synergies. It will also have to spend £600m on capital expenditure, mainly to do with IT systems and putting Argos units in Asda stores.
Investment bank UBS believes the tie-up will boost Sainsbury’s earnings per share by 28% from 2021/22.
WILL THE DEAL WORK?
The last big deal in the UK grocery business was Morrison’s £3bn purchase of Safeway in 2004, notes Russ Mould, investment director at AJ Bell.
‘This resulted in multiple profit warnings from Morrison, which ultimately reaped financial and strategic benefit from the deal – although its shares are no higher now than they were then.
‘Getting the most out of a combination of Sainsbury’s and Asda will not be straightforward, even if there is relatively limited overlap in terms of the store estate; either major sites or local, conveniences ones.
‘Sainsbury’s has also pleasantly surprised many with the strategic benefits it has wrought from its acquisition of Argos, in terms of online capability, but investors are likely to have more faith in promises of cost synergies than there are in revenue benefits, as the history of big M&A deals suggests sales synergies are rarely, if ever, delivered, at least on time,’ adds Mould.
WHERE NEXT FOR SKY’S BIDDING WAR?
After expressing interest in a bid for Sky (SKY) earlier in the year, US media conglomerate Comcast, owner of NBC and Universal, made it official on 25 April with a £12.50 cash bid.
This is a big improvement on the £10.75 bid from Rupert Murdoch’s 21st Century Fox and has led Sky’s board to withdraw its recommendation for that bid and to cancel a co-operation agreement with Fox.
Sky is currently trading at £13.73 which is a near-10% premium to Comcast’s offer. The market is clearly anticipating a response from Fox. The situation is rendered more complex by Disney’s own $52bn acquisition of Fox’s media assets which includes its current 39% stake in Sky.
HOW MUCH MORE COULD FOX/DISNEY OFFER?
Liberum media analyst Ian Whittaker does expect a counterbid but can’t see Fox, and by extension Disney, sanctioning a deal above £13.75 per share.
Since Fox launched its attempt to swallow the 61% of Sky it did not already own in December 2016, the deal has been mired in regulatory issues.
To address concerns over media plurality Fox had recently announced Disney would consider buying Sky News, even if its takeover of Fox’s other assets didn’t go through. A decision from culture secretary Matt Hancock on whether to approve Fox’s bid is expected by 13 June.
Comcast is unlikely to face the same levels of political scrutiny as Fox has, given that unlike Murdoch it does not own several other media assets in the UK and nor has it been hit by any big scandals.
Even before the Comcast interest became apparent major investors in Sky had argued the Fox offer was opportunistic. This argument gathered greater credibility after some positive developments for the stock, notably a good outcome from the latest round of bidding on Premier League TV rights.
WHAT WILL HAPPEN WHEN WHITBREAD BREAKS INTO TWO?
Whitbread (WTB) has confirmed plans to demerge its global coffee chain Costa, worth an estimated £2.6bn, and list it as a separate entity within the next two years.
The company hasn’t published a timetable for when it will happen, nor has it confirmed the details for how the demerger will work. Analysts believe it won’t happen for at least 12 months.
In principle, demergers tend to involve a listed company giving its shareholders free shares in the business being separated. Theoretically shareholders would see the value of their Whitbread shares fall by the value of Costa, but owning both sets of shares would be equal in value to the previous Whitbread conglomerate.
WHY DO COMPANIES SPLIT?
Companies often demerge assets if they become non-core or they think the separate entities could be worth more than as a single unit. Splitting entities can also result in a tighter focus on growth as each constituent would be free to run their own show rather than report to a board overseeing a group of interests, often unrelated.
A study in 2003 by the Krannert School of Management found that subsidiaries spun out of companies outperformed their former parent by more than 20% over the first three years following the demerger; with most of the excess returns within the first 12 months of trading.
In Whitbread’s case, Premier Inn is widely considered to be the stronger part of the business and may be more appealing to investors post-split out of the two parts of the group.
However, it has been suggested that Costa could be a potential takeover target as a standalone business, particularly if it can accelerate its expansion overseas.
WHAT WILL HAPPEN WITH PREMIER INN?
We assume post demerger that Whitbread will change its plc name to Premier Inn. The company’s restaurant interests will also stay with Premier Inn.
Credit Suisse analyst Tim Ramskill forecasts higher earnings for Premier Inn. He estimates £511m in earnings before interest and tax (EBIT) in 2019 compared to Costa’s forecast £173m.
Premier Inn is looking to Germany for future growth after acquiring 19 hotels in the country earlier this year, comprising 3,100 rooms. The hotel chain hopes to boost room numbers to 5,720 by 2021.
WILL SHIRE’S TAKEOVER ACTUALLY HAPPEN?
Questions remain over whether Takeda’s takeover of rare diseases business Shire (SHP) will actually happen following concerns over debt.
Japanese pharma colossus Takeda first expressed an interest in acquiring Shire in late March. It wants to tap into the highly lucrative rare disease space in the US and strengthen its gastrointestinal and neuroscience pipelines.
Takeda’s shares have fallen by nearly 20% since it confirmed interest in buying Shire on 28 March. This decline suggests the market has little faith in the deal given the suitor could end up with more than $100bn of debt. Shares in Shire have increased by 27% over the same period.
HOW IS THE PROPOSAL STRUCTURED?
The latest proposal for Shire has been structured 44% in cash and 56% in shares. Should the acquisition complete, Shire would be delisted from the London stock market and investors would inherit Tokyo-listed stock or US-listed ADRs which are packets of shares.
Many shareholders may be uncomfortable owning overseas-listed stock and objections to the way the deal has been structured could be an important factor in whether or not shareholders approve the acquisition.
Takeda has until 8 May to make a firm offer. (DC/TS/LMJ)
More examples of recent FTSE 100 corporate activity
Prudential is to demerge its UK and European operations
GKN has been taken over by Melrose
BHP Billiton is considering a demerger of its US shale oil and gas business
Smurfit Kappa has received a takeover approach from International Paper