Before rumours emerged over the weekend the proposed tie-up of J Sainsbury plc (LON:SBRY) and Walmart’s Asda would, to many casual observers, have seemed unexpected.
In a statement on Monday, Sainsbury’s said it had agreed a £15bn deal with Asda’s parent company Walmart Inc (NYSE:WMT) and that both supermarket brands would remain intact.
Walmart will hold 42% in the combined business and will receive £2.975bn in cash, valuing Asda at £7.3bn on a debt-free, cash-free and pension-free basis.
When you stop to think about it there are many reasons why a deal like this not only makes sense, but, actually it was somewhat inevitable.
1 - Competition
The march of the German retailers Aldi and Lidl has led to an intensification of what was already a bloody battle on Britain’s high streets and retail parks.
Market share concerns and the erosion of paper-thin operating margins meant consolidation was inevitable.
Tesco’s £4bn swoop for Booker, which was recently given regulatory sign-off, paved the way to this far more ambitious deal.
2 - Snug fit
While both have tried to diversify from their traditional bases, Asda and Sainsbury have failed.
The former is incredibly strong in the north, while the latter still has a firm hold with the white collar shoppers around the M25.
But this is a positive in the eyes of the City: little overlap that would necessitate the closure of scores of shops at the cost of thousands of jobs and hundreds of millions of pounds.
At the same time there are buying and supply chain synergies that will drop to the bottom line (and may also be ploughed into lowering prices).
The regulators are also expected to look a lot more benignly on this transaction than they might say an Asda-Tesco alliance given it is unlikely to create a huge swathe of new local grocery monopolies.
3 - Amazon
This point really should be top of the list. The online retailer’s acquisition of Whole Foods put American grocers on notice: Amazon really was in earnest about the hybrid model dominating online and ‘offline’ retail.
Wal-Mart’s sale of Asda for £7.3bn in cash and shares is first defensive move by the Arkansas-based giant.
Selling spreads the risk with UK investors owning around 58% of the enlarged company.
It also lessens Wal-Mart’s exposure to an already uber-competitive market, where Asda was struggling to compete with a revitalised Tesco and an on-song Sainsbury as well as the aforementioned Aldi and Lidl.
4 - Tesco
Britain’s biggest retailer, like Dr Frankenstein’s monster rising from the table, is coming around after a period of retrenchment marked by a whole series of profits warnings and an accounting scandal.
Most seasoned observers believe Tesco is getting back on track under ‘drastic’ Dave Lewis; however, many would also argue the business is not completely out of the woods.
While it might have been better and easier to engineer a merger when Tesco was out on the canvass, drivers for this deal and probably the opportunity just weren’t there.
The next best thing is to get proceedings underway now, before the monster is fully on its feet stomping on all and sundry.
5 - The internet
This is a variation of the Amazon theme, broadened out to look at wider the retail sector.
The march of the likes of Amazon, along with the online delivery service Ocado point to an industry that is centralising around big distribution hubs in the golden triangle that exits in the East Midlands where the M1 and M6 connect.
Having built up massive property portfolios in the 1990s and early noughties Sainsbury et al now find they have surfeit of shops where footfall isn’t nearly high enough to make them fully efficient.
Tesco and Marks & Spencer are particularly exposed to this, but Sainsbury and Asda will have felt the pinch too.
Financial engineering being what it is, property brings with it a lot of debt.