Tesco has signalled its desire to increase its already sizeable market share and strengthen its distribution through acquiring Booker in a £3.7bn transaction. Tesco is an international retailer specialised in grocery sales. Booker Group plc is the United Kingdom's largest food wholesale operator, offering branded and private-label goods with iconic brands such as Londis under its umbrella.
Digging straight into the financials, Booker’s shares are up 21% since the announcement of the transaction, underpinned by the 13 % premium Tesco offered for the stock compared to its Friday prior price. The deal values Booker at 205.3p a share, and Booker shareholders would receive 0.861 newly issued Tesco shares, along with 42.6p in cash, giving them a 16 per cent holding in the new company. The combination of share and cash provision indicates two things. Firstly, that Booker shareholders have significant confidence in the newly merged company, especially given the considerable stake they will now own in the newly merged company. In addition, the transaction was funded by cash from Tesco’s own reserves, indicating the current strength of the firm’s balance sheet.
With an EV/EBITDA of approximately 19, one way to determine if the transaction was effectively priced is to compare that multiple to comparable companies. The New York Business School took a set of 16 of the largest food retailers, and derived a median multiple of 11.28. Clearly then, Tesco has paid an incredible premium for Booker. Was it worth it?
Well, the first step would be to take a look at the rationale for why Tesco decided to go about this transaction. Firstly, the firm wanted to put its excess cash to use, and arguably the best way to do this is to look for acquisitions that complement your current business model. Booker provides Tesco access to the tertiary food market, through a network of wholesalers and small shops. The cheap prices that wholesalers are able to obtain combined with the fat profit margins made by local shops due to their prime location presents an incredibly valuable proposition. Tesco will be able to enhance this model further through offering even more discounted prices, due to its significant buying power. Furthermore, the transaction is expected to create over £175m in cost synergies annually through cutting overlapping operations such as distribution channels and warehouses.
Despite the fact that these are clearly tangible benefits, the question still remains whether these benefits justify the heavy premium. Major shareholders of Tesco’s seem to disagree, with asset manager Schroder’s voicing their dissent. The minority stakeholder argues Tesco’s is still struggling to compete in its core market, and the firm’s slew of scandals including accounting malpractice points to a culture that in need of serious reform. Up until last month there was also a major issue relating to regulation, with the transaction on the verge of being blocked by anti-competition watch dogs. Last month however, they ruled in favor of the transaction as both Booker and Tesco were not direct competitors, operating in the tertiary and secondary food market respectively.
To conclude, I would take the tentative view that despite Tesco’s organic growth issues and internal cultural problems, the premium is justified due to the potential for Tesco to simultaneously strengthen its distribution channels and diversify its income into a highly profitable business model which has the potential to be greatly enhanced by Tesco’s current capabilities.