After more than four months of negotiations, J Sainsbury (LSE: SBRY) has finally persuaded the board of Argos owner Home Retail Group (LSE: HOME) to accept a £1.4bn takeover offer.
Home Retail shareholders will receive 0.321 new Sainsbury’s shares, plus a total of 82.8p in cash for each Home Retail share they own.
The cash portion includes a 55p cash payment from Sainsbury. The remainder comes from a 25p payment relating to the £200m sale of Homebase, and a 2.8p final dividend from Home Retail Group. Home Retail shareholders would almost certainly have received these payments anyway.
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In total, the offer is worth about £1.4bn, or 170p per Home Retail share. Home shareholders still have to approve the offer at a general meeting, but I don’t think there’s any risk of a revolt.
In my view, this deal is a good result for Home Retail shareholders. Sainsbury’s offer values Home Retail at around 20 times 2016 forecast earnings, which seems ample for a low margin retailer.
What about Sainsbury’s shareholders?
The big question is whether Sainsbury will make a success of integrating the Argos retail and financial services businesses into its own operations.
Sainsbury believes it can make savings worth £160m within three years. According to today’s announcement, the deal will provide benefits in three main areas.
Sainsbury wants to expand its non-food sales and banking businesses. The Tu clothing range is a particular focus. Sales rose to £800m last year and increased by 10% during the first half of the current year. The Argos customer credit business is also attractive. The £550m loan book should fit well with Sainsbury’s Bank and will ultimately be used to help finance this deal.
The supermarket chain also believes it can make big savings on property costs by moving a number of Argos stores into supermarkets when their leases expire. The group has trialled 10 Argos concessions in existing supermarkets for an average of 38 weeks. They’ve found that Sainsbury’s customers welcome the chance to buy non-food goods, while Argos customers like the free parking and easy access.
The final attraction is that Sainsbury believes that Home Retail is “a leader in online and mobile retailing”. Acquiring Home Retail is expected to improve Sainsbury’s online sales and the supermarket’s click and collect and delivery services.
Is Sainsbury a buy?
Sainsbury appears to believe that grocery sales are likely to remain fairly flat for a while, while sales of non-food items and general merchandise provide significant growth opportunities.
Current forecasts suggest that Sainsbury’s post-tax profits will fall next year, while sales remain largely flat. This isn’t ideal, but is diversifying the answer?
I think the truthful answer is that we don’t yet know. This deal should certainly cut the cost of running the Argos store network. I can also see that Sainsbury customers will be happy to pick up items at Argos while they’re in-store.
Sainsbury looked attractive without Home Retail, on a forecast P/E of 12.5 and with a 3.8% yield.
In my view, the worst case scenario is that this acquisition won’t boost sales or profits, which will remain flat. The risk of an outright disaster seems very low. On that basis I’d argue that Sainsbury remains a decent long-term buy.
