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Acquisition Proposal for J Sainsbury (Corporate Finance Project)

Acquisition Proposal for J Sainsbury, Corporate Finance Project, for University of Reading, ICMA Centre.
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  1 Acquisition Proposal for J Sainsbury (Corporate Finance Project)   After viewing the initial proposal to look at J Sainsbury as a candidate for takeover, I can see many potential reasons for such a move to be a success and that should create value for the shareholders of Kwik-E-Mart (our company). Alongside all the reasons to move forward with the takeover, there are several problems that need to be addressed that could increase the risk of profitability in the acquisition. Not to liken this proposal to Walmart’s  acquiring of Asda, which since 1999 has been somewhat a success, but previous to this Walmart acquired two German grocery companies, which were subsequently sold at billion dollar losses in the mid-2000s, these were due to several issues including cultural differences and not understanding the market before entering. A quote from a report written about Walmart’s failed exploits in Germany; “Wal - Mart’s failure on the German market has been the inevitable result of its inability  –  caused by an astounding degree of ignorance of key principles of internationalization strategies and intercultural management  –  to select and implement an adequate entry and business strategy.” 1  We therefore would need to be fully in tune with the UK business culture and consumer base and be clinical in our implementation of our strategies. Our key sales markets being Central America and Asia, are in itself very widespread due to the large marketplace available, however it is understandable to see the European market and especially the UK as a country to be good place to move into for diversification purposes, and some much needed corporate governance and corporate social responsibility expertise. To begin establishing a supermarket brand within the UK, would be very time consuming, and costly, as the biggest four supermarkets in the UK, Tesco, Asda, J Sainsbury, Morrison, account for 76.2% of the UK grocery market. These companies have been trading for many decades with 3 of them close to or over 100 years old. With this in mind, it would be unfavourable to try and build our brand in the UK (a highly contested market), and acquisition would be the most efficient way to enter. The UK consumers seem to have a brand loyalty, which would make it hard to build a reputation, but would make for a good reason to acquire a company with strong branding and loyalty such as J Sainsbury. However to use this takeover as just an exercise for diversification would in my opinion, be a mistake and not in the best interest for the shareholders. Even though it will hedge our risk when certain regions aren’t performing well, o ur shareholders can diversify their risk and exposures 1  Why did Wal-Mart fail in Germany? By Andreas Knorr and Andreas Arndt  2 themselves by investing in companies such as J Sainsbury or other firms of their choice and rationale, at a much cheaper price than the total costs involved in the acquisition. Unless we can exploit synergies and economies of scale to cost-cut and improve growth, we will not find shareholder approval in this deal, as creating a more diversified firm with less risk, may actually transfer wealth from stockholders to bondholders, which will leave investors further disappointed if we fail to see value creation by going through the acquisition. If this was to happen and even though it may be an extreme case, it would lead the views of Kwik-E-Mart being under threat of takeover, being strengthened, if the share price of our firm was to fall in such a case. Diversification of product lines could be a great reason for the merger, to introduce European lines, some of which are synonymous with prestige and great quality, and vice versa bring American products across the Atlantic to the British market. However in recent times, we faced criticisms of too many foreign products being sold in our stores, personally more choice the better, but we need to stay in line with our customer’s  views, as we do not want to alienate our domestic market and be at the risk of harming our business. Although, what does come with a more global product line, is a bigger global buying power, which should give us better margins on some our products as well as J Sainsbury products. We have a conservative estimate of 0.7% reduction in J Sainsbury cost of sales, which should not only reduce their costs, but ours also, for global brand products we will be able to negotiate better contracts with suppliers, for example brand name global appliances. Although this synergy has a short to medium term hurdle, due to current contracts in place for both us and them, and so immediate synergy might not be realised. My opinion would be to on acquiring, not to rebrand J Sainsbury, as it already has a loyal customer base and is a recognised brand in the UK. Therefore we would not inquire any costs, as we would run J Sainsbury as a subsidiary carrying on with its own name and branding. However, this would make it harder to sell our own branded products, as a cost saving synergy, as it would then rival J Sainsbury another of our brands if we were to buy them. We could however, merge production facilities and have all our own brand food stuffs for example at the same processing, packaging and manufacturing facilities. Following on from facilities, the wider integration between ourselves and J Sainsbury would have to be behind the scenes, as we do not want to have a major impact on the current brand that is working well in the UK, which is 3rd in market share and not far behind 2nd placed Asda. In the initial information provided, you have calculated additional growth in sales and reduction in cost of sales, but I also believe we can save costs in IT; J Sainsbury will have a large IT team and on-going costs to maintain their online grocery service. I believe we could integrate the teams and make  3 savings, in personnel and server costs. We could also save on wages paid by ourselves and J Sainsbury to maintain a 24/7 team on hand to tend to the IT networks, as we could consolidate our teams and theirs, due to our different time zones, so we can cater their night and vice versa. With online sales growth in both the US and UK markets, growing strongly, over time this consolidation of IT, could be a great cost saving synergy. J Sainsbury’s online sales growth is better than its rivals. 2  Part of the J Sainsbury ’s success has been their sustainability and responsibility campaigns, for example J Sainsbury was the first to back and sell Fairtrade products in the UK, and is currently the largest seller of Fairtrade produce in the world. 3  We could bring these networks and marketing teams that made Fairtrade in the UK a success and scale it up to the American market which is a much larger consumer audience. Another initiative they have used is to promote domestic produce, a region we have been lacking and have even seen criticism over, due to stocking too many foreign goods, we could learn from J Sainsbury strategies that would help us regain faith as a supermarket from the American consumers. My valuation of J Sainsbury will be a valuation on the multiples and comparables with other UK supermarket firms. Another option would be to use the discounted cashflow method however, J Sainsbury has had several years of negative free cashflows and therefore, I do not wish to use this method of discounted cashflows, as basing it on the historical figures, the valuation of J Sainsbury would be too far from the reality. DCF tries to find the intrinsic value of the firm, and in this circumstance a company with possible anomalies in its FCFs and therefore the calculations will be off. It is also very sensitive to inputs such as terminal growth, current profitability and J Sainsbury’s weighted average cost of capital. Valuation by comparables attempts to price the company relative to similar peer firms such as Tesco, Morrison and Marks & Spencer. This gives us an idea on how it is currently priced against its peers. Comparables also therefore takes into account for market consensus, rather than DCFs based purely on fundamentals. I will not be comparing J Sainsbury with any other firms from outside the UK, due to having different financial cultures in terms of capital structure and debt to equity norms. The multiples I will be using to compare firms will be several different financials but will all be using Enterprise Value of the company rather than the stock price. This is because as an acquirer we are looking at the entire business, debt included, as we would be taking on this obligation for any outstanding liabilities. Another benefit of this is we will avoid any distortion of valuations due to 2   J Sainsbury’s Annual Report and Financial Statements   3   J Sainsbury’s Sustainability Report    4 varying cash reserves between firms. (Enterprise Value is calculated as “ EV = market capitalisation + (long-term debt  –   cash & cash equivalents”) . The table above 4  compares some selected financials between 4 UK listed supermarkets. Firstly the Market Capitalisation is the stock price multiplied by the total amount of outstanding shares. This is the total value of all the equity in the firm, when you add debt and subtract cash reserves you get the EV value. Debt/EV is a figure which shows you the portion of the total value of the company that is arrived from debt. With all the firms having very similar Debt/EV it shows that J Sainsbury does not have an irregular capital structure for the sector. EV/Sales shows us the EV as a function of Sales, however this does rely on the firms all having similar profitability margins. However, even so in this case if we were to simplify the figure as cost per unit sales, J Sainsbury is the cheapest out of the 4 firms shown. The next two columns are the most interesting; these show us the EV as a multiple of Earnings Before Interest & Tax (EBIT) and Earnings Before Interest, Tax, Depreciation & Amortisation (EBITDA). Again for these a lower figure the better, however here we can see that J Sainsbury is slightly higher than both Morrison and Marks & Spencer. J Sainsbury is significantly lower in this respect compared to Tesco, and these could be explained by the fact, J Sainsbury carry out a large amount of sustainability agendas, which can have an adverse effect on profitability margins, for example on Fairtrade goods where the idea is to not to aim for the best margin but rather help the farmers and producers of the goods. This could be improved by our conservative estimates of an additional 2% sales growth, 0.7% fall in cost of sales to sales ratio and 12% in administrative costs to sales ratio. All of these benefits would be shown by an increase in EBIT and EBITDA, and therefore the EV/EBIT and EV/EBITDA would fall. I have also included EV/CF to show you that although the EV/EBIT may not be as desirable, the EV/CF is still very healthy and the 4  Bloomberg Terminal
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