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Sainsbury (SBRY) and Home Retail Group (HOME)

Sainsbury have announced today (5/1/2016) that they may be making an offer for Home Retail Group (the owners of Argos and Homebase) although their first approach in November was rejected. No doubt the publication of this information, and the advantages of such a merger, is intended to bring pressure on Home Retail to talk further.

Now I have to declare an interest in this matter have recently purchased a few Sainsbury shares on the basis it looked the best value in a depressed supermarket sector, which might recover sooner or later. So it’s a “value” purchase for me, with a good dividend yield which looks sustainable.

The relative market caps of these companies are £4.9 Billion for Sainsbury and £800 Million for Home Retail so it might be digested without too much difficulty via a mix of cash and shares, which is what is on the table apparently. But the key question is why would Sainsbury want to acquire these businesses which have shown no growth in the last few years? Cash flow has been negative since 2011, with £55m more working capital to finance a loan book, £23m in restructuring costs (a persistent feature of recent accounts) and £49m in market share repurchases last year. Home Retail does look cheap (forecast adjusted p/e of 10.1 but whether it makes a good strategic fit looks more questionable.

No doubt Sainsbury are currently working on their institutional investors and the media to convince them of the rationale behind this merger, and some information is provided about the possible benefits in today’s announcement. But the immediate share price reaction of Sainsbury was negative and I can’t say that it immediately strikes me as a sensible diversion of management resources to move into non-food general retailing.

Let’s see what the commentators in tomorrow morning’s papers have to say about it before jumping to conclusions though.

Postscript: Home Retail’s share price jumped by 40% on the day of the announcement by Sainsbury, putting it on a prospective p/e of over 14. Paying anything like that price for Home Retail would surely be opposed by many Sainsbury shareholders.

Roger Lawson

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