The Mature Supermarket Industry and a Growth in Sales of Local Food - Essay Example

? WHY TESCO PLC HAS TO BE ACQUIRED? – AN ANALYSIS Introduction The term merger and acquisition have a broader meaning which includes “licensing, joint ventures, equity carveouts, spinoffs, restructuring, tracking stocks and alliances.” The basic aim of the merger and acquisition (hither after will be referred as M&A) to facilitate the companies to fine tune more efficiently to new opportunities and challenges. Past empirical studies on the subject revealed that about sixty percent of mergers were failures as they had not received the needed cost of capital for the product –market activity associated. As per available data, mergers have overall enhanced the market value of the companies. Besides resorting to increase the operational efficiency and cost cutting measures as a way to enhance the profitability, one another way to attain corporate growth is through acquisition. In 2005, Proctor & Gamble made a major acquisition when it bought out The Gillette Company Inc., so as to expand its reach in the consumer products' industry. The recent big successful mergers are Blizzard, which is acquired by Vivendi, eBay acquisition of PayPal, Disney’s acquisition of Pixar, yahoo’s acquisition of Overture, which turned to be Yahoo’s ad system now.( Goodman 2008:67). As regards to the recent acquisition , PayPal can be regarded as the most successful buy-out in the consumer Internet space , as it had the deep effect on the trajectory of the acquiring company namely eBay. PayPal acquisition whose service facilitates the exchange of money between individuals over the Internet fetches further transaction –based fee revenue to eBay. (Laudon 2008:458). Google has acquired Android, YouTube, Keyhole, Where2, DoubleClick and Urchin and this has added more value to its business. In the year 2003, Google acquired Applied Semantic for $102m. Google AdSense is being powered by Applied Semantics technology. (Books LLC 2010:79). How a business can grow? It may indulge in an acquisition of another business, it may cut costs, or it may increase its revenue, which is known as top-line growth. (Sherrington 2003:2). In this research essay, an attempt is made how an acquisition will enhance the overall growth of an acquirer. In this research essay, an open advice is being given to acquirer to acquire Tesco Plc, UK a leading supermarket in UK and the world’s largest online supermarket. This research essay will analyse in detail the background of Tesco Plc, the financials, its business, and a recommendation why Tesco Plc is to be made as a target company to be acquired by the proposed acquirer. TESCO PLC, UK -Business Overview TESCO is the giant supermarket retailer in the U.K and has been ranked the globe’s biggest on-line grocery retailer and is the 4th biggest supermarket in the globe trailing after Home Depot, Carrefour, and Wal-Mart. TESCO is continuously earning profits from the year 1999 onwards. Initially, Tesco started to specialise in food products and then shifted into provinces like consumer electronics, clothing, Internet services, financial services, fuel services, banking services and customer _ telecom. In the year 2003, Tesco established a UK telecom division by associating with other telecoms in UK. For instance, with O2, it launched a joint venture for Tesco mobile. In the year 2004, as a joint venture, it established a broadband service. Tesco announced in the year 2006 that more than one and a half million customers had signed up for its telecom account, which provides services like fixed-telephone line , mobile phone services and broadband accounts. In association with Royal Bank of Scotland, Tesco also provides customers with financial services named Tesco Personal Finance and thus during 2006, Tesco was able to register more than 5 million customer accounts. (McLoughlin & Aaker 2010:128). As of date, Tesco Plc, UK is having about 2463 retail stores and there are 472, 04 employees working for Tesco. Source: Tesco’s Annual Report 2010:85 Tesco Plc has markets symbolising about 53% of the global GDP as against just 8% one decade ago. In the year 2010, it earned about 22% of its revenues and 31% of its sales was generated from its international operations and 78% of its revenues and 69% of sales was generated in UK. It has 2463 stores across all formats and about 65% of its selling space is located outside the UK. In the year 2010, it generated more than 50% of its profits from Europe and Asia and is having a market value of international property around ? 14.7 bn. TESCO Group turnover for the year 2009-10 stood at ?62, 537million, which represented an increase of 6.8% as against ?58, 571mn in the year 2008/09 and its group revenue stood at ?56, 910mn, which represented an increase of 10.1% as against 53, 115mn in the year 2008/09. Likewise, TESCO Group trading profit was ? 3, 412mn in 2009-10 as against ?3, 039mn in the year 2008-09, and it declared dividend per share p 13.03 in the year 2009-10 as against p 11.96 in the year 2008-09.(Tesco Annual Report 2010:2). Industry Overview All the five supermarket chains in UK are controlling about eighty percent of the market. Out of this, Tesco alone vouches for ?1 for every ?3 expended on foodstuffs in the UK. The following is the market share of the top five supermarkets of UK: Name of the Supermarket Their Market Share Tesco 30% Sainsbury 18% Asda –Wal-Mart 16% Safeway 10% Morrison 6% Source: Kantar 2010 From the year 2006 onwards, supermarkets in UK have witnessed a tremendous growth with the turnover achieving over four percent growth per year. Such growth even in economic recession indicates that defensive nature of UK supermarkets with the fundamental concept that consumers still require to buy groceries and food items from supermarkets despite the economic downturn. In spite of inflationary trends, supermarkets in UK have attained good growth by attaining substantial market share. Supermarkets in UK are able to develop their own private brands or labels to enhance premium offers and value, which have been regarded as a giant leap. In the year 2010, in UK, the increase in the public spending on grocery and food items trimmed down, but it remained positive. Presently, UK supermarket industry is under constant pressure and witnesses a lot of pressure due to recent food inflation, which is affecting upon the ability to spend and the spending styles of UK consumers. UK’s Super market leader Tesco Plc anticipates that its local food sales would likely to reach ? 1 billion during the year 2011 as against ?870 million in 2010. According to a research, about 44% of U.K shoppers are buying more from local food as compared to five years earlier. At any given time, TESCO stocks about 4000 types of foods, which are locally sourced. In the year 2010, Asda witnessed an increase of 25% of sales of local food. In the mature supermarket industry, such a growth in sales of local food is very rare and comes despite the fact of highly priced local foods. As per forecasts by the research firm Mintel, local food sales in UK are set to attain ?6.2 billion by the year 2013 as against just ?5.1million in 2009. (Rohwedder 2011). In non-food sectors also, UK supermarkets have been triumphantly gaining a lion’s share of shoppers. Non-food sector will prolong to be a driver of growth for Asda, Sainsbury and Tesco. Thus, from development of non-food channels to private labels, supermarkets in UK will prolong to be resourceful to achieve market share and to enhance sales. From the year 2006 onwards, supermarkets in UK have witnessed a tremendous growth with the turnover achieving over four percent growth per year. Such growth even in economic recession indicates that defensive nature of UK supermarkets with the fundamental concept that consumers still require to buy groceries and food items from supermarkets despite the economic downturn. UK’s Super market leader Tesco Plc anticipates that its local food sales would likely to reach ? 1 billion during the year 2011 as against ?870 million in 2010. According to a research, about 44% of U.K shoppers are buying more from local food as compared to five years earlier. At any given time, TESCO stocks about 4000 types of foods, which are locally sourced. In the mature supermarket industry, such a growth in sales of local food is very rare and comes despite the fact of highly priced local foods. As per forecasts by the research firm Mintel, local food sales in UK are set to attain ?6.2 billion by the year 2013 as against just ?5.1million in 2009. (Rohwedder 2011). Footed on Dunn and Bradstreet analysis, IPDs IRIS system underlines a “negligible “risk for TESCO. Thus, within the UK supermarket sector, Tesco derives advantage from a low risk revenue profile, which is not only an attractive quality but also most sought after given the recent subprime mortgage crisis. In the last three years, UK supermarkets have seen good returns despite economic recession, and this positive trend has paved the way for enhanced performance for investors. The continued growth of UK supermarkets and their significance within the UKs retail scenery, along with a momentous record of total return outmatching and lesser volatility should make TESCO as an attractive market province amongst investors. As at 27th Feb, 2010, the market capitalisation of Tesco Plc Group is ? 41.4 billion as against ? 35.9 billion in 2009. The share capital of the Tesco Plc as at 27th Feb 2010 was ? 399 m as against ? 395m in the year 2009. In view of the above, it is strongly suggested that acquirer should take immediate efforts to acquire the TESCO PLC, UK by either by paying in cash or by cash and shares or by raising debt. Strategic Benefits Loyalty cards like Tesco Clubcard, which has around 15 million cardholders, offers Tesco with unmatched leadership in the UK supermarket industry. Footed on Dunn and Bradstreet analysis, IPDs IRIS system underlines a “negligible “risk for TESCO. Thus, within the UK supermarket sector, Tesco derives advantage from a low risk revenue profile, which is not only an attractive quality but also most sought after given the recent subprime mortgage crisis. Though there exists harsher planning limitation in UK and due to prevalence of cut-throat competition, which creates issues for UK supermarkets to plan for further expansion, UK markets strive hard to retain their market share and thus all the main supermarkets in UK are all having massive store expansion plans to accomplish. Economic Benefits In the last three years, UK supermarkets have seen good returns despite economic recession, and this positive trend has paved the way for enhanced performance for investors. The continued growth of UK supermarkets and their significance within the UKs retail scenery, along with a momentous record of total return outmatching and lesser volatility should make TESCO as an attractive market province amongst investors. Tesco’s UK and International Operations: Revenue ? m No of Stores Employees United Kingdom 38,558 2,482 287,669 Europe Republic of Ireland 2382 119 14,158 Poland 1942 336 23,655 Hungary 1698 176 20,079 “Czech democracy “ “1,287 136 12,949” “Slovakia “ “891 81 8,105” “Turkey” “595 105 7,630” Aggregate 8695 953 86,576 Source: Tesco Annual Report 2010:7 United States of America 349 145 3,246 Asia South Korea 4162 305 22,739 Thailand 2344 “663 34,775” “China” “844 88 22,668” “Malaysia” “633 32 9,423” “Japan” “449 142 4,636” Overall 8432 1230 94,921 Source: Tesco Annual Report 2010:7 During the year 2010, Tesco’s international operations achieved a turnover of ? 19.4 billion, which is up by 8.8% as compared to previous year, a trading profit of ?749 million, which is up by 5.6% as compared to earlier year, thereby adding new spaces of 5.1 m square feet and with new stores about 324.Comparing to UK, there are more Clubcard holders in their international operations. In the year 2010, Tesco UK sales was ?42.3 billion, which is up by 4.2% as compared to earlier year and is having around 15 million active Clubcard holders. Tesco UK achieved trading revenue of ?2.4 billion, which is up by 6.7% as compared to last year. Tesco Plc is having 15 million active customers in the UK. Clubcard is offering not only large benefits to Tesco’s customers but also offers an insight into transforming shopping styles .During the year , Tesco’s customers earned ?550 million in aggregate in vouchers and about 18% of households in UK are redeeming their Clubcard vouchers now as compared to earlier year. Further, Tesco has about 2600 improved or new own-label food lines, which were introduced during the year 2010. (Tesco Annual Report 2010:16) Financing Strategies The acquirer may incorporate a new company to acquire the assets of the Tesco and share capital in such acquirer company can be held either by the private equity investors or through the parent company itself. An Acquirer can follow the following any one method to buy out Tesco: By making an open offer and paying the sellers by cash By exchanging the shares. I.e. Issuing one share for every five shares held by Tesco shareholder on the basis of valuation arrived at. Funding the Tesco’s acquisition may be carried through by any of the following: By issuing new shares and by employing internal surpluses as reflected by reserves & surpluses of the acquirer. By resorting to long term loans from banks and financial institutions By issuing bonds and other financial instruments to finance the Tesco’s acquisition. (Ogilvie: 255). Capital Structure of the TESCO PLC As at 27th Feb, 2010, the market capitalisation of Tesco Plc Group is ? 41.4 billion as against ? 35.9 billion in 2009. Return on capital employed as at 27th Feb, 2010 is 12.1% as against 12.8% in 2009. The share capital of the Tesco Plc as at 27th Feb 2010 was ? 399 m as against ? 395m in the year 2009. Management of the Company The board of directors of TESCO Plc is comprised of eight “independent Non-executive Directors “and eight “Executive Directors “and one “Non-executive chairman”. Source: Tesco Plc Annual Report 2010:47 Regulatory / Legal / Tax Disclosure Regulatory and Legal Issues The legal documentation for the transfer of ownership of a company in an acquisition is necessarily complex and each acquisition must be scripted to the particular scenarios of the business transaction and close attention should be paid to drafting of acquisition agreement which will be having warranties, representations, conditions precedent to closing the acquisition, covenants and indemnification. (Ernst & Young 1994:117). Tax Disclosure Gilson, Scholes and Wolfson have expressed the theoretical structure explaining the association between M&As and tax benefits. Hayn has empirically proved that there exists “probable tax advantages deriving from unused tax credits and net operating profits positively impact announcement –period, profits of the companies associating capital gains, tax-free acquisitions and the step-up in the purchased assets' basis which may impact returns of companies associated in taxable acquisitions. Further, whether an M&A can be arranged as a tax-free exchange may be a focal deciding issue in whether to opt for such a deal or not. Sellers sometimes demand tax-free status as a precondition of sanctioning a deal. (Gaughan 2008:165). In UK, in the context of leveraged acquisition, optimising probable tax deductions for interest payments is a pivotal structuring objective. The deductibility of interest payments on the finance obtained for an acquisition is impacted by a number of UK rules. Interest deduction may be refused under UK tax laws, where the debt is attributable to a tax avoidance objective or the where the debt is convertible or where the interest results as dependent. Deductibility of interest may be refused if the debt transaction is between the related parties. Financials Source: Tesco Plc Annual Report 2010:71 TESCO PLC FINANCIALS Growth Rates % Tesco Plc “Industry S&P 500” “Sales ( Quarter vs Year ago qtr)” 7.1 25.7 11.6 Net Incom (YTD vs YTD) 15.3 11.4 53.2 Net Income ( Qtr vs Year ago qtr) 15.3 11.5 72.4 Sales ( 5-Year Annual Avg) 10.94 7.29 7.74 “Net Income ( 5-Year Annual Avg)” 11.5 6.34 7.64 “Dividends ( 5-year annual avg)” 11.54 7.71 4.87 Source: moneycentral.msn.com TESCO PLC FINANCIALS 2010 2009 2008 2007 2006 Total Revenue 56910 53898 47298 42641 39454 Net Income 2327 2133 2144 1892 1570 Normalised EBITDA 4602 4100 3595 3211 3037 Source: moneycentral.msn.com TESCO PLC Ownership Information Ownership Information Shares Outstanding 2.68 billion Institutional investors ownership % 0.31% Top 10 Institutions % 0.3 Mutual Fund Ownership % 0.01 5% insider ownership % 1 Float % 99 Source: moneycentral.msn.com Return Analysis 2010 2009 2008 2007 2006 Normalised EBITDA 4602 4100 3595 3211 3037 Basic Normal EPS 0.27 0.25 0.25 0.21 0.19 Rosenbaum & Pearl (2009) demonstrate how to arrive at a company’s value by employing EBITDA ( earnings before taxes ,interest, amortisation , depreciation ) , net-worth method, etc and also focus on multiples of analogous companies and has shown some earlier M&A transactions. (Rosenbaum & Pearl 2009:151). Tesco Plc is having a strong market presence, being a well known brand name in UK and in other countries and also having a strong performance. As far as online shopping is concerned, it is the world leader, it is going on increasing its strong presence in the video and music market, it is having bright chances in private label markets and has a strong presence in the growing economies like China and India. However, Tesco’s future growth is highly depending upon on its increased reliance in Europe and UK market. Further, its inventory turnover is also somewhat weak. Intense competition and ever rising food prices are the threats faced by Tesco Plc. Conclusions Tesco Plc is planning to make further investment to the tune of ?1. 6billion in the year 2011 in UK and this will create many thousands of jobs, which include the long-run employment through their Regeneration Partnerships schemes. With sustainable growth for the years to come, Tesco is developing a business for the future through diversification into new product areas, new geographies and new services. Tesco has weathered the economic storm as well by staying concentrated on its approach and assisting clientele to accumulate monetary rewards through customer loyalty awards. Footed on Dunn and Bradstreet analysis, IPDs IRIS system underlines a “negligible “risk for TESCO. Thus, within the UK supermarket sector, Tesco derives advantage from a low risk revenue profile, which is not only an attractive quality but also most sought after given the recent subprime mortgage crisis. In the last three years, UK supermarkets have seen good returns despite economic recession, and this positive trend has paved the way for enhanced performance for investors. The continued growth of UK supermarkets and their significance within the UKs retail scenery, along with a momentous record of total return outmatching and lesser volatility should make TESCO as an attractive market province amongst investors. In view of the above, it is strongly recommended that acquirer should take immediate steps for the acquisition of TESCO PLC UK either by paying cash or partly by cash and by shares and acquirer can raise finance for the acquisition either by issue of new shares, bonds or raise long-term debt from banks and “financial institutions.” Lists of References Books LLC. (2010).Google Acquisitions: AoI, Android, YouTube, List of Acquisitions by Google, Google Voice, Picasa, Aardvark, DoubleClick, On2. New York: General Books LLC. Ernst & Young. (1994). Mergers & Acquisitions .New York: John Wiley & Sons. Gaughan, Patrick A. (2008). Mergers, Acquisitions, and Corporate Restructurings4thEdition. New York: John Wiley & Sons. Goodman Andrew. 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