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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 Walmarts 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 Walmarts failed exploits in Germany; Wal-Marts 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.
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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 arent performing well, our shareholders can diversify their risk and exposures

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Why did Wal-Mart fail in Germany? By Andreas Knorr and Andreas Arndt
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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 customers 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
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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 Sainsburys online sales growth is better than its rivals.
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Part of the J Sainsburys 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.
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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 Sainsburys
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

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J Sainsburys Annual Report and Financial Statements
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J Sainsburys Sustainability Report
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varying cash reserves between firms. (Enterprise Value is calculated as EV = market capitalisation +
(long-term debt cash & cash equivalents).

The table above
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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

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Bloomberg Terminal
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best out of the 4 firms. Pay only a small attention to the EV/FCF as this shows how much of an
anomaly the FCF data has been for the past few years, and I expect within the next few years to
come back into normal figures, as marked by Tesco who also have a high EV/FCF and are still a
monopoly in the UK supermarket sector, therefore we shouldnt be put off by J Sainsbury FCF figures
for the past couple of years.
Using some assumptions I will attempt to recalculate some of the comparables using our
projected additional growth and savings we can offer J Sainsbury. Firstly, an additional 2% in sales
growth, using J Sainsburys expected sales figures for 2013 from Bloomberg and adding an additional
2%, I can get a better EV/Sales figure. This may seem an odd thing to do due to not account for
projected growth in the EV of J Sainsbury without our input, however I am assuming this
informational being publically available is already price incorporated and discounted in the stock
price and therefore the EV shall remain ceteris paribus. EV/Sales, without 2% additional growth in
sales, becomes 0.40 which is even better of an already leading figure in the industry. The projected
EV/Sales falls to 0.39 without our intervention and therefore I see with our predicted 1% for the
following 4 years that EV/Sales will fall further potentially around 0.35 or 0.36 in total.
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For EV/EBIT, I will account for the savings in cost of sales to sales ratio and administrative
costs from Bloombergs 2012 filed accounts, and this should give a higher EBIT and therefore lower
EV/EBIT. I have calculated that the EV/EBIT will drop to 9.31 whilst EV/EBITDA falls to 6.20. These
figures are produced using 2012 posted figures on J Sainsburys admin costs, sales and sales costs.
These figures now show J Sainsbury as very cheap relative to the likes of Tesco, it becomes best in
terms of EV/EBITDA and close to best for EV/EBIT. This is all whilst J Sainsbury undertakes great
levels of social responsibility and sustainability projects, which would reduce profitability, small
sacrifice if its image is what makes it so successful, and something we need to be taking note of.
As for valuing the firms equity, using my new calculated amount of EBITDA which is 1526
million, times this value by the old EV/EBITDA of 7.47, I get a new EV of 11,403 million, subtracting
for debt from the EV, I value the equity in the firm to be 8627 million. With 1890 million shares
outstanding, I value each share at 456.5p. At a current share price of 380.4p, this represents possible
76.1p premium or exactly 20% at current market rate. Therefore it is my suggestion to move forward
with this acquisition as long as we pay below this premium. The lower the better, as it will give us a
better return, but we will be gaining many things aside from wealth gain, such as the expertise and
knowledge, which can be used in our own business, in areas already outlined as concerns in current
operating markets. I wouldnt advise paying any higher as a premium, as even though this is using

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Data is calculated using Bloomberg for J Sainsburys financial reports
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conservative figures for synergy levels, we need to be able to create value for our shareholders for
this to go ahead, as we are not doing this to just diversify or empire build, because this would mean
we would be paying over the odds and would fall victim to what is known as the winners curse. This
trap is easy to fall into if we dont Separate price from value. The intrinsic value of a target company
is a function of its future free cash flows, predicated on how it transforms market position,
organisation, capital and other assets into performance.
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We need to be paying less than the
intrinsic value + synergies, for this to be
profitable and reduce the risk of long
term failure. The graph
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shown nicely
visualises on our stand point dependant
on the value, and price point paid,
although we would need a better
intrinsic value method such as DCF
model, which can be done as further
diligence after this report.
For financing this acquisition, there are several possibilities, as to how we could do this. We
could buy the firm in cash, pay with shares or leverage and borrow to buy J Sainsbury. Our firm is
cash rich, and therefore it may be best and simplest to go with this route, but ill explore the
alternatives that are options. To pay with our own shares, may not be the best option, with our
depreciated value in stock, as usually when there are acquisitions with payment in shares, it signals
the acquirers share price is overvalued, and with our current undervalue in stock, we wouldnt want
our stock price to fall further. On the other side our stock is an undervalued currency at the
moment, so it would be not a good idea to use as payment anyway. We could go down the
leveraged buyout route, by borrowing ourselves, if we do not have enough cash reserves to buy the
company entirely. This would however change our debt to equity ratios in the firm and may alter our
investors views on the health of the firm, although we would have the advantage of being able to
borrow either using ours or J Sainsburys cost of capital and use J Sainsburys assets as the collateral
on the loans. For this we could talk to the J Sainsburys management and have them take out loans
to cover our shortfall, and they would go through a share buyback scheme, and we would take over
the firm using our cash reserves for the remaining cost, however we would receive a much more

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Making M&A Pay: Avoiding the Winner's Curse by Milyae Park


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debt loaded company. The other downside to this would our interest costs go up, even if is a tax
shield.
For these reasons, if the acquisition does go ahead, I would go with using as much as
possible of our cash reserves, which we have built up and would be distributing to our shareholders
eventually anyway, and instead we can retain these funds and hopefully create more value for them
in the long term by this deal. The key for the acquisition to go ahead is to be not bullied by the J
Sainsburys shareholders into paying over the odds for their shares, as my calculated maximum
premium to be offer is 20%, but it below 2012s average premium paid, which at the time was at an
11 year high.
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CNN Companies are paying up for deals
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References
Andreas Knorr and Andreas Arndt Why did Wal-Mart fail in Germany?
http://www.iwim.uni-bremen.de/publikationen/pdf/w024.pdf
BBC Wal-Mart abandons German venture
http://news.bbc.co.uk/1/hi/business/5223432.stm

Bradley, Don B., III. Urban, Bettina Wal-Mart's learning curve in the German market. Journal of
International Business Research
http://www.freepatentsonline.com/article/Journal-International-Business-Research/166850563.html

J Sainsburys Annual Report and Financial Statements
http://www.j-sainsbury.co.uk/media/649393/j_sainsbury_ara_2012.pdf
J Sainsburys Sustainability Report
http://www.j-sainsbury.co.uk/media/1377005/jsainsbury_20x20_sustainability_brochure.pdf
Milyae Park Making M&A Pay: Avoiding the Winner's Curse
http://law.wustl.edu/courses/lehrer/spring2006/CourseMat/2006/winners%20curse%20making_pay
.pdf
CNN Companies are paying up for deals
http://finance.fortune.cnn.com/2012/07/31/companies-are-paying-up-for-deals/
Google Finance (Stock price) (Accessed: 24 April 2013)
https://www.google.com/finance?q=SBRY