The supermarket business has not been a pleasant place to be for many years now in the UK.
Competition is brutal. The politics are tricky (big supermarkets are like mobile phone masts everyone wants the benefits but no one wants their rural idyll spoiled by the sight of one of the things). And few consumers are as fickle or as spoiled for choice as the Great British consumer.
And yet shares in J Sainsbury are rocketing this morning.
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What's going on?
The rise and fall of the big supermarket chains
The supermarket business in the UK has long been brutally competitive. But in the early parts of this millennium, the big names at least had the comfort of knowing exactly who they were up against.
Tesco would knock lumps out of the rest of the competition. J Sainsbury and Asda would wrestle for second place. And then you'd have Morrisons which didn't have quite the same geographic spread as the other three sitting in fourth place.
As the new decade dawned, Tesco seemed unstoppable. Sir Terry Leahy announced his retirement in 2010, and stepped down in 2011. By that point, he was the pin-up CEO who everyone aspired to be. Something like £1 in every £7 that was spent in the UK ended up in Tesco's coffers.
Indeed, people talked about Tesco the way they talk about Amazon now. Global expansion beckoned Tesco was trying to crack America, and it was going to succeed where countless other UK companies had failed; independent book shops were annoyed about Tesco selling cheap novels; electrical retailers were worried about Tesco selling tellies and cheap laptops.
And yet, as always happens, pride came before a fall.
Sir Terry stepped down just in time. The aftermath of his reign revealed a company that had over-expanded and under-invested. The foreign adventures ended badly. The existing estate was run down and the cracks started to appear. Eventually, in 2014, an accounting scandal blew up, which was a direct result of the relentless push for profits.
Tesco's woes and those of its rivals were only worsened by the fact that the nature of shopping had changed. The out-of-town shopping centres that we all hated in the 1990s and 2000s were suddenly having to compete with the internet. All those big expensive stores no longer looked like a competitive advantage they were a liability.
But worse still, a canny pair of German imports realised that their "no-frills" model was an ideal complement for the internet era. Discount chains Aldi and Lidl had been in the UK for a while, but as their big rivals struggled, they took the opportunity to press home their advantage, munching up market share via the same "pile 'em high, sell 'em cheap" strategy' that made Tesco a success in the first place.
Aldi is now the UK's fifth-biggest supermarket by market share overtaking the Co-op. And Lidl is in seventh place, ahead of Waitrose.
So what does an ailing giant do in an era where size has become a drawback, and nimbler rivals are eating your lunch?
Why, you find another ailing giant to merge with, that's what you do.
The big deal
Sainsbury and Asda (which is owned by US supermarket behemoth Walmart) have decided to merge.
Walmart will own 42% of the combined business (although it has less than 30% of the voting rights), and will get just under £3bn in cash. Sainsbury's current management team will run the business, although Asda will continue to have its own CEO. No stores will be closed, but the deal is expected to save the combined group about £500m a year.
To get an idea of just how far the mighty have fallen, you just have to look at the prices being paid. Lex in the FT points out that Walmart bought Asda for £6.7bn in 1999. This merger deal values the supermarket chain at just £7.3bn. That's not a great return (although it excludes dividends paid out). As Lex puts it: "adjust for inflation, and the Asda acquisition may have eroded capital."
Is it a good deal? The spike in Sainsbury's shares suggests so. And looking at it, it probably is. I'm usually sceptical of mergers (because history suggests that they rarely succeed), but these two businesses should work well together. They are in the same line of business, but their estates don't overlap too much (Asda has more stores in the north, Sainsbury's in the south), and their customer bases don't overlap greatly either.
Of course, one reason for the scale of the spike in Sainsbury's shares this morning is that the market has been rather down on supermarkets for a long time. Sainsbury's (at least up until now) was the seventh-most-shorted stock in the UK. It isn't quite as detested as it was a while back: about 10% of the shares outstanding are being shorted, whereas it was above 12% in 2014.
But it's clear that the gloom hanging over UK retail shows little sign of dispersing. M&S, for example, is the sixth-most-shorted stock, while Morrison's is also popular with short sellers, notes the FT.
One potential fly in the ointment is that the competition authorities might be worried. But then again, they let Tesco bag Booker, so it's hard to see them being able to justify blocking this deal. That said, the combined group may well have to sell off some stores (even although there are currently no plans to do so).
Overall then it's probably a good business move for Sainsbury's. And overall it's likely to be bad news for Tesco and Morrisons.
Would I buy any of them right now? Being honest, probably not. The whole sector is still beset by the same problems as before. This merger seems like a good idea, but execution risk even in two companies as similar as this still looms large. (That's before you consider the fact that Sainsbury's only bought Argos less than two years ago).
It's a fascinating sector. We all use these shops and most of us have opinions on which ones we prefer. But as an investor, I'd rather watch from a distance for now.
John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.
He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.
His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.
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