Tesco's $10.6bn sale of SE Asian Operations
By: Ben Willert, Carl Langodn, Mahir Yacub, Aryaman Sboti, Conrad Liebers, Hassan Hussein, Flavio Isaraj
Overview of the deal
The selling of Homeplus in 2015 marked the beginning of Tesco’s exit from the Asian market with the selling of their Lotus supermarkets and Hypermarkets to follow now in 2020. The rationale behind this sale on Tesco's end is extensive. The value of the sale being $10.6bn (£8.3bn) would “return significant value to shareholders” through a £5bn payout to investors through a special dividend payment and strengthen their balance sheet allowing Tesco to compete with Aldi and Lidl in terms of pricing. The sale would allow Tesco to also completely eliminate the deficit in their defined-benefit pension scheme through a £2.5bn payment, in turn benefiting all employees.
Dave Lewis, Tesco’s Chief Executive stated that the sale would release “material value” for the company and allow Tesco to “further simplify and focus”. Lewis didn’t state exactly what he meant by this. Therefore as Tesco’s main business lies within UK, Ireland and Central Europe we can assume that it is to shift Tesco’s focus back domestically within Europe, particularly since the COVID - pandemic has led to a major shift from eating out at pubs and restaurants to home cooking, in turn improving Tesco’s earning prospects.
Company Details: Tesco
Tesco PLC is a grocery retailer that also provides retail banking and insurance services. The former is Tesco’s core business; Tesco has stores in the United Kingdom, Republic of Ireland, Europe, Malaysia, and Thailand. It is Great Britain’s largest retailer (27% market share) and the fourth largest in the world. Home delivery is more important than ever before given the current pandemic, so Tesco has simplified the business by selling their Asian ventures to potentially focus on succeeding in this area.
Headquarters: Welwyn Garden City
President/CEO: Ken Murphy
Number of employees: 400,000+
Market capitalisation: $22,983 billion
LTM Revenue: $6,500 million
LTM EBITDA: $4,942 million
Company Details: Charoen Pokphand
The Charoen Pokphand Group is a Thai conglomerate based in Bangkok. As Thailand's largest private company (excluding its listed foods business, CP Foods PCL), it operates across many industries ranging from industrials to service sectors, which are categorized into 8 Business Lines covering 13 Business Groups. Currently, the Group has investments in 21 countries and economies.
Headquarters: Bangkok, Thailand
President/CEO: Dhanin Chearavanont
Number of employees: 360,000+
Market capitalisation: $5,57 billion
LTM Revenue: $14,700 million
LTM EBITDA: $1,800 million
Projections and Assumptions
Telefónica will no doubt still be nervous about the outcome of the decision by the EU antitrust chief on whether the CMA can rule on the merger, especially since this is not their first time trying to secure an exit strategy for their UK subsidiary. In 2016, the sale of O2 to Three for £10.25bn was blocked by the European Commission over fears that the deal would promote anti-competitive behaviour in the UK mobile market.
However, the merger between a fixed-line network company (Virgin Media), and a mobile network firm (O2) may be seen as more desirable by the competition watchdog as compared to 2016, where the proposed merger between 2 mobile network operators, O2 and Three, was blocked. This is because if two mobile network operators had merged, this could have encouraged anti-competitive behaviour since they were operating in the same markets as each other prior to the merger. This would have resulted in too few competitors in the market and the joint venture having too much market share. However, since O2 and Virgin specialise in different sectors, there is less concern of the joint venture holding too much market share in either the fixed line network sector or the mobile network sector.
Should the deal be approved, Liberty Global will pay Telefónica £2.5bn in order to create equal ownership in the joint venture (Telefónica, n.d.). According to the projections of Telefónica in their statement of results for January-March 2020, they expect to receive £5.5-5.8bn after dividend recapitalisation (Telefónica, n.d.). Dividend recapitalisation is where a dividend is paid to the shareholders by an entity who raises debt to fund the dividend. It ensures early and immediate returns for Telefónica.
Selling nearly 2000 stores in Thailand and 74 in Malaysia marks the final stage of the UK retailer’s exit from Asia as Tesco also sold its South Korean HomePlus business in 2015. This deal alongside plans to sell off the Polish division as well, comes as part of a wider strategy to get focus on the UK and Ireland business while strengthening the firm’s financial position. In the short term this will yield a lump cash sum that will be used for the elimination of the pension funding deficit (£2,5bn) and distribution of capital to shareholders (£5bn). However, this payout, set to be made early next year, is likely to prove controversial given both its size and the backdrop of the UK’s coronavirus pandemic.
Moreover, in the short-term Tesco will suffer from decreases in revenues due to this sale as the Thailand and Malaysian businesses were contributing to a combined revenue of £4.9bn making a profit of £286m which consists of about a fifth of Tesco’s total global profits.
This deal enables Tesco to focus on the UK, Ireland and central Europe. These comprise the heart of its business, therefore this deal strengthens and consolidates the firm's position within these markets. This sale also opens the door to a potential sale of Tesco’s central European operations. This would streamline further the business model.
Furthermore, as Aldi and Lidl continue to encroach on the large supermarkets’ market share within the UK, the expansion of cash and equivalents on Tesco’s balance sheet enables greater price flexibility. This also comes at a time when ASDA are under new ownership with the aim of also strengthening their low-price offering. Moreover, as home delivery becomes a more permanent change for consumers, Tesco are able to expand this part of their business. Generally, home delivery operations are negative on margins, so additional cash will facilitate this expansion deposit eroded EBITDA margins.
As for CP Group, they have gained substantial market power (most powerful retailer) which will better place them than their competition, Central Group and TCC Group. CP now operates 10,000 7-eleven convenience stores as well as the country’s biggest cash and carry chain Siam Makro. Couple this with 2000 (Tesco) stores in Thailand and 74 in Malaysia - we could be seeing some serious synergy effects as CP becomes dominant in multiple retail segments.
Risk and uncertainties
In order for any merger or acquisition to go through it must first be approved by the appropriate competitions authority for that region. For the Tesco-CP deal it was the Thai Office of Trade Competition Commision (OTCC). As we know the deal now makes CP Thailand’s most powerful retailer. Although the deal gained regulatory approval, the threat of market dominance from CP is blatant given CP’s additional 2000 stores in Thailand. This threat is even greater given CP’s ownership of the leading 7-eleven convenience store and the Siam Makro cash and carry brand. However, the OTCC put it in certain rules for CP following the deal. For one, CP’s different retail businesses cannot share information on retailers or prices. In reality adhering to this rule will be extremely difficult for CP and in turn the breach could lead to fines for CP.
Along with this Tesco would also have to maintain existing commercial terms with current producers and distributors for the next two years, which may prove to be difficult given they want to focus completely on their UK, Ireland and Europe business. However, relationships between Tesco and producers and distributors may break down following the deal, potentially posing a threat again for fines and even a blockage of the deal. The conditions of the deal also include a ban on CP entering any other modern trade retail mergers for three years, excluding e-commerce.
As seen from the table, the implied value based on the acquisition announcement of US$10.6 billion is in line with average EV/Sales implied valuation based on precedent transactions. However, Tesco’s disposal, valued at a 12.5x EV/EBITDA multiple, is lower than all three of these previous acquisitions within the Thai retail space, and significantly below the acquisition of Siam Makro by CP ALL (2013).
However, is it important to note that the acquisition of Siam Makro is an outlier that significantly skews the upper range valuation figures. The price paid for Siam Makro was 53x previous year earnings; stores were valued at US$100 million – by comparison, Costco (one of the world’s best retailers) is valued at US$70 million per store. Notable reasoning for the significant high premium paid for Siam Makro was to enable CP ALL to further widen its position as Thailand’s largest retailer, enhancing its monopoly power. Exclusion of Siam Makro from the transaction table reduces the average EV/Sales implied value to US$10.6 billion and the average EV/EBITDA implied value to US$11.5 billion – closer in range to the implied valuation of $US10.6 billion of the announced disposal of Tesco Asia.