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Morningstar | CMA Preliminary Findings Point to No Deal for Sainsbury's-Asda Merger; Reducing Our FVE to GBX 273

On Feb. 21, the U.K. Competition and Markets Authority issued a much-awaited preliminary findings report on the proposed merger of Sainsbury's and Asda. In contrast to its milder first-phase findings, CMA now expects the merger to result in a substantial lessening of competition in U.K. markets in a number of respects, from in store to online on a local and national basis. Our previous GBX 360 fair value estimate was supported by a 75% probability of the merger going through with modest remedies (close to 80 store disposals), a scenario that now looks unrealistic. Given this set of preliminary findings and the strong language that CMA uses throughout the report, we are reducing our fair value estimate to GBX 273 per share, reflecting Sainsbury's equity value as a stand-alone entity, as we anticipate that no viable divestment plan could check the boxes for CMA to deem the deal acceptable. We have lowered our uncertainty rating for Sainsbury's to high from very high to reflect a narrower range of scenarios ahead.

CMA identified in its notice two potential structural remedies: (1) prohibition of the merger or (2) divestiture of assets and operations to a suitable party to address concerns about substantial lessening of competition. According to the report, suitable candidates would have to demonstrate a credible record and capability to compete in these markets while at the same time not creating competition issues, which makes the task of unloading large numbers of stores to current competitors (Tesco, Morrisons) even more difficult. In fact, CMA's initial view is that any combination of remedies would be more likely to be ineffective, given the substantial scale of divestments required and complexity of grocery (in-store and online) retail operations.

More important, CMA's view with regards to competition concerns in the online market is particularly telling, with the organization demanding more or less the disposal of one or the other Asda or Sainsbury's brands in addition to physical assets and operations, which we think is out of the question for either grocer.

Although the findings published Feb. 21 are part of the preliminary assessment and interested parties (suppliers, competitors, and any other party affected by the ruling) would have to provide their opinions/views on those findings in the next couple of weeks, we can't imagine a situation whereby CMA's final decision could be materially different than the current results suggest, nor do we see a realistic remedy plan that could benefit all parties involved. CMA is expected to publish its final report by April 30.

Our long-standing thesis on Sainsbury's as a stand-alone entity remains. We think the firm continues to be less prepared to face the competitive environment in the U.K. grocery market, first on the need to continue to reinvest more heavily in the business to improve its pricing position relative to its Big Four peers, and second on the Argos deal, which we believe will not benefit the supermarket’s core grocery offering. Rather, it will add to top- and bottom-line cyclicality in a soon-to-be post-Brexit world.