“But even assuming that the transaction goes through on the nod, both companies must now satisfy investors that the deal passes the four tests which will determine whether the merger creates long-term value or long-term trouble for shareholders.
Is the deal designed to boost growth or create it?
Will the deal deliver the targeted cost and revenue benefits?
Does the deal introduce just one new variable to the business?
Is Tesco paying the right price?
“On the first two counts, investors can reserve the right to remain sceptical. Tesco and Booker operate in mature markets and there is therefore a suspicion that the idea is to create growth where little exists, while the vast majority of merger and acquisition (M&A) deals fail to deliver the targeted revenue or cost benefits. Tesco’s poor handling of Giraffe and Dobbie’s Garden Centres raises further questions here, although that was under a different management team, while Booker’s handling of its 2012 purchase of Makro was exemplary.
“On the third count, investors can be more relaxed, as Booker takes Tesco into a new area (wholesaling) but only does so in one country – most deals come to grief when they bring not just a new type of product or service but a new geography too.
“The issue of the price paid is more vexed. The offer of 0.861 Tesco shares plus 42.6p in cash plus any dividends due before the deal closes equates to around 210p per Booker share, or 20 times earnings – that’s a big premium to the 14 to 15 times multiple currently attributed to the broader UK market, which looks very full for a business that has a fairly skinny 3.3% full-year operating margin and operates in a competitive, mature market.
“Tesco says the deal will be earnings accretive after two years, but this excludes implementation costs and assumes all synergies are met so the price offered for Booker leaves little margin for error, especially as Tesco still has its hands full dealing with competition from Aldi, Lidl, Morrisons, Sainsbury and others.”