The merger of J Sainsbury (SBRY) and Asda will see US retail giant Walmart become the biggest shareholder in the business, initially at 42% with scope to sell down to a minimum of 29.9% in the two to four years post completion.

The business combination will see the group overtake Tesco (TSCO) in UK market share terms. That may explain why shares in Tesco have fallen by 2.4% to 232.3p on the news.

Morrisons (MRW) comes off even worse with a 4.3% decline in its share price to 229.75p.

In contrast, shares in Sainsbury’s soar by 19% to 321p on the merger news.

Latest figures show that Tesco has a 25% share of the grocery market, while Sainsbury’s has 13.8% and Asda has 12.9%; so the combined share of the latter two is 26.7%.

Walmart will also get £2.975bn in cash as part of the merger deal, roughly 41% of the total value of Asda.

Sainsbury’s largest shareholder, the Qatar Investment Authority, says it will support the deal.

WHEN WILL IT HAPPEN?

All shareholders in Sainsbury’s will have to wait at least a year for the transaction to complete. Sainsbury’s believes the deal will be all wrapped up in the second half of 2019.

That all depends on the Competition and Markets Authority approving the transaction, which could be tricky given the dominance of the proposed enlarged business.

You would have expected a number of store closures in order to help achieve cost savings and appease the competition commission, however the merger announcement states there are no such plans.

WHAT ARE THE KEY POINTS TO THE MERGER?

- Both the Sainsbury’s and Asda brands will continue to exist.

- Argos (owned by Sainsbury’s) will be introduced to Asda stores, expanding its reach.

- Central to the deal is the proposed cost savings by combining strengths, in particular on the buying side.

Sainsbury’s says it could achieve £350m of net EBITDA (earnings before interest, tax, depreciation and amortisation) synergies from ‘access to better harmonised buying terms’.

Essentially that poses a major risk to suppliers that they will have to cut selling prices further.

Suppliers on the stock market who serve either Sainsbury’s and/or Asda include fresh prepared foods group Bakkavor (BAKK), meat supplier Cranswick (CWK), sandwiches specialist Greencore (GNC) and cosmetics group Warpaint (W7L:AIM).

Other quoted players with relevant relationships to one or both of the supermarket companies include services group Clipper Logistics (CLG) and digital marketing group Eagle Eye Solutions (EYE:AIM).

Further synergies eyed from the tie-up of Sainsbury’s and Asda include £75m on the property side and the same amount from operational cost efficiencies.

The enlarged group will incur £150m one-off operating costs to achieve the identified synergies. It will also have to spend £600m on capital expenditure, mainly to do with IT systems and putting Argos units in Asda stores.

WHAT DOES IT MEAN FOR GROUP EARNINGS?

Investment bank UBS believes the tie-up will boost Sainsbury’s earnings per share by 28% from 2021/22.

WILL THE DEAL WORK?

The last big deal in the UK grocery business was Morrisons’ £3bn purchase of Safeway in 2004, notes Russ Mould, investment director at AJ Bell.

‘This resulted in multiple profit warnings from Morrisons, which ultimately reaped financial and strategic benefit from the deal – although its shares are no higher now than they were then.

‘Getting the most out of a combination of Sainsbury’s and Asda will not be straightforward, even if there is relatively limited overlap in terms of the store estate; either major sites or local, conveniences ones.

‘Sainsbury’s has also pleasantly surprised many with the strategic benefits it has wrought from its acquisition of Argos, in terms of online capability, but investors are likely to have more faith in promises of cost synergies than there are in revenue benefits, as the history of big M&A deals suggests sales synergies are rarely, if ever, delivered, at least on time,’ adds Mould.

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Issue Date: 30 Apr 2018