The Tesco-Booker merger: all you need to know

Let’s start from the beginning. What do I need to know?

Tesco stunned the City by merging with listed wholesaler Booker in a deal worth £3.7bn last Friday. The aim of the share and cash merger is to “delight consumers with better availability of quality food at attractive prices across retail and eating out locations” (while creating synergies of around £200m a year).

The deal, nearly a year in the making, started out as an exploration of “a few tactical opportunities,” Booker CEO Charles Wilson recalls. “But we ended up saying, hey, this could be bigger than that.”

“Charles and I have known each other a long time,” adds Tesco CEO Dave Lewis. “The decision came from a conversation we were having on how the market was evolving. We got ourselves to a place where the big prize was in merging the two businesses.”

It could take another year for the transaction to actually go ahead. Lewis said his “best estimate” for completion was the end of 2017/early 2018.

Is it really a merger?

Some analysts have contested that Tesco’s relative size - it has £59bn in sales compared with Booker’s £5bn - makes it more of a takeover. How you classify the deal is arguably of little importance, though. Booker shareholders will own 16% of the combined group and Wilson will be a central figure in the new company, sitting on the combined group’s board and combined group executive (along with Booker chairman Stewart Gilliland). Wilson has also invested his Booker shares (worth £220m at the offer price) in a ‘lock-up agreement’ for a five-year period from the start of the deal.

How is Tesco funding the deal?

The offer is an 80/20 split between shares and cash, meaning Tesco will need to put up £760m in funds. It says this will come from “existing cash resources”.

What benefits will the merger create for Booker and Tesco?

Tesco has identified synergies of £200m a year, with at least £25m per annum from revenues and the remaining £175m from procurement and distribution savings. Head office job losses are expected to be minimal.

“This deal creates a very powerful combination,” says Wilson. “What you’ll see on procurement and supply chain is we’ll take carbon out of the equation. We can buy all of the broccoli out of a field, and put it into stores, into catering, into pubs. That’s why wholesale/retail puts us into the same platform.”

Will the deal lead to major job cuts?

With Tesco staff having already been through huge job cuts since he took over, Lewis was adamant that the merger would not mean another round of the axe, despite speculation already in the City that one of the appeals to Tesco would be the opportunity for huge cost savings. “I can’t emphasise enough that the idea is to bring expertise to the business,” said Lewis. However, analysts predict a huge period of rationalisation if the merger does goes ahead. “There are very material cost savings,” said Monteyne. “Both have a big UK food supply chain network, which means big rationalisation. This is additional to Tesco’s plan for 3.5% to 4% margin.”

What opportunities are there to grow the ‘out of home’ sector?

Tesco and Booker say their newly formed company will lead the market in both the ‘in home’ and ‘out of home’ food markets, but named the faster-growing ‘out of home’ market as the biggest prize.

“What this does is take us much further forward in getting closer to the growth part of the market.”

Booker supplies 450,000 catering businesses including Wagamama, Prezzo and Carluccio’s, and Wilson sees “very significant” growth potential.

“When you’re talking to pubs, for example, with a better supply chain that will grow our sales. Many customers are looking for better choice, prices, service and quality. We serve 11,000 schools. We serve Aramark, which serves caterers. We serve Byron. There is lots of headroom,” he said.

Speaking exclusively to The Grocer, Tesco’s chief product officer Jason Tarry says the move will tap into an increasing customer appetite for eating out. “Customers are changing their buying habits,” he said. “Eating on the go, eating out and ordering in the home. In our space it’s difficult to do that. The lunchtime meal deal we do well. Breakfast and take-home tea we don’t do so well. What this does is take us much further forward in getting closer to the growth part of the market.”

What does it mean for Tesco’s online offer? 

As it seeks to compete with the growing threat of Amazon, Tesco has seen a huge opportunity to add to its online offering with the addition of an extra 8,000 click and collect points set to become available at a stroke under the merger.

Having scaled back on its online ambitions in 2016 and faced competition from others such as Sainsbury’s Argos takeover, the Booker merger suddenly gives Tesco a powerful extra advantage over its supermarket rivals in terms of delivery capacity, without extra costs.

Is the City convinced?

Not entirely. On the morning of the announcement, Tesco shares jumped nearly 10% in early trading to 206.7p as the deal was enthusiastically welcomed. Booker shares jumped 16.2% to 212.8p, thanks in part to the premium Tesco is offering for Booker’s stock.

HSBC European retail analyst Andrew Porteous praised the “excellent deal”. “It combines two of the best management teams in the food industry and merges two market leaders,” he said. Neil Shah, director of research at Edison Group added: “With Booker on side, Tesco will have first mover advantage in tying up the food supply chain in the brave new world of online shopping, with Amazon the main disrupter and a pricing race to the bottom [among] core grocery stores.”

“It combines two of the best management teams in the food industry”

One of the only voices of dissent came from Shore Capital analyst Clive Black. “The strategic rationale of this combination is neither wholly straightforward nor compelling,” he said. “In particular we see a real danger that focused, cash-positive and high cash-converting Booker, with a very well-funded dividend and special distribution on an ongoing basis, may be de-rated.”

And the Tesco share price has actually slipped back to 194p as The Grocer went to press amid concerns about the complexity and viability of the deal.

How have rivals reacted?

Competitors have remained tight-lipped over the deal, but “rivals certainly won’t be sitting around congratulating Tesco for its brilliant strategic play. They will view the move as very negative for them and may well decide they need to do something about it,” says one anonymous dealmaker.

They could even consider a rival bid. After all, broker Peel Hunt described Tesco’s offer as a “skinny” deal for Booker shareholders. But the dealmaker believes few competitors will have the weight behind them to present a real threat.

“Tesco’s firepower is such that they can make this into a good deal and offer more to Booker shareholders, making it very difficult for a third party to come in.”

Will independent stores be living in terror?

“I think they’ll be excited,” claims Wilson. “It may take a little persuading at first, but when they understand they will be excited. Independents are facing a lot of pressure right now on rates and the national living wage. What they are looking for is better choice, price, service. We think we’ve made good progress. Sales to retailers are growing strongly. With the combined capabilities of Tesco, we’ll do a better job for them. In five years they’ll say we’ve been able to do a better job for them.”

Paul Baxter, CEO of the NFRN, also backed the deal as “great news for independents” on Twitter as he pointed to the better access to banking, payment services, products and competitive prices.

Will brands like Budgens and Happy Shopper be scrapped? Could we see Tesco brands in local independents?

Wilson said the arrival of Tesco would not mean the kiss of death for the Booker brands. “I would be really surprised,” he said. “Independents are very passionate about their branding.”

But he does claim there are opportunities. “Some people who don’t have access to the One Stop brand might be really excited about it but we serve the retailers. We don’t own their businesses.”

Lewis added: “When we explore, we do think there are services that could be provided that aren’t there at the present. We will ignite your imagination. Delivery capability in terms of Tesco. Reach and frequency that when our vans are lying idle is when they are most needed by Charles’s customers. We expect to launch innovative new services. There will be innovation at every level.”

What will the impact be on suppliers?

Despite the huge power a merged group would have, Lewis claimed the deal was a massive opportunity for suppliers, who he promises will be “right at the heart of what we’re doing”. Tesco said the deal would broaden their market opportunity, with “strong growth prospects and a clear opportunity to develop better own-brand and fresh ranges”, especially in the relatively untapped out-of-home sector.

But broker Peel Hunt believes branded suppliers will be “firmly in the firing line” of this new superpower. One supplier MD is also wary of the ramifications. “It’s about as welcome as a kick in the head. It’s very worrying that they are now going to be looking at making £200m savings and the danger is they will see that the best way to get that is to put the squeeze on suppliers.”

What are the implications for Tesco and Booker’s delivery fleet?

One of the key areas of rationalisation spoken about by Lewis and Wilson today concerned the huge combined delivery fleet of the two operators. With Tesco boasting 5,200 vans and Booker a fleet of 1,200, they said it made economic and environmental senses to combine deliveries.

Putting an environmentally friendly spin on the deal will do its cause no harm and alongside the deliveries, Lewis also spoke of the benefits of the deal for whole crop utilisation and the prevention of food waste.

“Nobody likes waste and if you’ve got an opportunity to combine deliveries in one journey it makes sense, “ said Lewis. Whether it is seen as such good news by Tesco’s and Booker’s delivery drivers remains to be seen.

Can anyone stop it?

Since the deal emerged, three petitions have sprung up calling on the government to prevent Tesco from becoming overly powerful in the UK. But the government has rejected all three and will leave it to the Competition & Markets Authority to decide.

Tesco is believed to be already in informal talks with competition authorities over its plans, and it is easy to see why. Tesco already operates 730 large supermarkets, alongside 2,839 smaller stores under the Express, Metro and One Stop banners, while Booker supplies almost 6,000 sites owned by independents at symbol groups Premier (3,358 stores), Budgens (150 stores), Family Shopper (52 stores) and Londis (1,903 stores) from 172 C&C sites under its own name and 28 trading as Makro.

“Regulators will be concerned about Tesco taking control of the supply chain to its downstream competitors in the smaller grocery end of the market”

The Times reported there are 635 Tesco stores situated less than 500 metres from a shop in Booker’s network of Premier, Londis and Budgens stores. And Stuart Rose, Wilson’s former boss at Booker and Marks & Spencer believes the CMA “will be all over it like a rash - and they should be. The small shopkeepers are now effectively going to be supplied by Tesco,” he told the Sunday Times.

Competition consultant Vivienne Robinson believes Tesco will have a hard time convincing the CMA. “What regulators will be particularly concerned about is Tesco taking control of the supply chain to its downstream competitors in the smaller grocery store end of the market. It will ask what the implications are of Tesco being the distribution chain supplier to those stores and whether they could raise prices.”

Yet Becket McGrath, partner in antitrust and competition at Cooley law firm, can’t see the deal being blocked. “This is essentially a vertical merger and it seems unlikely that a post-merger Tesco/Booker would have the incentive to discriminate against Tesco’s retail competitors.”