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Why Tesco PLC Could Shrink Further Than You Think

News reports today have it that Tesco (LSE: TSCO) recently asked around six firms to consider the possibility of buying its South Korean operation, Homeplus.

Is this the tip of an asset-sale iceberg?

There’s no certainty that a sale will happen, of course, and for all we know these rumours could be the figment of someone’s overactive imagination. However, it seems logical that Tesco should consider flogging off whatever it can to strengthen its balance sheet and to retreat and retrench from international operations. After all, in April with the release of the full-year report, the firm pointed to tough trading conditions overseas, especially in Korea.

Given what we know about the state of the Tesco’s core operations on the home front and the declining trading conditions in the UK supermarket sector, it’s possible that the company may need to cash in as many non-core assets as it can merely to survive in the medium to long term.

Talk of a turnaround at Tesco seems misplaced to me. I don’t think Tesco has much chance of recovering its previous profits through the old ways of trading. The landscape has changed too much. The best we can hope for is a phoenix-like metamorphosis from the carcass of the ‘old’ — rising profits will likely come from new business methods and lines… if they come at all.

Small fry

Some estimate that Tesco could raise about £3.9 billion from a South Korean asset sale, although we don’t know if that’s a net figure, free of expenses. That figure would be enough to make some difference, though. In April Tesco’s borrowings stood at about £13 billion and its net asset value came in at around £7 billion.

Yet, in the context of Tesco’s overall business operation South Korea is small fry. Last year the firm turned over £5,383 million of revenue in the region compared to £62, 284 million overall. In South Korea, Tesco runs about 433 stores compared to a figure of around 7305 outlets worldwide.

A gathering threat

The potential deal might be small but it’s significant in what it tells us about Tesco’s survival strategy. The hatchet is unsheathed and its chopping actions could sweep broad and cut deep. International operations are an obvious target, but I think the firm’s mega store space here in the UK could fall into the axe man’s sights before much longer.

The threat to the traditional supermarket sector from hard-discounting purveyors of enhanced quality and value (like Aldi, Lidl and others) might seem small in terms of market share right now, but the threat is dynamic. Once a successful disrupting alternative in a market gains traction its growth can pyramid exponentially, so what seems like a small problem today could become unbeatable tomorrow. If that happens, Tesco could increase its rate of asset sales and shrink much further than we think.

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Kevin Godbold has no position in any shares mentioned. The Motley Fool UK owns shares of Tesco. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.