Would A Bid By J Sainsbury plc For Home Retail Group Plc Be A Game Changer?

Today’s update regarding a possible offer for Home Retail (LSE: HOME) by Sainsbury’s (LSE: SBRY) has the potential to cause a significant shift in the UK retail space. Although it’s not yet a formal offer and Sainsbury’s can choose not to proceed, it now seems likely that a bid will be made since financial terms have been agreed between the two companies.

The terms of the potential bid are as follows. Investors in Home Retail would receive 55p in cash per share, as well as 0.321 New Sainsbury’s shares. In addition, they would receive 25p per share as a capital return from the proposed sale of Homebase as well as 2.8p per share in lieu of a final dividend in respect of the 27 February 2016 financial year.

The deal values Home Retail at around £1.3bn (161.3p per share) and with its shares trading at a market capitalisation of £1.25bn they offer limited upside from here (around 5%) if the deal goes through.

Strategy divergence

In terms of what this means for the UK retail sector, it essentially shows a divergence in strategy among the major supermarkets. Tesco and Morrisons have gone back to their core offering and are making asset disposals, closing down unprofitable business lines and seeking to reconnect with their customers via a back-to-basics approach. Sainsbury’s is instead diversifying into new areas.

Certainly, the operations of Argos have some overlap with Sainsbury’s in so far as it’s a UK-focused retailer. But the purchase of Argos will help to diversify Sainsbury’s and could reinvigorate the company’s bottom line in the coming years. For example, Sainsbury’s believes there are substantial cross-selling opportunities on offer through having Argos concessions in its stores and intends to generate synergies of at least £120m from the deal.

Turnaround project

Of course, Home Retail is itself a turnaround project. As its most recent update showed, sales at Argos continue to fall on a like-for-like basis. They fell by 2.2% during the Christmas period. Although there’s a transformation plan in place that appears to be moving the business in the right direction, there could be a number of short-term challenges ahead that cause uncertainty in Sainsbury’s financial outlook.

And with Home Retail recently reporting that profit for the full year will be at the lower end of market expectations, its purchase would be a longer-term move rather than a means of significantly boosting investor sentiment or profit growth in the near term.

Clearly, Argos has substantial long-term growth potential and could prove to be an excellent buy further down the line. Furthermore, Sainsbury’s appears to be buying it ahead of potentially improved performance. In fact, Sainsbury’s believes that the deal will lead to double-digit earnings per share accretion in the third full year following completion. If met, that would represent a significant improvement on its own long-term outlook.

So, while it appears to be a relatively risky move due to both companies struggling to grow their earnings at the present time, it’s one that could pay off handsomely in the long run.

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Peter Stephens owns shares of Morrisons, Sainsbury (J), and Tesco. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.