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Sainsbury’s – Asda merger: all you need to know as deal hits rocks

We have a look at why the proposed merger between Sainsbury’s and Asda is in doubt and what it could mean if it is blocked.

Sainsbury's Source: Bloomberg

Last year, the chief executive officer (CEO) of Sainsbury's, Mike Coupe, was filmed singing ‘we’re in the money’ to himself ahead of a television interview that he used to promote his grand plans to create the UK’s largest supermarket chain, promising a merger with Walmart-owned Asda would lead to lower prices and better service for customers. But the CEO’s celebrations have proven premature and his belief the deal would be approved with ease misplaced.

With the Competition and Markets Authority (CMA) having all but blocked the deal, warning it could push up prices and drive down quality for consumers, Coupe has accused the regulator of moving the goalposts. He is now fighting to save a deal that he has described as vital if both supermarkets are to remain competitive in a market undergoing 'profound change'.

Read more on how takeovers and mergers work in the UK and how you trade them

We have a look at the deal, why it looks likely to be blocked, and what it could mean for the industry if both companies must remain independent.

Sainsbury’s-Asda merger: a snapshot

Sainsbury’s announced it had agreed to acquire Asda Group in a deal that valued the US-owned retailer at £7.3 billion on 30 April 2018. The deal was structured so Walmart would bank almost £3 billion in cash and own a 42% stake in the new enlarged entity, although it would only have voting rights of 29.9%.

Together, the pair would have nearly 2,800 supermarkets, convenience stores and petrol stations, with both brands being maintained. It would allow Sainsbury’s to roll out Argos (which it bought in 2016) stores in Asda outlets and benefit from the US firm’s logistical capabilities, while allowing Asda to tap into Sainsbury’s stronger online offering. By creating the largest supermarket chain in terms of market share, the duo believes the deal can provide enough scale to cut at least £500 million in annual costs without the need to shut stores or cut jobs. Sainsbury’s has promised those savings will feed through to a 10% reduction in prices for customers.

Will the Sainsbury’s-Asda merger be blocked?

The CMA, in its provisional findings of its investigation into whether the combination of Sainsbury’s and Asda would lessen competition in the grocery market, has warned the deal could 'lead to a worse experience for in-store and online shoppers across the UK through higher prices, a poorer shopping experience and reductions in the range and quality of products offered'. It has also said the merger, which would create the largest fuel seller by volume, could lead to inflated petrol prices.

Sainsbury’s and the CMA fundamentally disagree on the following areas when it comes to Sainsbury's-Asda merger

  1. Cutting costs and prices
  2. The threat of Aldi and Lidl
  3. The Tesco-Booker merger approval
  4. The CMA: all stick and no carrot

Cutting costs and prices

The CMA has disagreed with the pair’s prediction that the cost-saving benefits of the deal will lead to lower prices for consumers. The regulator has said the merger is ‘likely to give rise to potential efficiencies, some of which would lead to an incentive to reduce prices,’ but said for the ‘specific purpose of our assessment we have not accepted the evidence advanced by [Sainsbury’s and Asda] regarding the scale of those efficiencies’. The CMA said it believed the efficiencies that could be delivered is ‘equivalent to around a 1% downwards pricing pressure in groceries and general merchandise markets’, considerably lower than Sainsbury’s 10% forecast.

Sainsbury’s argues the threshold set by the gross upward pricing pressure index (GUPPI) – used by the CMA to quantify how prices could be impacted by any lessening of competition – was set too low. It said the CMA had ‘moved the goalposts’ and described the analysis as ‘inconsistent with comparable cases’. It went on to say that, ‘despite the savings being independently reviewed by two separate industry specialists, the CMA has chosen to discount them as benefits’.

The threat of Aldi and Lidl

The success of the discount retailers Aldi and Lidl, which cut costs by sticking to the basics and stocking significantly fewer brands, is often cited as the biggest threat to the so-called Big 4 supermarkets and blamed for the gradual decline in sales at Tesco, Sainsbury’s, Asda and Morrisons.

Aldi and Lidl held a combined market share of just 4% ten years ago but today, having opened around 500 new stores to take their total network to around 1,500, they now enjoy a market share of almost 13%. The Big 4 have lost 1.7% market share over the last two years alone while the German discounters have gained 2.3%, having also stolen custom from small independent chains.

Big 4 lose share of UK grocery market to smaller chains

In the 12 weeks ending… 27 Jan 2019 22 May 2016
Tesco 27.7% 28.4%
Sainsbury's 15.9% 16.3%
Asda 15.3% 15.8%
Morrisons 10.6% 10.7%
Aldi 7.5% 6.1%
Co-Op 5.9% 6.2%
Lidl 5.3% 4.4%
Waitrose 5.1% 5.3%
Iceland 2.3% 2.1%
Independents 1.5% 1.90%
Others 1.7% 1.9%
Ocado 1.1% 1%

Sainsbury’s has said ‘we must combine’ with Asda if it is to continue meeting customer demand and tackle the ‘profound change’ that Aldi and Lidl have introduced to the market. But the Big 4 still control 69.5% of the market and the combination of Sainsbury’s and Asda would create a new market leader with 31.2% share of the market, overtaking the 27.7% share held by the current incumbent Tesco. Although the pair intend to maintain both the Sainsbury’s and Asda brands, the deal would result in just two companies owning 58% of the UK grocery market.

Sainsbury’s rationale is the deal will allow it to scale up and lower prices, so it can compete at the lower end of the market, particularly for Asda which targets more cost-conscious consumers compared to Sainsbury’s. It argues Lidl and Aldi are gaining enough market share to warrant consolidation and believes they are formidable players that can provide the competition needed to replace any that is lost through the merger.

For the CMA, maintaining competition between the Big 4 supermarkets is far more important. It says that the discounters ‘provide a competitive constraint’ on Sainsbury’s and Asda but argues ‘that constraint is generally less significant than that provided by the other Big 4 retailers’.

The Tesco-Booker merger approval

The ‘comparable cases’ that Sainsbury’s refers to, although not confirmed, is the merger between market leader Tesco and Booker Group, a wholesaler that also owned around 5,000 convenience stores around the country.

When Tesco agreed to buy the UK’s largest food wholesaler for £3.7 billion there was some doubt the deal would go through and minor shareholder resistance, but it ultimately completed with relative ease. The approval by the CMA was significant as it was regarded as a green light from the regulator for the next wave of consolidation to occur in the market. The approval was undoubtedly one of the reasons why Coupe and his team felt so confident their plan would come to fruition and the merger would be approved.

But the CMA has argued the Tesco-Booker merger was a different situation: a vertical merger between a retailer and wholesaler which didn’t spark any pricing or competition concerns with their respective convenience stores in overlapping areas because Booker’s franchised stores were free to buy goods from other suppliers, meaning Booker didn’t control pricing in its network. In comparison, any tie-up between Sainsbury’s and Asda would be a horizontal merger that places nearly one third of the market under the control of one company, not only in groceries but in general merchandise, and especially fuel, where no price reductions are forecast by the regulator.

The CMA: all stick and no carrot

If the CMA feels competition will be affected by a merger or acquisition it usually forces the companies involved to sell off aspects of the business. This is generally used as a way of addressing concerns in specific industries or in local markets and Sainsbury’s was expecting the CMA to simply force it to sell off a small number of stores where the two chains overlap. However, the regulator has said the deal threatens competition in over 600 local areas and, more importantly, on a national level.

It is thought the pair would need to sell off around 300 stores (and around 130 petrol stations) to gain approval, and possibly one of the two brands altogether. That virtually eradicates the rationale behind the deal. In addition, the CMA has admitted it has set a high bar in terms of what would be deemed an acceptable buyer, stating a ‘suitable purchaser would need to demonstrate, among other things, a credible track record and capability to compete effectively … whilst at the same time not creating further competition concerns.’ That virtually rules out any viable buyer as rivals won’t be able to allay competition concerns and anyone else is likely to lack the necessary experience.

At the bottom line, the CMA’s ‘initial view is that divesture caries a significant risk of being an ineffective remedy’ and admits it is ‘likely to be difficult for the companies to address the concerns it has identified’.

With this in mind, the CMA believes there is only one other option: blocking the merger altogether.

What next for the Sainsbury’s-Asda merger?

Sainsbury’s has said it will be ‘working to understand the rationale behind these findings’ and will continue to make its case in the coming weeks. Sainsbury’s and Asda have until 13 March to submit responses to the CMA’s provisional findings, including potential remedies they think could sway the CMA.

The CMA is scheduled to make a final decision on the case on April 30, when it will either approve the deal with significant undertakings to sell off large parts of the business or reject the merger and keep both brands independent. The provisional findings suggest the CMA is highly likely to block the merger altogether, which could prompt the pair to seek a judicial review of the decision.

Notably, Sainsbury’s annual results for 2018 are due to be released the day after the CMA’s ruling, which will undoubtedly set the scene for the day.

Where next for the Sainsbury’s share price?

Sainsbury’s share price has been highly sensitive to the merger since being announced in late April 2018. Shares rallied over 17% after the announcement and went on to hit a post-announcement high of 341.50p on August 22 before heading into a steady decline. The CMA’s latest announcement has put a serious dent in the merger’s prospects and sent Sainsbury’s share price down by over 18% to trade lower than they were before the deal was unveiled.

Sainsbury's chart
Sainsbury's chart

Sainsbury’s share price vs Tesco share price vs Morrisons share price

The ups and downs of the merger has meant Sainsbury’s shares have significantly underperformed its UK-listed peers over the last two years (as of 27 February).

Six months One year Two years
Sainsbury's -30% -8.4% -12%
Tesco -14% 8.5% 17%
Morrisons -14% 3.3% -6.1%

What will happen if the Sainsbury’s-Asda merger is blocked?

Both Sainsbury’s and Walmart will face a challenge should the CMA prevent them from merging. Sainsbury’s will have to formulate an entirely new strategy to go it alone and must address some of the comments it has made about how crucial the merger is to the company’s future. Walmart will have to demonstrate a renewed interest in Asda after agreeing to sell the business for a minority stake, which some believe was prompted by the US firm losing interest in the UK supermarket.

Some believe it could lead to Coupe leaving Sainsbury’s because he has bet so much on the deal, particularly after completing the acquisition of Argos in 2016. Considering the timeframe, Sainsbury’s could be forced to adopt a new strategy that is able to convince investors it has what it takes to go it alone at a time of heightened uncertainty following the UK’s scheduled departure from the European Union on 29 March. Although some think this would require the supermarket to take drastic action with new management, others argue a new CEO would do little to address the structural challenges facing Sainsbury’s and the wider market.

The future of Asda would be more uncertain. It is likely Walmart would recommit itself to the supermarket as finding another buyer could be difficult. Although there are reports that private equity firms are mulling a bid for the supermarket, including KKR, the attractiveness of Asda to those outside of the sector is considered limited because they would not be able to deliver the cost-savings and synergies that a peer like Sainsbury’s could. Although Walmart may have lost interest in Asda it is not regarded as a burden: the supermarket has paid over $2 billion worth of dividends to the US firm since it was acquired in 1999.

What does the Sainsbury’s-Asda merger mean for the industry?

The final ruling on the Sainsbury’s-Asda merger will have consequences not only for the two supermarkets but the rest of the industry. If the CMA blocks the deal then it will be setting a blunt tone for the rest of the market by effectively ruling out any consolidation within the supermarket sector. This will raise questions over how the larger supermarkets achieve the scale they need to compete with the German discounters. If M&A is to succeed, it seems the CMA is only happy with vertical integration, which has already proven fruitful for Tesco and Sainsbury’s which, amid stalling growth from their core businesses, have sourced new avenues of growth through their respective acquisition of Booker and Argos.

If the UK leaves the EU as scheduled on March 29 then the CMA’s ruling could have an even bigger impact on the future of UK M&A as the regulator will gain more control over cross-border deals after Brexit.

The UK grocery market is undergoing huge change. Discounters like Lidl and Aldi, as well as others like Iceland, are poaching market share from the Big 4, which are constantly locked in price wars between themselves rather than with those that are truly undercutting them on price. Online sales still account for a small proportion of the total market but is growing fast, forcing them to invest heavily in online systems, and formidable competition is also gaining traction, with Amazon, which started selling groceries in the UK in 2016, firmly on the radar. And all the Big 4 are struggling as the middle ground they have traditionally dominated – sandwiched between discounters like Aldi and premium brands like Waitrose – gets smaller. Tesco has already launched a new brand named ‘Jack’s’ that is designed to directly compete with the discounters by operating under a similar model with basic stores offering fewer perks and simpler product lines.

Sainsbury’s confidence it would gain approval for the merger with Asda was predicated on the CMA concentrating on the promise it would lead to lower prices for consumers but, with the CMA having disagreed with the pair’s predictions, the supermarket has said it is 'surprised that the CMA would choose to reject the opportunity to put money directly into consumers’ pockets, particularly at this time of economic uncertainty'.

But there is a justified argument in favour of the CMA’s tough stance. It is, after all, talking about significant consolidation and the concentration of power over a vital market: everyone needs food and the UK grocery market was worth £190 billion in 2018, accounting for over half of all UK retail sales. The average household spends over 10% of its wages on food and for those on the lowest income the figure rises to above 14%. The importance over whether the CMA should pave the way for one company to own over 30% of the market and for two companies to own close to 60% should not be underestimated.

This information has been prepared by IG, a trading name of IG Australia Pty Ltd. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients.

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