Competition for Safeway, PLC In mid-January 2003, Walmart, the U.S. leading reta

Question

Competition for Safeway, PLC

In mid-January 2003, Walmart, the U.S. leading retailer, announced a bid for Safeway PLC, the fourth largest supermarket chain in the United Kingdom. For Walmart, this move is just the latest in an expansion of its international operations. The huge discount retail company began to look for international opportunities in Mexico, then Canada in the early 1990s. In 1997 Walmart entered European markets in Germany and in 1999 it bought Asda, a UK grocer with 229 stores. More recently, it purchased a controlling interest in Seiyu, a Japanese supermarket operator. (WSJ, January 14, 2003)

The bid by Walmart raises a number of interesting issues. First, Walmart would be one of at least four bidders for Safeway. The other three include Tesco, the largest grocery chain in the U.K., William Morrison Supermarkets, and J Sainsbury PLC, the current number two supermarket firm in Britain. In addition, Kohlberg Kravis Roberts, the Wall Street takeover masters, indicated an interest in Safeway. The result could be a full scale auction for Safeway.

In March 2003, the British government reffered the matter to its Competition Commission to assess the impact of the combination of Safeway with any of the three major supermarket chains in the county. An earlier analysis by the U.K. Office of Fair Trading expressed concern over the impact on competition in local grocery markets but also over the possibility that the resulting Big Three chains would have 85 percent of the grocery market in the country. (WSJ, March 20, 2002)

Finally, the merger competition comes at a time when economic conditions are pretty discouraging on all sides of the Atlantic. Safeway's performance in 2002 and in early 2003 were disappointing. In addition, weakness in the U.S dollar may play a role in the attractiveness of any deal. Between the time of the announcement by Walmart on its interest in Safeway and late spring 2003 the dollar-pound exchange rate fluctuated dramatically.

Questions:

Offers by J Sainsbury and William Morrison both are stock deals while Walmart contemplates an all cash offer. What are the implications for Safeway shareholders?

What is the likely impact of multiple bidders for Safeway for that company's shareholders?

What is "the winner's curse" and is there a threat of that problem for Walmart?

What would a two percent swing in the exchange rate mean in an approximately £3 billion deal?

What is the likely impact of the competitive issues raised by the British government on a deal for Safeway and on its shareholders?

Explanation / Answer

J Sainsbury and William Morrison are offering stock deals. In such a case the shareholders of Safeway will get shares of the company taking over Safeway. The ratio of share allocation will be determined by the investment bankers involved. Suppose William Morrison buys Safeway. The deal terms is 2:3 all stock deal. It means shareholders of Safeway will receive 2 shares of William Morrison for every 3 shares of Safeway held by them.

In case of an all cash deal, Walmart will purchase the majority of the common shares outstanding. The minority stake will be identified as liabilities in Walmart's balance sheet.

The likely impact of multiple bidders is that the buying price will increase. There are 4 interested parties. Each party will try and pursue the deal upto the maximum threshhold price, as identified by them. This will keep pushing the asking price of Safeway.

Winner's curse is that the winner tends to overpay. In other words, the company finally buying Safeway will have paid a price higher than the price as justified by financials. Walmart has been following a strategy of inorganic growth i.e growth through mergers and acquisitions. Walmart's growth of international operations is being pursued by buyouts. To pursue such a strategy, there is every possibility that Walmart may overpay, thus becoming a victim of winner's curse.

Current exchange rate: 1 GBP = 1.555 USD. At this rate, walmart will have to pay = 3 billion*1.555 = GBP 4.665 billion. If the USD depreciates by 2%, the rate will beocme, I GBP = 1.5861 USD. In such a case, walmart will have to pay = 3 billion *1.5861 = GBP 4.7583 billion. This transaltes to an extra 4.7583 - 4.665 = GBP 0.0933 billion.

If the Competition Commission is of the view that the entity created by the acquisition will abuse its competitive position, then it can cancel the deal. In such a case, Safeway and its shareholdres will not benefit from the price increase likely to be caused by multiple bidding.

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