Asda/Safeway plan triggers bid fever

In only 25 words Asda and Safeway announced that one of the most implausible deals of recent corporate history was dead: “The boards of both companies confirm that very exploratory discussions had taken place in recent months about a possible merger. Those discussions have been discontinued.”

The secret talks were leaked to The Sunday Telegraph, but the fact that the deal is over is less interesting than the fact that it existed in the first place. Safeway will announce worse than expected interim results on November 19, after 12 months of slower sales growth than its rivals.

City analysts predict interim pre-tax profits will be flat at 230m. And although its operating margins remain higher than those of rivals Tesco, Sainsbury’s and Asda, large parts, but not all, of the City have been recommending the sale of Safeway stock.

That explains, to a degree, the attempt to get the deal off the ground, which some believe could still be revived despite adamant denials, especially from Asda. It has also fuelled speculation that

Safeway will be bought by a European or US group. And has boosted the share prices of targets such as Morrisons.

It was Safeway which made the first approach in April. “That fell on stony ground,” says one source, “it (Asda) was not convinced of what could be achieved until it started to see the potential for economies in buying and distribution.”

A unit of no more than six people, including Asda chairman and the then prospective Tory MP Archie Norman, chief executive Allan Leighton and his Safeway counterpart Colin Smith, began negotiations. Asda finance director Phil Cox and his Safeway counterpart Simon Laffin are also understood to have been part of the unit.

The Safeway team presented its version of what a deal could look like. And the two sides made the first tentative approaches to the Office of Fair Trading (OFT), to find out if there was any point in continuing with the merger discussions. The Department of Trade & Industry saw the preliminary proposals.

The two apparently agreed that if the deal was either referred or became public knowledge they would withdraw from the talks.

It would have given the alliance over 15 per cent of the UK food retail market, with an estimated 33 per cent in Scotland and over 25 per cent in the North of England. “The competition authorities seem to take a special interest in food retailers,” says one City source, who believes the deal would not have got past the regulatory authorities. “They would have seen any merger in food retail as against consumer interest, and the relationship between the two would not have survived a referral.”

Although the OFT refuses to say what advice it gave the two parties, the fact that they did not stop talking over the summer indicates they were not laughed out of court. Safeway corporate development director Steve Webb says the parties were still waiting for guidance from the OFT when news of the deal became public.

In the meantime, Norman was elected MP for Tunbridge Wells, which according to another source accelerated the negotiations. “This had a lot to do with Norman moving on at the election. Safeway saw an opening and thought that Leighton would both want, and need, to impress the City.”

In the light of its collapse the deal has been interpreted as Norman’s last bid for corporate fame. He would go out on a high by creating the largest supermarket group in the UK, leaving others to actually weld together something that would struggle to fit, because of competing interests and the very different cultures within the organisations.

Despite the glaring differences in positioning of the two brands – one cheap and cheerful, the other characterised by its middle class Harry and Molly advertising – they continued to talk. Safeway has tried, with some success, to get away from its expensive image and to attract younger families, but it is still a million miles away from Asda’s positioning. There is, however, a geographic fit, with Asda strong in the North and Safeway in the South.

“The central problem was what this single company would look like,” says an Asda source, “Asda could not comfortably sit with Safeway. There were economies of scale in distribution and buying, but the cultures are so different that to merge them could have created greater problems.”

Asda sources claim decisions had already been taken enabling its facia to dominate and that Leighton would have overall control of the merged retailer. Safeway denies this.

The savings have been estimated at an annual 200m. In the later stages of the talks it is believed that Asda’s thinking had turned to a partial store swap, or a deal to improve its distribution of non-food items like its George clothing range where better margins can be extracted. Although Asda is known to be open to deals, it had taken the decision that a merger was not part of its future even before the deal blew up in its face last weekend.

Safeway denies speculation that it leaked the story to apply pressure on Asda or another possible purchaser. Webb says: “This was the deal we wanted, we were talking to Asda and nobody else and we are bitterly disappointed that this leak has ended the talks. Both of us have proved that we can compete in this market and this was an attempt to compete more strongly with the market leaders.”

“It was a serious runner with a few handicaps,” says one retail analyst of the deal, “but Safeway looks like it needs the deal more than Asda. This must have left a sour taste at Asda.

“Asda is trading well but the management has not covered itself in glory when it comes to strategic corporate moves. Last year’s deal to buy Welcome Break did not work and it needs to set out its strategy in a forceful way in the next six to 12 months.”

But that is not a universally held view. Henderson Crossthwaite analyst David Stoddart believes the talks with Safeway show that Asda has an open mind to deals. “Asda should take credit for turning down the Welcome Break deal. Equally, with Safeway it was approached with the idea of creating a company with potentially 1bn pre-tax profits, which could have made annual 200m savings in its core food retail sector. It had to look at it.”

Asda’s share price slipped three per cent on Monday while Safe way’s rose because it is now viewed as a target. Elsewhere in the market the value of Morrisons rose six per cent, which excited speculation that it would be the next takeover target. While the Safeway/Asda merger appears dead, it has stirred up the market and will lead to more activity.