Co-op gears up for big 4 battle

Can the £1.57bn takeover of Somerfield help the Co-op challenge the major supermarket chains and regain its historic standing on the British high street? Nick Clark reports on a 'renaissance'

The Co-operative Group hailed its £1.57bn takeover of Somerfield yesterday as the start of a "renaissance" for the mutually owned company, as it sets about closing the gap on the "big four".

The Co-op claimed victory after a seven-month pursuit, as it secured Somerfield for up to £1bn less than its target's backers had hoped when they first hung out the "for sale" sign a year ago.

Announcing its largest-ever deal yesterday, Peter Marks, the Co-op's chief executive, said: "For The Co-operative Group this is a transformational deal, cementing our position as the UK's premier community retailer and helping us significantly as we lead a renaissance of the Co-operative brand."

The deal came as little surprise to the market, as Co-op was understood to be in the late stage of negotiations in the past week, as none of its rivals stepped in with an alternative bid for the entire group.

Mr Marks added: "The acquisition of Somerfield will provide the rocket fuel for our three-year growth plan, outlined in April of this year."

Part of that drive is to challenge the big four of Tesco, Asda, J Sainsbury and Wm Morrison in the ultra-competitive £31bn-a-year convenience store market.

The merged business will operate about 3,000 grocery stores – all bearing the Co-op brand – with net sales expected to be around £8bn, strengthening its position as the fifth-largest food retailer in the UK. The business will have about 8 per cent of market share, closing the gap on Morrisons, which has 11 per cent.

Mr Marks talked of the need to refer to a "big five" now, but his bullish talk failed to convince the market. Justin Scarborough, analyst at ABN Amro, said: "It's a good deal for the Co-op, but I don't think the top players will be quaking in their boots."

Mr Scarborough added that the companies could cut out a lot of costs through the deal but would still find it hard to challenge its larger rivals. "On average, the Co-op is about 15 per cent more expensive. They will have to sharpen up their value offer."

The announcement left a few unanswered questions. The group admitted there would be staff cuts but declined to elaborate on how many. It said it would have to sell some stores to satisfy the comp-etition regulator in the UK, the Office of Fair Trading, but again there was no indication of how many chains would go.

Somerfield was taken private in 2005 by a consortium of property tycoon Robert Tchenguiz, private equity group Apax Partners and Barclays Capital in a deal worth £1.08bn. It is understood that Co-op considered bidding at the time.

The investors put Somerfield up for sale last year, and all of its supermarket rivals, excluding Tesco, are believed to have taken a look. At the time, they were rep-ortedly hoping to secure a deal worth between £2bn and £2.5bn.

Analysts said yesterday that although the deal was lower than hoped, the investors would still be happy given the decline in value of the sector after the credit crunch and worsening consumer spending conditions. Mr Marks said: "We think we've got a very good deal. It's a good deal for Somerfield in the current climate." One source close to the deal added that the group had been confident it would sec-ure its target despite talk of rival interest. "We felt we were the best bidder given all the antitrust issues that the others would have faced," the source said.

To finance the deal, the Co-op raised £2.2bn of debt underwritten by Barclays, Lloyds TSB and Royal Bank of Scotland. Additional funding was provided by the Bank of Ireland and its own Co-operative Bank. As negotiations rumbled on, some feared the talks could have floundered over the costs of financing the deal, but it finally completed this week.

One source close to the deal called the process "messy; it was not straightforward". He continued: "The whole thing did take quite a long time, as there was a fair bit of due diligence to get through. Somerfield has changed quite a bit in the past few years."

The Co-op called on advice from Credit Suisse, Royal Bank of Scotland and HSBC, while the original auction for Somerfield and advice was run by Citigroup.

Mr Marks called it "good news for consumers and for competition in the grocery market", before adding that the store will have "unrivalled geographic reach".

Somerfield, which currently operates about 880 UK grocery outlets and generated sales of £4.2bn in the year to April, was set up in 1875 in Bristol. At the end of the last financial year, its assets were valued at £1.3bn. Its chief executive, Paul Mason, formerly of Asda, said: "Over the last two years, we have transformed every aspect of Somerfield, and as a result we are now trading from a position of strength."

History of the Co-op dates back to industrial revolution

Co-operatives trace their roots back more than 150 years to the Industrial Revolution. The first was formed in 1844 in Rochdale, when 28 flannel weavers and artisans pooled £1 each to open a shop selling food they could not have otherwise afforded.

From the start, a share of the profits were distributed among the Co-op members according to their purchases in a scheme that became known as "the divi".

The Rochdale Society of Equitable Pioneers had 600 members by 1850. Its founding principles took root, and co-ops gained legal corporate status within two decades. Over the next ten years, the Co-operative Wholesale Society (CWS) was formed, followed by the Co-operative Union and the Co-operative Bank by 1872.

At the movement's peak, in the 1950s, there were 1,400 co-ops in the UK, controlling a fifth of the grocery market. But supermarkets took market share and marginalised co-ops as they refused to combine. Before yesterday's deal they held just over 4 per cent of the grocery market, little more than a tenth of the share held by Tesco.

Through a series of mergers culminating in the two largest – Co-operative Group, which had its roots in CWS, and United Co-operatives – linking last July, the Co-operative Group emerged in its present form, although other, smaller ones remain. The Co-op Group has signalled its plan to challenge the supermarkets, and in April announced plans to invest £1.5bn on acquisitions and store overhauls to try to double its profits. This led to yesterday's takeover of Somerfield.

The Co-op Group today is the UK's largest mutual retailer, owned by its 2.5 million members, and employing more than 85,000. Beyond its operation as a traditional food seller, the Co-op has the largest funeral services business and third largest pharmacy business in the UK. It also competes in the travel and legal markets, which all come under the umbrella of the Co-operative Trading Group. The Co-operative Bank, the first to introduce an ethical policy in 1992, is also affiliated to the group but does not form part of the trading operation.

The founding idea of sharing profits among Co-op members persists, having evolved via the 1960s blue co-op stamps scheme to its current Divi card, which this year is set to hand back £45m to shoppers.

Nick Clark