The dogs may bark, but the Tesco juggernaut moves on

Property/REITs; Debenhams
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The Independent Online

Business Pages tend only to report the biggest transactions of the day, yet the smaller ones are sometimes the more instructive. In a deal apparently picked up only by The Grocer, the trade magazine for the food retailing industry, Tesco recently acquired a sizeable supermarket in Slough from the Co-op, which is selling its larger outlets to concentrate on smaller ones.

Planning restrictions are such that acquisition opportunities of this type are like gold dust, and the sealed bid auction for the premises was hotly contested by all the big supermarket chains. Tesco's bid was far and away the highest, or to use the parlance of the property market, it blew everyone else out of the water.

As it happens, Tesco already has a major outlet little more than 400 yards from the one it has just bought. The high price it was prepared to pay reflects the monopoly value it derives from displacing all potential competition. The Office of Fair Trading confirms it is examining the transaction and may even end up referring it to the Competition Commission, raising the possibility that in future even very small local acquisitions will be subjected to the full vigour of public scrutiny alongside the national ones.

To rivals, the Slough episode is typical of the way Tesco has managed to strengthen its grip on the UK supermarket sector. The big land-grab battle of Safeway is the transaction that makes the headlines, yet it is the small, unnoticed, incremental acquisitions that have been most effective in snuffing out local competition.

When Tesco joined the stampede for Safeway, the reaction was one of incredulity. Was it really possible for a company, which already has more than 27 per cent of the market, to buy another 10 per cent of it? Not many people thought so, yet from Tesco's point of view, the intervention is a wholly understandable one. If the Competition Commission is going to judge the battle in terms of national competition issues, then of course Tesco shouldn't be allowed, but nor arguably should any of the others with the possible exception of William Morrison, the smallest.

On the other hand, if the Commission were to decide that the only really important thing is maintaining local competition, then national market share becomes irrelevant. So long as there is a sufficient number of rival supermarkets in each locality, competition is maintained. The Competition Commission's door stopper of a report on the bids is complete, although unpublished. The verdict awaits only the formal approval of Patricia Hewitt, Secretary of State for Trade and Industry.

There's little point in trying to second guess the Commission's thinking this close to the announcement, but my suspicion is that it has found against the supermarkets on both counts - national as well as local. Tesco won't much worry about its own position if William Morrison is the only rival allowed to bid, and if Sir Ken is outbid by Philip Green, who wants to make Safeway into something other than a conventional grocer, so much the better. In such circumstances, Tesco will continue to pile on the market share.

There is presumably a ceiling beyond which its share of the groceries trade won't be allowed to grow. Acquisition of the Co-op in Slough, for instance, raises Tesco's share of the local market from 40 to 52 per cent, which is surely unacceptable. But then there's always the rest of the retail sector to aim at. Whatever the competition authorities do, the process of retail consolidation looks unstoppable.

Property/REITs

The Uk listed property sector is not yet on the endangered species list, yet it seems fast to be moving in that direction. The total equity value of property companies in the UK has declined by 25 per cent over the last five years. This has very little to do with the collapse in the market for central London office space, or indeed a fall in valuations, as most property company share prices are broadly the same as they were five years ago.

Rather it is to do with the number of property companies being taken private - 12 of them since 1998. Big share buy-back programmes and capital returns have compounded the effect. The latest companies to be heading for the exit are Chelsfield, where the veteran property magnate Elliot Bernerd is attempting to take the company private, and Canary Wharf, which is in exclusive takeover negotiations with a Goldman Sachs/Morgan Stanley consortium.

If present trends continue, the sector will more than halve in 10 years. The prime reason for the shrinkage is that property-company shares tend to trade at a big discount to the underlying assets, making them obvious targets for breakup specialists. Yet they are also an incredibly tax inefficient way into property for most big institutional investors. Furthermore, they tend to be characterised by poor corporate governance and top-heavy cost structures. Sometimes they seem little more than a way of maintaining expensive lifestyles for directors in the posher parts of Mayfair.

All of which explains the growing lobby to persuade the Treasury of the merits of Real Estate Investment Trusts, or REITs. One of the drawbacks of a conventional property company is that it must pay tax on any income it derives from its property portfolio before paying it to investors. The removal of the tax credit on dividends in 1997 made the situation even worse. Big pension funds and insurance companies get round the problem by investing directly in property themselves, but for smaller funds, the costs of doing so are prohibitive.

A REIT provides a tradable security which allows the income on property to be passed directly to the investor without the complication of corporation tax. The effect is all but to remove the discount to net assets. Fine for investors, you might say, but why would the Government agree to anything so apparently tax-disadvantageous to itself? Actually, many countries outside Britain have already done so. The City is very much behind the curve in failing to develop an active REITs market. Simon Clark, a real estate specialist at the City law firm Linklaters, reports an encouraging dialogue with ministers and is hopeful that the Government can eventually be persuaded that the effect would be at least tax neutral for the Exchequer if not positive.

In any case, if the Government doesn't do something with dispatch, there may soon be nothing left to tax at all. Forget the public-to-private phenomenon, in the past few years offshore vehicles have been some of the most active players in the UK property market.

For the health of the City as well as its own tax revenues, it is essential the Government moves quickly to restore Britain's position as an attractive domicile for property investment. By allowing companies to convert to REIT status on condition they pay tax on half their inbuilt capital gains, the French government has found the process can be beneficial to tax revenues, at least in the short term. The Chancellor needs to be doing something similar.

Debenhams

In the end, the board of Debenhams seem to have extracted a decent price with yesterday's 455p-a-share offer from CVC Capital and Texas Pacific. Whether this entirely vindicates the controversial way in which directors cosied up to the private equity interest in their company is more debatable. One suspects that yesterday's reasonably satisfactory outcome was as much luck as design. Standard Life says the offer is still not enough. Permira may come back with more, but it seems unlikely.

Nonetheless, long-term investors in publicly quoted companies are absolutely right to regard takeovers agreed between management and private equity with the utmost suspicion. A few years from now, these same investors will be asked to cough up double the price when the private equity bidders, having stripped the company down to its last lightbulb, attempt to bring it back to market. In the meantime, management will have enriched itself beyond the dreams of avarice.

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