Somerfield in merger talks with Booker

News analysis: Merger would create a pounds 2.7bn food retail giant to slot in behind Tesco and Sainsbury
SOMERFIELD, the supermarket group, yesterday revealed that it is in merger talks with the troubled Booker cash-and-carry chain just six months after it completed its pounds 1.2bn merger with Kwik Save.

Somerfield said it was holding preliminary discussions with the Booker board over a possible nil-premium share-for-share deal. A further announcement is expected by the time of Booker's interim results on 10 September.

Both sides have started their due diligence enquiries, although Booker said it was still considering other options. Other suitors are thought to have included Kohlberg Kravis Roberts, the American buy-out specialist, and Metro, the German retail group, but Somerfield is seen as the front- runner.

Somerfield claimed the merger would create a new force in food retailing with buying power of pounds 11bn, third behind Tesco and Sainsbury's. The combined group would have sales of more than pounds 8bn and a stock market value of pounds 2.7bn, putting it on the brink of the FTSE 100. It also hopes to achieve substantial cost-savings via a merger of the two companies' distribution chains.

The City reacted sceptically, marking Somerfield's shares down 18.5p to 404.5p. Booker's shares slipped 5.5p to 267.5p, valuing the business at pounds 665m.

Though analysts recognised the potential cost and buying benefits, they said management would be over-stretched as they had only just begun integrating Kwik Save.

Paul Smiddy, food retail analyst at Credit Lyonnais Laing, said it would be "an extraordinary deal if it goes through" as management would face a massive task. Panmure Gordon described it as "a deal too far" and marked the shares as a "sell".

Andrew Marsh at Charterhouse Tilney said: "I'd be positive if they construct some big savings from buying, and they can obviously cut a lot from distribution and administration costs. But I do think you have to question the quality of the business and the long-term sustainability of it."

Talks between the two companies started a month ago following Booker's statement in June that it was planning to sell its non-cash-and-carry businesses and had received interest in all parts of the group. Somerfield, advised by Warburg Dillon Read, approached Booker.

There are three key drivers to the deal: cost savings; buying power; and improved distribution. Analysts estimate the deal could yield annual saving of pounds 50m a year. They also predicted that Somerfield would not go ahead unless the merger could deliver a 20 per cent uplift to earnings per share.

With combined buying power, Somerfield claimed it would be in a much stronger position to secure lower prices from suppliers. Booker is thought to pay far higher prices than the major supermarkets as the top food manufacturers perceive it as a soft target.

Somerfield could push its own brand through Booker's customer base of smaller high street corner shops which focus on Booker's Happy Shopper brand. It could also provide them with its fresh food range.

In distribution, Booker's system is seen as "state of the art" and a major asset to Somerfield which already has 1,400 stores to service under its Somerfield, Gateway, Kwik Save and Food Giant formats.

David Simons, chief executive of Somerfield, acknowledged that the deal had come along quickly after Kwik Save, but said: "The integration of Kwik Save is going extremely well. In systems and store development we are ahead of schedule. We had a long hard look at this. Our management team is known for its turnaround skills and we have a record of delivering on our promises."

It is understood that neither side has sought confidential guidance from the competition authorities. However, they do not foresee a problem as the combined group's share of the UK grocery market would be around 10 per cent, according to Warburg's. They also claim there would be no regional monopoly as Booker does not own the independent shops it supplies.

However, when Dee Corporation, the former Gateway business, tried to take over Booker in 1984 the deal was referred to the Monopolies and Mergers Commission. It was eventually cleared, but Dee's financial performance had deteriorated by then, and the deal was dropped.

Somerfield has been enjoying improving fortunes after its troubled stock market debut two years ago.

Booker has had a much tougher time: its pounds 267m takeover of rival Nurdin & Peacock two years ago gave it a total of 181 cash-and-carry depots serving 450,000 independent shops and caterers, but the integration proved difficult and its corner-shop customers have been hammered by the major supermarkets. It has issued a series of profits warnings, and in March its chief executive, Charles Bowen, resigned.