By Jorge San Roman (IE Business School), Raynor Yeo (Singapore Management University), Helene Kapelari (Vienna University), and Bradley Smahon (Singapore Management University)
Just days prior to the market crash, Thailand’s CP Group announces its acquisition of Tesco PLC’s South East Asian stores - a group of assets it had been forced to sell two crises ago during the AFC. At the time of its announcement, the deal, valued at USD 10.6 Billion, was Asia’s largest deal in 2020. The deal grants the CP group greater market share and the ability to further innovate in offline retail. However, the addition of c. 2000 convenience stores to CP Group’s already extensive holdings of mass retail outlets, places it in the crosshairs of Thailand’s newly revamped anti-competition body.
Acquirer Company Details: Charoen Pokphand Group
CP Group is Thailand’s largest conglomerate. It operates through its numerous subsidiaries across several sectors (including consumer staples, telecommunications, real estate), servicing clients worldwide. Over 30% of the group’s revenue stems from their operations within their agribusiness arm: Charoen Pokphand Foods.
Founded in 1921, Bangkok, Thailand.
Owner (private): Chearavanont Family
Number of Employees: 304,000
Target Company Details: Tesco PLC
Tesco is a British retail company focused on grocery and general merchandise retail as well as retail banking and insurance services, that services customers mostly within the United Kingdom, Ireland and Europe. The company recently exited the Asian market, having operated in Thailand through its Tesco Lotus business (a brand they previously acquired from CP group in 2003 but is now being sold back to the Thai conglomerate).
Founded in 1919, London, UK
CEO: Dave Lewis (due to step down before Q1 2021)
Number of Employees: 423,000
Market Cap: USD 29.16 billion - EV: USD 47.17 billion
TTM Revenue: USD 84.77 billion - TTM EBITDA: USD 5.41 billion
TTM EV/Revenue: 0.56 - TTM EV/EBITDA: 8.73
The assets will be paid for through cash on a “Cash and Debt Free” basis. Collectively the CP Group will hold 100% of Tesco's Thai business and 86.9% of its Malaysian business. The assets, valued at approximately 12.5x EV/EBITDA, places the deal beneath the 25th percentile of similar past transactions, reflecting the poorer economic outlook at the time of the acquisition and Tesco PLC’s desire to offload the assets.
The deal will be funded primarily through a bridge loan of USD 7.5 billion underwritten by JP Morgan, Siam Commercial Bank and UBS with a tenure of 12 to 18 months. In spite of a poor retail outlook that stems from the particularly wounded tourism-reliant economy, the loan still garners support and is set to be one of the largest that Thailand has seen, rivalling a USD 6.2 billion loan for the purchase of Tesco competitor, Big C, in 2016.
The deal allows CP Group access to a significant market share of the convenience store and mini-mart format within Thailand. It also grants the group the ability to explore offline retail innovations within the modern trade sector.
The deal is a reflection of Thailand's growing modern trade sector with a focus by key players in developing an extensive distribution network supported by a robust internal supply chain as opposed to localised but small and conventionally family-owned retailers within traditional retail. The proliferation of modern retail stores will allow for a greater degree of delivery of customer needs in the face of broad consumer trends of diversification and sophistication of needs as the retailers are able to adjust store formats, size and product ranges.
With the inclusion of Tesco's Thailand assets, the CP Group will collectively hold up to 75.8% of the modern trade market in Thailand. The deal will allow the CP group to have a significant share of the fastest growing convenience segment of the mass retail sector in Thailand with 12,500 out of 16,000 brand name convenience stores under their management.
Much as the deal is synergistic in granting CP Group market share of the Thai Mass Retail space, there exist more obscure familial undertones within the auction of the Tesco assets.
The auction received bids from three of Thailand's wealthiest family-owned conglomerates. The TCC Group and Central Group had also submitted bids which would have also placed the Tesco deal at the top of Asia league tables in 2020, with the latter having triggered the sale process by approaching Tesco. Winning the bid was the CP group which had previously sold the Lotus chain to Tesco in 1999 when it had only consisted of 13 hypermarkets at a relatively discounted price of USD 188 million.
The deal marks the reclamation of assets lost by the Chearavanont family from its consolidation during the 1997 Asian Financial Crisis. A similar deal was seen in 2013 with the acquisition of Siam Makro PLC after it was similarly sold to SHV holdings in 1997, despite analysts claiming that CP Group had overpaid for the assets.
Tesco’s sale of its Asian assets marks the final steps of its turnaround plan following massive losses incurred in 2014.
Tesco PLC had begun a series of divestments since 2015 following the revelations of overstated profits in its UK Foods business by over USD 431 million. The accounting scandal, which was uncovered by its then new CEO, Dave Lewis, occurred as a result of highly unconservative payments to suppliers. It then prompted the wipeout of 25% of Tesco's market cap and a one-off writedown of property assets by over USD 6bn.
The sale of its Asian assets is part of Lewis' turnaround plan for Tesco and follows the sale of its South Korean and Turkish businesses in the years prior. Proceeds from the deal will primarily be used to clean up Tesco's balance sheet and provide a USD 6.62bn special dividend to shareholders, marking the end of the turnaround plan. USD 3.31bn will be used to fund Tesco's pension deficit of USD 4.1bn that has been valued as of March 2020 in addition to a yearly contribution valued at over USD 397 million for FY 20/21. The plug will cover most of the deficit and given Tesco's replacement of its defined benefit pension fund with a defined contribution scheme in 2015, the business expects an additional c. USD 344 million of Free Cash Flows each year.
Tesco is not alone in its divestments of its Asian segments. Metro AG of Germany and Carrefour SA of France have scaled back from Asia with the latest being exits from China in 2019 for similar reasons of refocusing on their core geographies. European Mass Retail brands have not fared well in Asia despite the rapid growth potential. Local brands have rapidly grown over the last decade with multi format networks that are tailored to the local preferences of each region. A cursory study of mass retail leaders in the region reveals each country being led by a homegrown brand.
Assuming an approval of the deal by the Office of Trade Competition Commission (OTCC), CP´s acquisition of Tesco would represent the biggest takeover in Thailand´s history with the deal’s volume amounting to USD 10.6 billion. The acquisition of Tesco is regarded as highly strategic to CP. This is due to expected cost savings and other synergies on the one hand, and improved diversification across its products, services and store formats on the other. As a consequence, the acquisition should boost operating results of both Tesco and CP, which have been consistently high for both companies in the past.
One major resource that can be utilized by the merged entity in an anti-competitive fashion is the augmented product data. CP´s dominance as a distribution channel together with the expected increase in product data would imply a huge gain in bargaining power. This, in turn, would result in significant disadvantages for suppliers in the industry. This data could be directly used by CP to create its own similar products, which again would represent competition for suppliers.
This competition among suppliers might represent a major improvement for consumers, as they are expected to profit from enhanced product variety. CP also announced, the company will plan to adapt its distribution channels, especially in regards to meat products in order to match demand.
However, there are concerns regarding the leverage of CP. The proposed acquisition is intended to be largely debt-funded, resulting in an expected increase in debt-to equity ratio of almost 80% from 1.1 to 1.95. This is believed to impose a material risk and raises major concerns about the deal.
This deal hopes to take place as part of Tesco’s greater strategy to centralize its operations back around its largest markets, namely the UK and Ireland (where it currently operates 3,769 stores). Selling its Lotus & Malaysian business to CP would mark the British retailer’s final step in its total exit from the Asian market, as Tesco has also announced their divestment from a 20% stake in its only Chinese venture (the failure of which can be attributed to the late timing of the expansion and poor market research, which led them to believe their loyalty Clubcard program would enjoy similar success as it did it Europe). Sources believe Tesco might consider re-entering the Chinese market in the future, but for now the deal with CP serves to drive forward a strategy that Tesco’s soon-to-be former CEO Dave Lewis has denominated an attempt to “simplify and focus the business, as well to return significant value to shareholders”.
Barring any obstacles to prevent the closure of this deal, Tesco would be left only to its UK, Ireland, and Central Europe businesses, although analysts believe that this shift away from international markets could go even further. Predictions have the retailer dumping its 895 stores in Central Europe, despite comments from chairman John Allan that it would be “extremely likely” that the company still owned Central European locations by Q4 2020.
Overall, this transaction is in line with the long-term goals outlined for Tesco -the entirety of Tesco’s board backed this transaction unanimously- as they look to centralize operations and return focus to their home markets.
For CP, the long-term outlook, should the deal be approved, is one of great dominance in the retail sector, albeit not without its challenges. Hoping to increase sales mutually in CP’s and Tesco’s locations, CP looks to improve and further develop its distribution network both in Thailand and Malaysia. If the deal proves successful, CP will add over 2,000 of Tesco’s stores in Thailand and Malaysia, controlling nearly 87% of all of Tesco’s Thai business and 100% of its Malaysian business. This will come in addition to CP’s already considerable presence in the sector, which originates from the 11,000 7-Eleven stores they currently operate and franchise in Thailand through CP All (the entirety of 7-Eleven’s business in that market, growing at 700 stores per year), as well as their co-ownership (through CP Group and CP All) of the cash and carry chain Siam Makro.
It is precisely due to CP’s perceived dominance in the retail sector that this acquisition has raised antitrust concerns from the regulatory authorities; this has led to uncertainty regarding the outlook for the conglomerate, which remains unpredictable as long as their status as a monopoly stays undecided. The foremost subject of discussion here stems from CP having divided its properties in cash and carry chains, hyper-markets and convenience stores; thus making it hard to regard as a monopoly but not entirely without reason, as they will still boast a nation-leading market share in this sector (CP will own over 78% of all brand name convenience-like stores in Thailand). Taking the lead in the retail sector, however, might not seem particularly enticing to CP given the current climate, which has seen the Thai retail market contracting an estimated 5%-10% in Q1 2020 due to the severe drop in tourism caused by the COVID-19 pandemic.
Nevertheless, the long-term outgrowth for this deal remains positive for the most part; the retail sector had grown 3% in recent years before the health crisis, with grocery shopping accounting for over half of all retail sales nationwide. Moreover, convenience stores and supermarkets display defensive qualities that could prove rewarding in the medium to long term, as the shift away from public spaces towards people’s homes becomes more widespread. Not only does this benefit supermarkets selling basic consumer goods, but it also presents huge upside for the online retail industry, which is expected to grow to USD 295 billion by 2023 in Asia alone. CP Group’s acquisition of Tesco’s Asian assets looks to take advantage of this trend by fitting into their long-term strategy of taking more of their business online; a disposition that was already showcased by their USD18 million acquisition of Chilindo (a Hong Kong-based e-commerce platform), which will complement their already existing online presence in WeMall.
Notwithstanding the favorable long-term upside within the industry, the road ahead for CP is not altogether encouraging, even under a scenario in which they overcome their biggest hurdle and authorities decide on a favorable ruling for the acquisition. Concerns start mostly with suppliers, who are fearful about future negotiations with CP due to their increased size after the acquisition. Several small businesses have complained about this issue, and many are already looking for alternative ways to distribute their products as a way to minimize the risks present when dealing through CP’s numerous distribution channels. Furthermore, analysts are worried about CP All’s debt levels should the acquisition take place, in addition to stressing how bonds worth over USD 320 billion due to be redeemed in 2021 could burden the company if faced with greater liquidity problems.
Barriers to Deal Closure
As the deal is still pending closure, the key considerations to this deal’s closure revolve primarily revolve around a stricter competition regulator which may act as a firm opponent to the deal’s closure. As of 11 August 2020, the Office of Trade Competition Competition (OTCC) in Thailand has been given greater teeth in having direct authority to oversee trade and anti-competitive practices. Prior to this, the OTCC was required to pass potentially anti-competitive M&A activity to the public prosecutor.
Within the context that CP has pre-existing majority stakes in 7-Eleven and Makro convenience stores which overlap with Tesco Thailand, an inquiry into this potentially anti-competitive acquisition is inevitable. At present, the OTCC’s ruling is expected within 90 days of its previous request in July to CP for more information behind its rationale and projected post-merger structure for the proposed bid for Tesco. A potential violation of antitrust laws may result in fines totalling USD 53 million (0.5% of the transaction value) or an outright injunction on the deal itself.
Factoring in these hurdles to closure, an intangible trump card to this scenario may be CP Group’s reputational influence within Thailand, which runs across most of the major industries including telecommunications, real estate and finance amongst many others. This very intangible might surreptitiously shoe the deal through, amidst the formidable regulatory hurdles it is presently faced with. Ultimately, the deal’s closure will come down to how legitimate the latest incarnation of the OTCC is in terms of implementation of antitrust and anti-competitive laws within Thailand.