Sainsbury’s finds novel way to fund Home Retail deal

J Sainsbury is relying on a piece of financial engineering not immediately associated with a grocer to fund its takeover of Argos, owner Home Retail Group.

Britain’s second-biggest supermarket chain agreed on Tuesday to pay £1.3bn to acquire Home Retail, whose Argos catalogue concessions will be introduced into sparsely occupied spaces in the grocer’s shops.

To structure what analysts at Sanford Bernstein described as “a carefully crafted deal” — and to raise the £440m in cash needed to pay for the transaction — the supermarket turned not to investment bankers or financial markets but to its own retail banking arm.

By the supermarket’s own account, the most unusual feature of the deal is the fact that it will eventually be financed using deposits at Sainsbury’s Bank.

The manoeuvre involves a £600m book of consumer loans acquired as part of the Argos sale. These loans will be transferred from Sainsbury’s group to its banking unit over a period of about three months, as the bank attracts deposits to pay for them.

The parent group will inject £100m of capital into the bank to meet regulatory requirements. It plans to raise the other £500m from savers — a sum that would represent a 14 per cent expansion in its deposit base since the last reported level in 2015.

Peter Griffiths, chief executive of Sainsbury’s bank, said the bank would use marketing initiatives and price competition to attract the new deposits. “We will be competitively priced,” he said, adding: “We have never been in a position where we’ve had to pay beyond market rates to attract savings.”

In the current market, raising the extra deposits will be “very easy indeed”, said Ian Gordon of Investec. “A small but growing bank can turn on the taps because big banks are generally trying to manage surplus liquidity away rather than compete for it.”

Mr Griffiths said that, in contrast to the bank’s existing “super-prime” borrowers, customers who had taken out loans in response to “buy now pay later” offers at Argos were likely to reflect “quite a mix of credit profiles”. But he insisted he was “very comfortable” with the debts he was acquiring.

Analysts pointed out that defaults on consumer credit had fallen back since the financial crisis to levels that were low by historical standards, and that low lending rates offer little margin to absorb the cost if defaults increase again. “I would have concerns about the performance of the existing book through the cycle,” said Mr Gordon, “given the relatively thin margins, if you had normal levels of default”.

Sainsbury’s Bank borrows from depositors at a cost of “2 per cent or better”, said the supermarket group’s chief financial officer, John Rogers — less than the 6.7 per cent yield on the grocer’s corporate bonds. “It is a very efficient way of funding” the deal, he added.

It is not just deposits Sainsbury’s is planning to expand following the Home Retail acquisition.

It hopes that, by offering a range of 100,000 non-food products to order online and collect in Sainsbury’s stores, it can tempt customers to do more of their shopping at the supermarket chain.

It also plans to cut the rent bill by closing standalone catalogue stores that have a Sainsbury’s nearby.

Online customers are usually “indifferent about where they click and collect”, said Mr Rogers, and might even prefer to load up at a supermarket with a car park rather than an Argos high street store.

The concessions will lead to an extra £60m in annual profit within three years, Sainsbury’s calculated, accounting for half of the projected synergies it expected from the deal.

Argos suffered a decline in like-for-like sales over Christmas and analysts are divided about whether the deal will make Sainsbury’s less reliant on the increasingly competitive grocery market, or whether it will force a new distraction on to the supermarket’s management team. “You are adding a very very challenged business to a very challenged business,” said Tony Shiret of Haitong securities.

Although the deal will involve a large cash outflow to Home Retail shareholders, it will not cause an increase in reported net debt, analysts said. That is because, although the bank will in effect owe an extra £500m to its depositors once the refinancing is complete, debt owed by the bank is excluded from Sainsbury’s reported net debt.

After adding in £200m on Home Retail’s balance sheet, which will also be transferred to Sainsbury’s, the supermarket will report a stronger cash position than it had before paying £440m to Home Retail shareholders.

“At the group level we are better off by a bit over £300m”, Mr Rogers said.

But many analysts were dismissive. “It is financial engineering plain and simple,” said Mr Shiret.