Is Tesco PLC Really About To Buy WM Morrison Supermarkets PLC?

According to the Daily Mail, there's currently "red-hot gossip" that top supermarket Tesco(LSE: TSCO) and a private equity consortium led by Permira are both "stalking" the UK's no. 3 grocer Morrisons(LSE: MRW).

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The Mail reckons "an offer in the region of £6.42bn, or 275p a share, could not be far away". Morrisons' shares are trading at 188p, as I write.

Consolidation

It's no real surprise that rumours of consolidation in the supermarket sector are rife. New shopping habits and the rise of deep-discounters Aldi and Lidl have changed the landscape for the major mid-market operators, which also include Sainsbury's and Wal-Mart-owned Asda.

With Aldi and Lidl having lately extended their combined market share to above 10% (and still rising fast), some form of deal resulting in the traditional Big Four turning into a Big Three has become less likely to fall foul of the competition regulator.

Sainsbury's and Morrisons have previously been considered a good combination, with the former's heartland being in the south, and Morrisons' stronghold being in the north. Speculation increased when it emerged late last year that former boss of the Bradford-based firm Sir Ken Morrison and his son, William, had built a combined £12m stake in Sainsbury's.

However, chatter of a potential Sainsbury's/Morrisons tie-up has gone cold, with Sainsbury's currently intent on doing a deal to acquire Argos-owner Home Retail.

Tesco/Morrisons

So, what's the likelihood of a Tesco/Morrisons combination? As the Daily Mail points out: "Morrisons' management is now crammed with ex-Tesco people [including the chairman and chief executive] ...They know each business inside and out so both would be able to help bring about a trouble-free union".

It seems to me, though, that such a union -- Tesco with its market share of 28% and Morrisons with 11% -- would likely be anything but trouble-free were it to come before the competition regulator for consideration.

Funding the deal would also be problematic for indebted Tesco, and, indeed for private equity. Analysts at Exane point out that, while Morrisons owns 90% of its property, and that asset-stripping has been used many times to fund deals in the past, "we'd question the property market's appetite for so much single user, single use property coming its way".

So, due to competition issues and debt, it looks a tall order for Tesco to be able to pull of an acquisition of Morrisons.

Private equity?

A private equity bid for Morrisons -- which, of course, wouldn't raise competition problems -- is perhaps more plausible. On a price-to-sales valuation, UK supermarkets are among the cheapest in Europe, so there is clear potential for an acquirer.

The problem is profitability. Morrisons is trading on over 20 times current-year forecast earnings, which rises to over 30 times at the Daily Mail's mooted 275p takeover price. Paying that much, turning the business around, and building it to a level of profitability to enable an exit at a good return, looks pretty risky, although private equity players may have an appetite for it, if they can finance it.

One thing's for certain, gossip and rumour about M&A activity in the supermarket sector aren't going to go away any time soon. And heaven help us should Sainsbury's come back into play, if its pitch for Argos doesn't come off!

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G A Chester has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.