LONDON Sainsbury's (SBRY.L), Britain's second-biggest supermarket chain, made a takeover approach for Home Retail HOME.L in November but was rejected by the owner of Argos and the Homebase do-it-yourself chain and is considering its next step.
The approach is a bold gambit by Sainsbury's boss Mike Coupe to reduce its reliance on food sales when the wider British supermarket industry is being hammered by the growth of German discounters Aldi [ALDIEI.UL] and Lidl [LIDUK.UL] in a brutal price war.
Sainsbury's did not disclose the value of its proposal but said on Tuesday that it had approached Home Retail's board about a possible cash and shares offer for the group, which had a market capitalisation of 804 million pounds before news of the spurned proposal emerged.
Home Retail said the approach undervalued the group and its prospects, advising investors to take no action.
Shares in Home Retail, Britain's biggest household goods retailer, jumped 41 percent to 139.5 pence on the news, while Sainsbury's shares fell 5.2 percent to 242.6 pence on concerns over the cost and implications of the potential acquisition, giving it a market capitalisation of 4.7 billion pounds.
Home Retail warned on its profit outlook in October and its share price had more than halved over the past year before Tuesday.
"GENIUS OR MADNESS"
Analysts at Jefferies, in a note titled "Genius or Madness?", said that Coupe's move could be construed in two ways.
"Either this is a sign of a lack of confidence in prospects for the core (grocery) business or a positive step in anticipating how the customer journey will develop in a multi-channel world," they said.
Sainsbury's said it is now considering its position and, under British takeover rules, has until Feb. 2 to make a firm offer.
Sainsbury's has shown greater resilience to the discounters than its rivals among the so-called Big Four, Tesco (TSCO.L), Asda (WMT.N) and Morrisons (MRW.L).
It used to own Homebase before it sold the business in 2000 for almost 1 billion pounds and said a deal with Home Retail would enable the two groups to optimise their store space, sell Argos goods through Sainsbury's and Sainsbury's products through Argos, making cost savings in the process.
The two companies have been working together over the past year, with Sainsbury's trialing Argos concessions in its stores. Plans for Homebase, now owned by Home Retail, are less clear.
"There would undoubtedly be substantial cost savings from putting Sainsbury's and Home Retail together and I can certainly see how Argos could enhance Sainsbury’s non-food offering," said one major institutional shareholder in both companies.
"What I am less clear on is what Sainsbury's could add in an Argos or Homebase store."
Investec analyst Kate Calvert, who has a "buy" rating on Home Retail, said the Sainsbury's move felt "reasonably opportunistic", given the recent underperformance of the business and its shares.
"You can easily do a sum of the parts and come up with 180 pence as a valuation on the shares."
Others said the possible deal made no strategic business sense.
Haitong Research analyst Tony Shiret said it served as a reminder of the weakness of British food retailers and the desperation of their strategic thinking.
"Why else would anyone countenance adding Amazon to their list of major competitors and take on 850 low-margin Argos retail outlets and 250 or so Homebase units that they thought would be a good idea to get rid of in 2000?"
Sainsbury's is being advised by Morgan Stanley (MS.N) and UBS UBSG.VX, while Home Retail is being advised by BofA Merrill Lynch (BAC.N).
(Additional reporting by Paul Sandle, Kate Holton and Freya Berry; Editing by Susan Fenton and David Goodman)