More NEDs should challenge takeovers like Tesco's Cousins
03 February 2017
Richard Cousins stood down from Tesco's board in protest at its move to buy Booker, John Colley, Professor of Practice in the Strategy and International Business group, writes that more Non-Executive Directors should do the same.
Most major acquisitions of listed businesses result in value destruction. For once extensive academic research over decades is unequivocal in its agreement on this point.
However, record after record continues to be broken in the volume and value of such deals. Many turn into complete disasters resulting in the CEO eventually being fired or the acquirer being taken over. For example, in the UK Poundland's recent acquisition of 99P Stores went so badly that Steinhoff International was then able to acquire Poundland at a knockdown price.
The key question is why do Non-Executive Directors (NEDs) on the boards of these companies keep agreeing to deals when the outcome is so high risk? Invariably they support the CEO and agreement is 'unanimous'.
Are NEDs adding value or are they unconditional supporters of the CEO or Chairman, who generally select them? Do they represent shareholder views and ensure good corporate governance occurs or look after their own interests?
Tesco's agreed bid of £3.9 billion for Booker, which distributes to independent convenience stores and restaurants, precipitated the resignation of Senior Independent Director Richard Cousins.
Cousins is CEO of Compass, a global leader in catering which has increased shareholder value by five times since his arrival 10 years ago. His philosophy is to maintain a clear focus on the business by avoiding diversifications, major acquisitions, and unnecessary complications.
He likes simple organisation structures, clarity of responsibility and a business the board understands. Contrast this with Tesco, which has diversified into myriad other businesses including cafes, restaurants, garden centres and more.
Its diversifications have generally not done well under Tesco's management. Its overseas interests in Eastern Europe and Asia are also struggling.
The UK grocery market is moving to online and convenience channels and now has enormous excess supermarket capacity. Tesco has by far the most; add to this low-cost competitors growing rapidly and Tesco is in the midst of a battle which could go on for many years.
Tesco pursued a policy of increasing range and adding large stores to pre-empt other entrants. Its supermarkets carried between 30,000 and 50,000 lines. Product range drives cost into any business and no more so than the grocery industry. Would consumers be willing to pay the added cost of an enormous range?
German supermarket groups Aldi and Lidl arrived offering ranges of 3,000 to 6,000 lines at much lower prices in smaller stores and less expensive parts of town. Customers are continuing to move to this lower cost offering. This left Tesco trying to rationalise its range and with a large amount of expensive surplus space.
The new CEO, Dave Lewis, is addressing these issues by cutting prices (and margins), closing stores and rationalising the range. He stopped the dividend and has started selling the land bank plus some of the less comprehensible diversifications.
Why is Tesco buying Booker?
Tesco has begun to sell off the poor performing overseas operations, but plenty remain to be addressed. These actions have brought a temporary end to lost market share, and a return to modest growth albeit at much lower profit levels. One suspects that there are a lot more write-downs and costs to come.
However, the UK grocery market is changing rapidly, which means plenty more work for Tesco. It is defending a 28 per cent grocery market share, down from 32 per cent. Tesco's share is everyone's target. Aldi and Lidl have more than 10 per cent of the UK grocery market but will continue their low cost, low prices approach permanently.
There is a move to convenience store shopping and internet deliveries. Dining out in restaurants is increasing, although this may be short-lived with inflation increases arriving in 2017, which may reduce demand.
There is some logic to Tesco moving further into convenience stores deliveries although not restaurants. The convenience stores Tesco is acquiring with Booker are all franchised (Budgens, Londis, Family Shopper), which will be an alien business model to Tesco.
The Competition and Markets Authority will scrutinise the deal and that may be protracted. Research shows the frequent haemorrhage of key staff and customers over these periods due to distraction and uncertainty.
Heavily-borrowed Tesco is adding to its debt by paying £700 million cash plus the rest in shares. While the premium to the undisturbed price is only 16 per cent, the price is an enormous 28 times earnings.
Cousins' view appears to be that there is limited logic to the deal. It adds complexity and distraction at a time when Tesco is in a price war in a changing market that will last for years.
The shareholders have not been receiving a dividend, although they are now promised some payment in 2017/18, presumably to gain support for the deal. Cousins’ resignation shows how strongly he feels about the deal.
However, he is not CEO of Tesco and is there to add advice, which may or may not be taken. That opportunity no longer remains.
The other NEDs were unanimous about the deal apparently, which is worrying. Perhaps it is time we saw more NEDs resign their highly paid jobs over risky and distracting major acquisitions.
John Colley teaches Strategic Advantage on the Executive MBA and Executive MBA (London). He also teaches Strategic Thinking: Strategic Evaluation and Analysis on the Full-time MBA.