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Analysts Suggest Ahold Would Be Ripe
For A Tesco Acquisition

Considering the extensive nature of our discussion related to Tesco’s Journey to America as Fresh & Easy, we are often asked what we see as the most likely outcome.

It is, of course, unpredictable, but it seems most unlikely that the stores will earn a good return on investment without a significant format change. Yet the kind of format changes required — we suggested switching the stores to Aldi or Trader Joe’s clones depending on location — seem to offend Tesco’s notions of serving everybody.

Closing the stores, though, would be an enormous embarrassment to Sir Terry Leahy, Tesco’s CEO and to Tim Mason, the son-in-law of Tesco’s former chairman Lord MacLairin, who was sent to America to run the operation.

So if Tesco can’t fix it and won’t close it, the logical choice is to expand the US division with a massive acquisition and then wash the numbers for the failed Fresh & Easy division through a much larger operation.

We have previously suggested that an acquisition of Meijer would make sense. As the last remaining independent supercenter operation, a Meijer acquisition would give Tesco a critical mass to roll out supercenters across the US.

We also suggested an acquisition of Whole Foods, since Tesco’s anxiousness to portray itself as green could be facilitated by such a move.

Now all over London, the papers have been picking up on a suggestion made by ING analysts Peter Brockwell and John David Ring. For example, Bloomberg ran a piece, Tesco Should Consider Buying Ahold, ING Analysts Say:

Tesco Plc, the U.K.’s biggest retailer, should consider buying Royal Ahold NV at a cost of about 15 billion euros ($22.2 billion) to accelerate its U.S. expansion, ING analysts wrote in a note.

Ahold, the Amsterdam-based owner of Stop & Shop and Giant supermarkets in the U.S., is “cheap on all metrics,” which may lead to takeover interest, analysts Peter Brockwell and John David Roeg wrote in a note dated Oct. 30 and received today. Tesco runs Fresh & Easy shops in the world’s largest economy.

“The U.S. market is too big to ignore, yet any attempt to increase the scale of Fresh & Easy could prove very risky,” wrote the analysts, who recommend buying both companies’ shares. “Ahold should be viewed as a one-off opportunity to acquire an undervalued asset at a low point in the U.S. consumer cycle.”

… Buying Ahold would add about 700 grocery stores operating in the eastern U.S. to Tesco’s 115 Fresh & Easy stores it has opened since 2007 in western states, including California and Arizona. Together with Albert Heijn, the biggest supermarket chain in the Netherlands and Ahold’s businesses in central and eastern Europe, that would boost Tesco’s full-year sales in 2011 to 96.9 billion pounds ($159 billion), the ING analysts said.

“A tie up with Ahold would enable Fresh & Easy to benefit from more favorable supplier terms, give it access to Ahold’s talented U.S. management team as well as enable Fresh & Easy to scale back the size of its overhead cost base,” ING said.

There are all kinds of economic reasons why such an acquisition might make sense. Tesco is a multi-format operator in the UK and other places; there is no reason to think it wouldn’t look to be a multi-format operator in the US.

The enormous overhead that Tesco has thrown — both physical and managerial — against what is basically a small chain of superettes makes profitability impossible without massive growth.

And, of course, Tesco has continental scale ambitions in North America and this would provide an easy and logical leap to the east coast.

If the acquisition happens though, the most likely reason is that it would allow Tesco to subsume its Fresh & Easy operation in a much larger “North American division” and thus avoid the embarrassment of closing it down or recognizing the waste of well over a billion dollars.

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