UK supermarket group Tesco, which in April announced that it would close or sell its Fresh & Easy (F&E) stores in California and end a six-year attempt to enter the US retail market, has reached a deal to dispose of the chain.
The company said that it will lend £80m (US$126m) to the Yucaipa investment company owned by US billionaire Ron Burkle to take over the loss-making F&E stores.
Tesco, the world’s third largest retailer, confirmed that Yucaipa will acquire over 150 of the California-based stores and its Riverside distribution and production facilities, while 4,000 F&E employees will transfer to the new business. Up to 50 more F&E stores, which are not part of the deal, will be closed.
“The decision we are announcing today represents the best outcome for Tesco shareholders and F&E’s stakeholders. It offers us an orderly and efficient exit from the US market,” said Tesco chief executive (CEO), Philip Clarke.
Under Clarke, Tesco has switched its focus to the disciplined allocation of capital to those markets with significant growth potential and the opportunity to deliver strong returns, while exiting from loss-making overseas ventures. In 2012 the company pulled out of Japan and last month said it would fold its unprofitable Chinese operation into a state-run company as a minority partner.
Following completion of this latest sale and disposal process, expected within three months, there will be no continuing financial exposure for Tesco.
Yucaipa, founded in 1986 by Burkle, has completed mergers and acquisitions (M&As) valued at more than US$30bn.
Focus on the Basics
Commenting on the announcement, Fitch Ratings said that the Tesco deal and a similar recent sale by Dixons Retail are part of a broader trend among European retailers to increase their focus on core operations. “These deals are positive for the credit profile of both Tesco and Dixons, as they reduce the uncertainty over financial results while allowing the companies to focus financial and management resources on the most important parts of their business,” the credit ratings agency (CRA) stated.
For Tesco, the cash outflow from the disposal of its F&E division is cheaper than either shutting the unit down or enduring several more years of operating losses. However, it does leave the group’s Asian and European operations as the only source of international diversification.
For a relatively small part of the business, F&E had taken up a significant amount of capital and management time. The sale therefore removes distractions from what we see as the group’s biggest challenge – the continuing drop in like-for-like sales, market share and margin at its core UK business.
Fitch has already downgraded Tesco’s long-term issuer default rating (IDR) to BBB+ from A- in April to reflect these challenges and the resulting drop in profits. While the US sale will allow the company to devote more time to these issues, the CRA doubts whether Tesco can reverse the rise of competitors such as Sainsbury, given the structural changes in the UK market and the weak economic environment.
In addition, Tesco’s European and Asian operations, which historically enjoyed robust growth, are facing increasing macroeconomic and regulatory challenges as well as pricing pressures. Tesco has pulled out of the Japanese market and is also in talks with China Resources Enterprise about forming a joint venture in China that would significantly cut Tesco’s exposure to the country. This further underlines the company’s shift in focus on to its core UK market.
Separately, Dixons’ announcement of the disposal of loss-making online unit PIXmania and Electroworld operations in Turkey resulted in Fitch placing the group’s long-term IDR of B on rating watch positive. Completion of the disposal has the potential to result in a one-notch upgrade as it means the credit profile will be driven predominantly by the core UK and Nordic operations.
Other Fitch-rated European retailers do not have such troubled assets that they would be willing to offload at a loss, but some are taking a similar approach of increasing their focus on core markets. France’s supermarket giant Carrefour, for example, has been selling international operations that are successful, but where it doesn’t have a chance of becoming the market leader, such as its supermarket chains in Colombia, Malaysia and Thailand. Other international markets, such as Brazil, are however considered part of the core business.
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