Tesco's Welwyn Garden City HQ

Tesco’s Welwyn Garden City HQ

Calls from two high-profile investors for Tesco to ditch its pursuit of Booker will doubtless fall on deaf ears at Welwyn Garden City, but pressure could mount on Tesco to respond.

Fund managers Schroders and Artisan, representing about 9% of Tesco shares, have written a letter to Tesco’s board. In it, they voice fears the £3.7bn Booker buyout will “destroy value” and distract from efforts to continue the turnaround of the business.

Despite being Tesco’s third and fourth-largest investors, the likelihood of them blocking the deal is miniscule.

Even if their call to arms to disaffected Tesco investors gains traction, they will need to persuade another 41% to defy the board, which looks a fanciful proposition.

The support of 75% of Booker investors is needed to rubber-stamp the deal, but the Tesco shareholder votes for the approval of the transaction and the allocation of new shares will be treated as ordinary resolutions at Tesco’s general meeting. This means only a simple majority of votes is needed for the deal to be approved.

Schroders and Artisan may have limited powers when it comes to blocking the deal, then – but they can certainly give the Tesco board a sizable headache.

Their complaints centre on the “high price” being paid for Booker, noting the valuation multiple 23 times peak operating profit and the fact that Booker has already achieved high margins before Tesco gets its hands on the wholesaler.

Such moans about price in M&A deals are not uncommon. Perhaps more significant is the dissatisfaction with the board’s communication about the deal to key stakeholders, and the call for other investors to speak up.

Communication around the deal is an issue for Tesco. Non-executive director Richard Cousins quit in mysterious circumstances earlier this year, only for it to emerge much later it related to a disagreement over the Booker acquisition. Schroders and Artisan clearly feel Tesco hasn’t done the full sell to investors and explained to them in detail why the transaction is in their interest.

Tesco has responded, stating: “We always listen closely to the view of our shareholders. We have had a wide series of meetings over the last two months and are pleased with the overall response… Since announcing the transaction the majority of our top 10 shareholders have chosen to increase their shareholding in Tesco and we hope to convince all our shareholders of the merits of the transaction.”

But if more investors start kicking up a fuss, Tesco will probably have to come out with more detailed rationale and strategic plans for Booker, in order to keep ahead in the PR battle.

Tesco will not want a shareholder movement to be created and may need to proactively head off any protests – even if they are highly unlikely to get anywhere near 50% of shareholders.

More drastic option 

If shareholder opposition does step up meaningfully, Tesco may consider taking the more drastic option of re-examining the terms of the bid. Such a measure is not unusual – though it is usually triggered by shareholders of the target company (as was seen in the renegotiation of the AB InBev/SAB Miller mega-deal) given they only need 25% to block the deal.

But if Tesco starts messing with the terms of the deal it could lose support with the Booker board itself or risk starting a Booker shareholder rebellion. There are suggestions that some Booker investors already feel the Tesco offer is not overly generous, so this doesn’t require too much imagination.

The most drastic option would be to eventually pull the bid entirely, but no one expects that to happen any time soon – including Schroders and Artisan.

Tesco and Booker remain relatively early in the bid process and there are still many hurdles to negotiate. Tesco shareholders may be the least of them as the threat of a complex and lengthy investigation by the CMA remains.

If the deal is derailed, it is far more likely to be regulatory issues that scupper it. The CMA has the power to block the deal outright or impose terms – compulsory sell-offs of stores and divisions or legal separations of businesses – that Tesco might find destroys the upside value of the deal.

Even if everything goes to plan, the deal is unlikely to close until late this year. It might even take until 2018.

Despite the emergence of yesterday’s letter, Tesco management will feel it has built enough shareholder goodwill over the past two years to be able to rely on investor support – even if it might need to throw them a bone or two in the meantime to keep them happy.

But a long fight remains before Tesco and Booker are together under one corporate roof.