J Sainsbury plc (ADR) (JSAIY.PK)

Investment Summary:

J Sainsbury is a favorable risk/reward investment. Priced at a reasonable EV/EBITDAR multiple of 6.08 (TTM ending 3/22/08) with operations transitioning from turnaround to growth, and a property value backstop of well over the market cap. J Sainsbury provides little downside with significant upside potential.

Operations have improved under chief executive Justin King. Sainsbury’s three-year plan (beginning in 2005) to increase sales $5 billion has just been successfully completed. J Sainsbury is planning to invest $4.9 billon over the next three years with the goal of increasing sales another $6.8 billion (2010). Year-over-year sales growth is 6% with 4.5% in same-store-sales increase. This is evidence of a sales led turnaround.

However, the key interest in Sainsbury’s stock is its property assets. Highlighted by Sainbury’s South-East properties, the 2007 estimated valuation is between $17.8 billion and $19.1 billion. The current market cap is $12.7 billion. LTD is $4.2 billion with $1.6 billion in cash making an EV of $15.2 billion.

Recapitalization of JSAIY is distinct option. Using a REIT structured sale and leaseback vehicle as a financial exit would realize its property values. With a REIT strategy a OpCo/PropCo structure would bring value to the shareholders.

Sainsbury gathers additional upside potential as a target. J Sainsbury has had two failed takeover attempts in 2007. Private equity CVC consortium offered $21.7 billion (excluding debt) - $45.86 share in April 2007 and Delta (Two) offered $24 billion- $47.28 share in November 2007. There are a number of other interested parties in the company.

In summary, JSAIY is a value priced turnaround/growth story with a real estate backstop, a recapitalization with a OpCo/PropCo REIT possibility, and a potential target.

Note: The currency exchange GBP = USD has adjusted over the past years. In this analysis all values are converted at a 1.97 exchange rate.

J Sainsbury Plc

Sainsbury is primarily a UK based grocer and related retailer. JSAIY has two operating divisions; 1) about 480 supermarkets, 290 convenience stores totaling 17.6 million square feet, and 2) financial services (Sainsbury Bank). About 114 stores provide internet-based home shopping service. Its non-food offerings are approximately 15% of sales (compared to an industry leading 24% by Tesco).

JSAIY’s 3-year strategy is to increase sales $6.8 billion with 2/3 coming from grocery and 1/3 from non-food items. Sainsbury’s sales have increased $4.9 billion in the past 3 years. March FY2008 sales were $35.1 billion. They plan to grow store space by 10%, and add another 200 online stores along with 100 new convenience stores. Sainsbury is in transition from turnaround to growth. The operating margin still lags behind its major competitors. TTM EBIT margin is 3.0% compared to industry leader Tesco EBIT margin of 6.0%. Margins are depressed about 1% because of previous management’s over investment in IT, and another 1% because of their comparative high rental space. JSAIY rents about 40% of their retail space compared with 30% at Tesco and about 10% at Morrisons. Excluding rent, EBITDAR margins were 7.2%, which fared much better with the competition.

Sainsbury, under King, is fixing the basics; adopting a customer-focused culture, refurbishing stores and broadening its product range. A 3-year cap-ex of $4.9 billion has been announced by management.

Trading:

J Sainsbury trades under symbol JSAIY, a 4-1 ADR, and in the pink sheets under JSNSF. JSAIY trades an average of 250,000 share a day. In March - April of 2007 JSAIY traded in the mid $40’s during the takeover attempts. It currently is trading at $27.40. There are 1,760 million shares. Delta (Two) owns 25% (up from 7% from 6/07 likely going to 30%), the Sainsbury family controls 17% (billionaire David Sainsbury holds 7.75%) and Robert Tchenguiz owns 5% (with another 5% in derivatives).

Sainsbury share price is currently under pressure; the macro economic environment is challenging, Paul Taylor and Delta are in a riff, and Robert Tchenquiz is preoccupied with taking Mitchells & Butlers, Britain’s largest pub operator, in a OpCo/PropCo deal. Tchenquiz has built his stake at an estimated $42 per share. Delta has increased their recent holding at $46.88

UK Supermarket Industry:

The UK supermarket industry is very concentrated. The top 4 competitors make up 75% of the retail market. Tesco Plc leads with a market share of 31%; Asda, a subsidiary of Wal-Mart, 16.7%, Sainsbury 16.3% and WM Morrison 11.2%. Consumers are trading upwards to healthier foods in premium categories, and supermarkets are beginning to extend beyond their non-food boundaries.

In May, Sainsbury reported that recent pressure on consumer spending and continuing competition shows no sign of easing. This underscores the current macro conditions in the UK.

Operating Valuation and Margin Comparisons

Company TTM EBITDAR (billion) TTM EV (billion) Multiple

Sainsbury $ 2.50 $ 15.2 6.08

Tesco Plc $ 7.58 $ 71.9 9.49

Morrison’s $ 1.76 $ 15.7 8.92

Company EBITDA EV/EBITDA EBIT EV/EBIT

Sainsbury $1,991 m 7.6 $1,044 m 14.5

Tesco Plc $7,050 m 10.2 $5,127 m 14.0

Morrisons $1,698 m 9.3 $1,142 m 13.7

Sainsbury Tesco Morrisons

March 2008 Feb 2008 Feb 2008

EBITDAR % 7.2 8.2 6.9

EBITDA % 5.7 7.5 6.7

EBIT % 3.0 6.0 4.5

Failed Takeover Attempts

CVC Capital Partners, The Blackstone Group, TPG Capital, and KKR made a bid of 582 pence for Sainsbury in April of 2007 - $21.7 billion ($45.86 share). The Sainsbury family essentially blocked the offer. A 75% approval rate was a technical factor in the takeover attempt. The economics of the offer were also changed by the pension trustees, who wanted $5.9 billion to “top-up” the $880 million accounting pension deficit, They claimed that the investment return assumptions were outdated. Goldman Sachs, RBS, and Barclays Capital initially agreed to back the LBO.

In November, Delta (Two), a Qatari backed 25% shareholder, offered $24 billion (600 pence -- $47.28 per share). Paul Taylor, manager of Three Delta, the investment advisor of Delta (Two), was forced to walk away from its proposed takeover after funding costs soared, and embarrassingly they could not raise additional equity from their partners. The pension plan also became an issue. Taylor, in response to Delta’s failed bid and increased holdings said: “we are . . . focused on long-term, exceptional businesses . . . with strong management teams, leading market positions and long term growth opportunities.” Delta is eligible to make another bid under UK law after 6 months (May 2008).

Recently, Taylor, who worked for the Tchenquiz brothers for 6 years, and Delta have had a falling out over other investments. Delta is now consulting with Credit Suisse. This may cool the immediate activism on Delta’s part.

Also, UK REIT law has a 10% maximum investor ownership to be eligible of tax consideration. Delta’s interest would be in an LBO. They may be able to create dividend swaps in the market to get around the 10% ownership law.

Other Interested Parties

Retailer Marks & Spencer chief executive Stuart Rose admitted considering a bid in the $20 billion range if another offer was made. Sainsbury’s chairman Philip Hampton was warm to this idea as he did not want to be vilified for ‘selling on the cheap’ to private equity.

Asda, Britain’s number two grocer has taken advice on an offer but is reluctant to act because of the competitive issues with the government. Apax, a private equity firm that owns rival grocery chain Somerfield ruled out a bid for the same reason.

It is reported that buyout firms Bain Capital and Apollo were considering a bid.

Property magnet and 5% shareholder of Sainsbury, Robert Tchenguiz has been an activist and is increasing his stake in the company. Tchenguiz was quoted as saying Sainsbury was “a real estate business with a retail business on the side.” Tchenguiz has suggested the company use a sale-leaseback approach to increase shareholder value. In 2007 before the commercial market began to slide, JSAIY could be worth between 600 pence ($47.28 a share) and 700 pence ($55.16 per share) using a OpCo/PropCo structure.

Property Valuation

Previously, J Stainsbury said its freehold property was worth $14 billion. This has been raised by JSAIY to $17.2 billion on an ‘investment basis valuation’, but still short of the 2007 speculated $19.8 billion. World renowned property consultant DTZ places the value at $17.8 billion. In March 2008, JSAIY purchased 38 stores from British Land which was under a sale/leaseback. 25 of the stores are scheduled for expansion. King stated that the $538 million deal would strengthen the property value of these assets.