My share price move of the week goes to Tesco (TSCO) for the grocer’s 11% rally today on the back of a £3.7bn bid for food wholesaler Booker (BOK). For prey Booker’s shares to jump 19% is understandable; shareholders are traditionally paid a premium to encourage them to give up the chance of future income and share price gains. However, for predator Tesco’s share price to rally over 10% is far rarer. A small rise, perhaps. But 10%? It’s very impressive!

Predator shares typically fall due to the company committing to spend cash, take on debt and/or issues new shares, and of course face integration risk. As the deal stands, Booker shareholders are being offered 42.6p cash and 0.681 new Tesco shares for each Booker share they own. While Tesco may not be taking on any new debt, it is spending some of its cash and new shares will dilute existing Tesco shareholders. Following the deal, Booker shareholders will own 16% of the new group. I wonder what it’ll be named? Besco? Unlikely, the two will almost certainly keep trading under separate brands, under a Tesco umbrella.

Back to why Tesco shares have rallied. We put this down to a host of reasons. Firstly the deal allows Tesco to reinforce its #1 UK grocer slot, becoming the UK’s leading food business by gaining access to a wider better-growth audience (‘out-of-home’ growing faster than ‘at-home’). Secondly, Booker’s wholesale experience and Tesco’s legendary buying power should allow it to better compete with the highly successful German discounters. Aldi and Lidl have, together, amassed a 10% market share  through fierce competition over the last decade while Tesco’s has fallen from 30% to 28%. However, things have stabilised. Thirdly, Tesco estimates the deal will boost group profits by £25m annually and offer sizeable synergies (supply chain, admin; £175m per annum). There is big potential that even this proves conservative and needs upgrading.

All the above are very valid reasons for the share price move linked to today’s M&A news. However, the most likely reason for Tesco’s share price soaring today may in fact be something totally unrelated; the long-awaited and welcome return of dividends from next year, following a 2-year accounting scandal fuelled interruption that saw it record one of the biggest losses in UK corporate history. Investors are cheering the prospect of a 4% yield as well as hoping today’s deal pays the proverbial dividends.

Those trading the shares are clearly hoping the newly combined and faster-growing entity can propel them out of a 3-month 190-215p range to back above 18-month highs of 220p. Only then would the door be unlocked for a return to 250p last traded April 2015 and 300p from summer of 2014, representing 40%  upside from here.

The shares having bottomed out last year and October’s interim results having revived confidence in the grocer, today’s news adds fuel to a story that increasingly hints of a corner being turned. It may have been a long time coming but, as they say, patience is virtue. The question now is whether this new chapter with Booker will have been worth the wait?  For the moment, the two are on the same page, both trading close to the highs of the day.

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Enjoy your weekend!

Mike van Dulken, Head of Research, 27 Jan 2017