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Tesco Puts Up “Tens of Millions” And Purchases British Transplants Wild Rocket And 2 Sisters Foods — Was A Secret Promise Made To Make The British Suppliers Whole? Did This Constitute Fraud Against Its Own Shareholders?

Jim Prevor’s Perishable Pundit, June 29, 2010

The Financial Times ran a small note in which it indicated that Tesco would be purchasing its two US “transplants” — those UK suppliers that came over to the US at the behest of Tesco when it was first opening its Fresh & Easy division in the US.

The two suppliers are Wild Rocket Foods and 2 Sisters Foods, both of which had built substantial facilities near Fresh & Easy’s headquarters and distribution center. As usual, Tesco tried to put a good spin on the news:

Tim Mason, the head of the Fresh & Easy business, told the Financial Times it was a sign of its commitment to the US business. While not large enough to require disclosure, he said the transaction involved “tens of millions of dollars” and “a real amount of money”.

In reality, it is a sign that Tesco never delivered the volume it promised these vendors, had no prospect of delivering that volume any time soon, and the vendors were thus going broke.

Still, under normal circumstances, where suppliers are completely independent organizations, Tesco should allow them to go broke. There are no services these companies provide that US companies can’t, and even if Tesco wants these facilities, it could buy them cheaper out of a Chapter 11 filing than by buying them directly.

The most reasonable explanation of why Tesco is spending, as Tim Mason said “tens of millions of dollars” of its shareholders’ money on these acquisitions, is that the investments in the US were made by companies Tesco has close relationships with back in the UK, and there was a promise made, either explicitly or implicitly, that if these private British companies made the investment to help launch Fresh & Easy, Tesco would “take care of them” if things didn’t work out.

The best explanation for the timing? Tesco’s CEO, Sir Terry Leahy, is going to be resigning. Since Sir Terry was in on the moral commitment, he needs to act now or the two companies need to force action now to make sure that this unwritten obligation is carried through. Who is to say the next CEO will care about the moral commitments made by Sir Terry or by Tim Mason with Sir Terry’s permission? Or perhaps it is the incoming CEO who asked Sir Terry to make sure all the moral obligations were “put on the books,” so he doesn’t have to take a hit on his compensation later on.

Of course, if this is all true, the implications of this matter are that Tesco has been effectively defrauding its investors. In a sense, it created an off-balance-sheet entity that has absorbed losses and made capital investments on behalf of Tesco. Had Tesco signed a contract obligating it to pay these bills, it would have had to account for them; instead, by not acknowledging the obligation to “make whole” these investors, Tesco kept these capital requirements and losses off its books. People have gone to jail for less.

Of course, Tesco will deny all this and claim it is doing this to gain synergies, etc., but that really makes no sense. If there were valuable synergies to gain, Tesco would buy the British operations of these companies and get much larger synergies. That it only chooses to buy these tiny loss-ridden US companies tells us there is more here than Tesco cares to speak about.

We had already noted here that Tesco had filed UCC liens against Wild Rocket and so, presumably, was in some fashion already helping to finance the operation. One other reason for the buyout… it avoids the possibility that Tesco would have to write off loans or advances it may have given these companies.

Jim Jensen, Fresh & Easy’s Director of Fresh Foods, had left to help develop the fresh food program at Walgreens, and Chris Harris, who had been Category Manager Produce and Horticulture at Fresh & Easy (and was a PRODUCE BUSINESS 40-under-Forty Winner) recently left Tesco to assume a new position with C.H. Robinson. Perhaps there will be some minor payroll reductions as a result of the acquisitions. Still, these acquisitions will only give Fresh & Easy more overhead and bigger losses.

There are a lot of signs Tesco still hasn’t learned its lessons in America. You would have thought the turnover in produce would be an excellent opportunity to hire some American leadership. Instead, Tesco sent Tim Lee to Fresh & Easy from Tesco’s corporate headquarters. Tim Lee’s position was corporate director of produce group procurement, and he had been charged with developing a global procurement effort for Tesco. We are sure he is brilliant, but Tesco has a penchant for treating the US like an underdeveloped country where managerial talent has to be imported, and this remains a major cause of its problems. Why not hire Bruce Peterson? Or bring in Dick Spezzano and Bob DiPiazza as consultants.

We see this whole transaction as Tesco “paying its bills” in preparation for the next step. The current operation is untenable. It is either going to give up and close up or do something dramatic that will hide the losses in a big US acquisition. We’ve previously suggested Meijer as ideal for Tesco — as Tesco needs a supercenter concept to effectively compete against Wal-Mart. In the past, there have been rumors Tesco was interested in Whole Foods; more recently that Tesco might come to the rescue of Supervalu, either by buying the whole operation or by paying cash for Save-a-lot.

Save-a-lot is composed of mostly franchise stores. The way out of Fresh & Easy might be to franchise them out and just operate as a wholesaler.

Of course, maybe while in Minneapolis to kick the tires at Supervalu, Tesco might visit the folks at Target. In Britain, Tesco is seeking to boost non-food sales. It needs supercenters to compete with Wal-Mart. There is only one national player that meets these criteria… perhaps it will be a Target in more ways than one.

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