J Sainsbury’s property assets will be the key to the success of any private equity bid for Britain’s third-biggest grocer.

A realisation of the value of properties held by the super-market has driven up its share price over the past year.

Analysts at Numis told clients this week that Sainsbury had vastly undervalued its basket of freehold and long leasehold assets, marked down in its 2006 accounts with a book value of £5.5 billion, which assumes depreciation from the £6.4 billion cost value of the sites.

A year ago Sainsbury raised £1.7 billion through the issue of commercial mortgage backed securities (CMBS), which valued half its portfolio at about £3.55 billion.

Analysts have calculated from that deal that it is safe to assume that Sainsbury’s entire portfolio could be valued at £7.5 billion, compared with a market capitalisation for the group of about £10 billion.

Analysts suggest that the property could be worth up to £8.5 billion, based on recent property deals in the sector, which would effectively underpin the financing of any bid.

One analyst said: “It is not difficult to see how they could get the deal under way. The question would be how they could make any money.”

Analysts believe that a private equity buyer could stump up a take-out price of between 550p and 650p a share, valuing Sainsbury at more than £11 billion, and still match its usual 20 per cent to 25 per cent rates of return. This would give Sainsbury an enterprise value, including existing debt, of about £13.5 billion, making it the biggest European private equity deal to date.

The obvious route for a private equity buyer is a large-scale sale and leaseback of Sainsbury’s property portfolio, which would immediately cut the effective purchase price.

However, analysts point out this would leave Sainsbury’s operating company as a highly leveraged and indebted vehicle with very slim profit margins. The retailer would be vulnerable to price competition from its competitors, most of which are free from having to pay high rents and so could be more competitive on price.

One analyst said: “A sale-and-leaseback arrangement might work on a two- to three-year view, but over five to ten years it would be more difficult to operate against competitors with a freehold property base.

Both Tesco and Sainsbury have come up with more creative ways of securitising their property assets in the past few years. Tesco has put properties into joint venture companies, which allow it more flexibility if it wants to move out of or extend stores and also limit potential rent increases.

Path to profit

March 26 2004: Sir Peter Davis, chief executive, announces a drop in sales.

March 29, 04: Justin King takes over as chief executive; Sir Peter chairman.

July 1, 04: Philip Hampton named chairman, a day after Sir Peter ousted.

July 2, 04: issues second profit warning in four months. Parts company with two directors and agrees a £3.6 million severance deal for Sir Peter.

Oct 15, 04: cuts a fifth of head office jobs

Oct 19, 04: writes off £550 million of investments initiated by Sir Peter

Nov 17, 04: reports first loss in its 135-year history

July 13, 05: management comes under fire for slashing the dividend

Oct 7, 05: Mr King unveils strongest growth in underlying sales since 2001.

March 29, 06: reports landmark fifth consecutive quarter of growth

May 17, 06: plans to spend £100 million over the next two years on new sites

Feb 2, 07: CVC, KKR and Blackstone weigh up bid

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