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J Sainsbury Plc. Acquiring Dixon Retail Plc.

BAM 521-Corportae Finance

Benoy Joseph Kingston Business School Kingston University

Table of Contents
1. 2. 2.1. 2.1.1. 2.1.2. 2.2. 2.2.1. 2.2.2. 3. 3.1. 3.1.1. 3.1.2. 3.1.3. 3.1.4. 4. 4.1. 4.1.1. 4.1.2. 4.1.3. 4.1.4. 4.1.5. 4.2. 4.3. 5. 6. Executive Summary:...................................................................................................................... 2 Evaluation of Target and Bidder Firm .......................................................................................... 3 Bidder Company: J Sainsbury Plc. ........................................................................................... 3 Sainsburys Financial Position ............................................................................................. 3 Sainsbury Business Strategy.................................................................................................. 5 Target Company: Dixon Retail Plc. .......................................................................................... 5 Dixon Retail Plc.s Financial Position .................................................................................. 6 Dixon Retail Plc. Strategy ..................................................................................................... 7

Opportunities for Synergy ............................................................................................................. 8 J Sainsburys rationales for Dixon Retail Plc. Acquisition ....................................................... 8 Synergies in Economies of Scale ......................................................................................... 10 Synergies in Earning Potential............................................................................................ 10 Synergies in Infrastructure/ Technological ......................................................................... 10 Synergies in Expansion (Exploring and exploiting) ............................................................ 11

Valuation of Dixon Retail Plc. Share price ................................................................................. 11 Sensitivity Analysis .................................................................................................................. 13 Sales Growth Rate ............................................................................................................... 14 Operating Profit Margin ..................................................................................................... 14 Incremental Fixed Capital Investment ................................................................................ 14 Incremental Working Capital Investment ............................................................................ 14 WACC ................................................................................................................................. 15 Value created with Synergy and Bid Price .............................................................................. 15 Bidding Price .......................................................................................................................... 17 Riposte to the bid of Dixon retail plc. ......................................................................................... 17 REFERENCES ............................................................................................................................ 19

1. Executive Summary:
As of 13March 2012, J Sainsbury (SBRY.L) one of the largest Brick and Mortar Retailer in UK announced its offer to acquire Dixon Retail Group(DXNS.L) for a share price of 23.68p 60% up from the current share price of 14.80 as of 13March2012. If the bid is accepted Dixon retail Plc. will be paid 5.34bnwith a premium of 3.2bn. Dixon Retail Plc. has ~32% of the Electronic goods market share and brands like Currys, PC world, Dixons, The link etc. The rationale of this acquisition is based on the integration of two giants in retailing with diversified products, however sharing almost the same strategy and competitive advantage. This acquisition is also a strategic move by J Sainsbury to acquire a Electronic retail giant at the minimal price as the market has devalued Dixon Retail Plc, with a high beta of 2.02. On the other hand, J Sainsbury to stay in competition it has to diversify from its core business or expand into international territory. From J Sainsburys perspective international expansion is highly risky and may take longer in order to find returns from its investment. For Dixon Retail Plc. which is not performing well financially, with inconsistent profit margins and unstable growth, the synergies created by this acquisition can not only help bring value to its current business, but will also help it to explore and exploit. Further to this Bid, Dixon Retail Plc. will have to decide if it has to agree to the substantial bid made by J Sainsbury or reject the offer.

2. Evaluation of Target and Bidder Firm


2.1. Bidder Company: J Sainsbury Plc. J Sainsbury plc. Traded in LSE as LSE: SBRY is the third largest chain of super markets in the United Kingdom with a market share of 16.5 % (Source: Reuters) of the UK supermarket sector. J Sainsbury has consistently shown strong financial performance year on year with 2011 revenues 22,943m (source: J Sainsbury annual reports). J Sainsbury plc. was founded in 1869 and today operates a total of 934 stores with 557 supermarkets and 377 convenience stores. It jointly owns Sainsburys Bank with Lloyds Banking Group and has two property joint ventures with Land Securities Group PLC and The British Land Company PLC. (Sainsbury: annual reports) 2.1.1. Sainsburys Financial Position

Figure 1: Sainsbury Revenue

Figure 2: Sainsbury EBITDA Table 1: Sainsburys Financials for the year 2011

FINANCIAL YEAR 2011 GROSS MARGIN NET PROFIT MARGIN OPERATING PROFIT MARGIN RETURN ON ASSESTS RETURN ON EQUITY RETURN ON INVESTMENT Source: FT.com J Sainsbury annual report 2011. Sainsbury has shown strong performance in the highly competitive retail industry in the UK with continual growth in revenues and EBITDA as shown in Fig 1&2. The revenue grew from 19.96bn to 21.10bn in 2011 showing a 5.7% sales growth. This significant growth is due to Sainsbury ability to provide its products at competitive price to its customers by concentrating on lean operation by cutting down its operation cost. Sainsbury also increase the dividend pay-out by 6.34%, which is well above the industry average and quite uncommon in the retail industry. 5.16% 11.13% 5.44% 2.73%

The competitive nature of the UK retail sector has forced Sainsbury to diversify and start looking for new venture in order to stay in business and ensure strong financial growth. 2.1.2. Sainsbury Business Strategy J Sainsbury focusses on five core competencies to bring value to its customers: 1. Great food at fair prices, 2. Accelerating the growth of complementary non-food ranges and services, 3. Reaching more customers through additional channels. For e.g. Online sales, click and collect, 4. Growing supermarket space, 5. Active property management. Hence the focus always remains on reducing the price of every product they sell and reach strong economies of scale.J Sainsbury also believes in diversifying their product range, this can be seen with it launching Sainsbury bank, partnership with Lloyds TSB, which resulted in a pre-tax operating profit of up over 50%. 2.2. Target Company: Dixon Retail Plc. Dixon Retail Plc. is Europes largest specialist electrical retailer and services company, operating in 26 countries, with over 1,200 stores in around 13 countries, across Europe employing over 38,000 people. Dixon Retail Plc. is the number one market leaders in the UK & Ireland, Nordics, Greece and the Czech Republic. Dixon Retail Plc. has a long established chain of brands under its wings like Currys, PC world, Dixon Travels, Knowhow, DSGI business, Part master within UK and Ireland. Dixon Retail Plc. does also have a strong presence in e-commerce with Pixmania.com and Dixons.co.uk. Figure 3 below is the description with regards to the financial contribution of each brand:

Figure 3: Financial contribution of each brand

2.2.1.

Dixon Retail Plc.s Financial Position The financial performance of Dixon Retail Plc. has not been very impressive, but

given the current economic downturn the company has shown significant resilience. Dixon Retail Plc. has shown flat sales revenue, however net income fell from 59.80m profits in 2010 to 239.00mn loss in 2011. This is due to a significant increase in selling, general and administrative cost from 5.48% to 7.88% as a percentage of sales.

Figure 4: Dixon Retail Plc. Revenue

Figure 5: Dixon Retail Plc. EBITDA

Table 2: Dixon Retail Plc.s Financials for the year 2011

FINANCIAL YEAR 2011 GROSS MARGIN NET PROFIT MARGIN OPERATING PROFIT MARGIN RETURN ON ASSESTS RETURN ON EQUITY RETURN ON INVESTMENT -2.84% -1.92% -6.32% -31.00% -13.36%

2.2.2.

Dixon Retail Plc. Strategy Dixon Retail Plc. believes in multi-channel approach to electrical retailing and provides

its customers with comprehensive range of after sales services. Since May 2008, Dixon Retail Plc. has formulated a 5 point strategic plan for renewal and transformation (R&T) of the group. 1. Focus on the customer. 2. Focus the portfolio on winning positions. 3. Transform the business 4. Reduce cost base 5. Win on the internet.

The R&T plan remains at the heart of the of Dixon Retail Plcs strategy and will show progress in the coming years. But a demoralising financial performance as mentioned earlier created a huge dent in the future operations for the company. However the company has risen to the occasion and had a quick review of its strategy and closed down a few of its loss making business in Spain and focus on high return on capital and increase cash from operations. Dixons focus now will be on the following: Upping the service: Delivering better value, choice and service to customers. Strengthening the multi-channel offer: Concentrate more on after sales service, as this is the differentiator from the other online retailers. Best practice across business and borders: Knowledge sharing and best practise sharing initiatives are given high regard. Source: Dixon Retail Plc. Annual Reports

3. Opportunities for Synergy


This section of the report talks about the synergy created for J Sainsbury Plc. with the acquisition of Dixon Retail Plc. And the strategic fit of both the companies in order to benefit from this acquisition.

3.1. J Sainsburys rationales for Dixon Retail Plc. Acquisition J Sainsbury is currently operating in a very saturated retail market and for the company to continue growing it has to diversify or expand. Expansion in terms of stores and geography is highly risky for e.g. Tesco struggling in its operation in Japan and US. Hence J Sainsbury has to strategically diversify from its core business, look out for opportunities which will empower the company when the market recovers. Sustainability/Survival is another key issue in front of J Sainsbury. Sainsbury core business is still food and drink retailing, wherein its competitors such as Tesco and M&S have wide product range offering furniture, electronics and clothing etc.

Sainsbury acquiring Dixon Retail Plc. will help them diversify from their traditional operation of Food and Drink retailer to a retail brand that offers wide range of consumer electronics as well. This in turn will help the organisation to compete with their immediate competitors like Tesco and M&S giving them a strong market share.

Figure 6: Market Share

Dixon Plc. market dominance will further help it to increase its market share, together with Sainsbury. The advantage of the size can help Dixon in the following ways: Buying advantage, Volume advantage, Access to new products, Advertising Scale, Access to retail property,

Source:<<http://tutor2u.net/business/marketing/market_analysis_marketshare_importance.a sp>>[Accesed on 13Mar2012] Keeping in mind the above facts, J Sainsbury can bring in value to Dixon retail Plc. As mentioned before, Dixon Plc. is struggling to keep its operations cost lower, however the financial performance of the company has made it evident that they have failed drastically. On the other hand Sainsburys competitive advantage is making sure that the operational cost is well maintained and operations margin is consistent. This will be one of the key synergy that Sainsbury can transfer to Dixons business and make it profitable. Dixon
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retail is also struggling with diminishing cash flow, which is curtailing its day to day operations. A cash rich retailer like Sainsbury can pump in cash to a large extent and still maintain its operations in high standard.

3.1.1.

Synergies in Economies of Scale J Sainsburys current market share is currently at 16% in the conventional retail

market and Dixons retail has ~32.4% accumulative of all it brands in electrical retailing (Gaurdian.co.uk). This shows the potential this acquisition can bring for Sainsbury. This will lead to a cost reduction per unit of commodity sold by improving the purchasing power of the group, reducing surplus facilities, reduction of marketing overheads and other distribution overheads. 3.1.2. Synergies in Earning Potential With the huge market share in both conventional retailing and Electronic retailing, this acquisition can lead to a direct threat to the existing players in the market. With the new trend in retailers trying to deliver everything under one roof, this acquisition can be the most cost effective approach by Sainsbury to diversify and gain market share. With the above mentioned market share, if both the group are able to sustain 4-5% OPM can lead to huge earnings for both the companies.

3.1.3.

Synergies in Infrastructure/ Technological

This acquisition can benefit both the groups from sharing the best practices, Sainsbury can bring in the lean operations expertise in order to reduce the operational cost for Dixon plc., and in return Dixon can share the expertise in e-commerce which will lead to Sainsbury gaining online market share and can avoid the threat of players like amazon and Tesco creating market dominance.

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3.1.4.

Synergies in Expansion (Exploring and exploiting) With this acquisition the group will have the potential to maneuverer and find new

potential markets for e.g. International expansion, expansion online, Product and Process development etc. and also give flexibility in their balance sheet with surplus cash to explore and exploit the market conditions.

4. Valuation of Dixon Retail Plc. Share price


As on 13Mar2012 market close, Dixon Plc. share price was at 14.80p (London Stock Exchange)

Figure 7: Market snopshot

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DCF valuation -Pre Bid Dixon Retail Plc


Planning period 1 2 3 -3.0% 0.0% 35.0% 0.0% 0.0% 7.90% 12.0% 12.0% 10.0% 4.0% 35.0% 10.0% 20.0% 7.90% 12.0% 12.0% 12.0% 5.0% 35.0% 10.0% 20.0% 7.90% 12.0% 12.0% 12.0% 6.0% 35.0% 10.0% 20.0% 7.90% 12.0% 12.0% 12.0% 7.0% 35.0% 10.0% 20.0% 7.90% 12.0% 12.0% 12.0% 7.0% 35.0% 10.0% 20.0% 7.90% 12.0% 12.0% 12.0% 7.0% 35.0% 10.0% 20.0% 7.90% 12.0% 12.0% 12.0% 6.0% 35.0% 10.0% 20.0% 7.90% 12.0% 12.0% 4 5 6 7 8 9 10 -2.0% 0.0% 35.0% 0.0% 0.0% 7.90% 12.0% 12.0% -3.0% 0.0% 35.0% 0.0% 0.0% 7.90% 12.0% 12.0% 8.0% 2.00% 35.0% 4.0% 15.0% 7.90% 12.0% 12.0% 0.0% WACC calculator 8,154.0 1,294.0 1,025.0 0.0 3,610.35 Equity/Market Cap Long Term debt Cost of borrowing % Cash Tax Rate % Risk free rate % Equity premium % Beta WACC 7.90% 530.0 1025.0 6.8% 35.0% 4.0% 5.3% 2.02 Sensitivity analysis* SGR OPM CTR IFCI IWCI WACC Impact 47.0% -60.8% -32.7% -15.2% -40.6% 21.1% Terminal value FCF t+1

Figure 8: DCF Valuation pre-bid

Value Drivers

Sales Growth Rate (SGR%) Operating Profit Margin (OPM % sales) Cash Tax Rate (CTR % of OPM) IFCI (% incr sales) IWCI (% incr sales) Weighted Average Cost of Capital Depreciation (% of sale) RFCI (= depr)

Growth in perpetuity

Inputs

Sales prior year Cash and marketable securities Market Value of Debt Value of Equity Options Number of shares outsdanding (mill)

Corporate Value Share price

532.8 14.8

* 10% adverse change of each Value Driver at a time

Key valuation assumptions: 1.SGR in Y1&Y2 will be negative due to economic slowdown, but will improve and be consistent delivering ~8% growth. 2. OPM is expected to grow with improvement in sales, and grow ~2% every year. 3. No Expansion plans till Y3, as economy is slow. Y4 onwards Dixon Plc will be planning on expansion and investment higly on purchase of stores etc. 4. The nature of the business demands huge investment in working capital and is assumed at 20%. 5.WACC is expected to be be lower in the coming years, as the company expects to recover from the financial loses it incurred.

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Dixon retail Plc. was highly impacted by the economic slowdown and hence there financials were highly unstable. Last 5 years average is taken in order to derive at a future forecast of the companys financial performance, I.e. sales growth, OPM% etc. The market still in the recovery stage, the assumption is that Dixon plc. Will be having negative sales growth and no profit margin in Y1-Y3, however with the market recovering in the future the sales growth will improve and is expected to deliver 8% on terminal value. The above assumptions have helped in deriving at the current share price of Dixon Plc. which is at 14.80p as of 13-03-2012.
Table 3: WACC Calculation source

WACC Calculation Equity/Market Cap Long Term Debt Cost of Borrowing Risk Free Rate Equity Premium Beta 4.1. Sensitivity Analysis
Sensitivity analysis* SGR OPM CTR IFCI IWCI WACC

Source http://uk.reuters.com/ Dixon Plc. Annual Report Interest/Debt Dixon Plc. annual report Yield of 10 year UK Bond

http://uk.reuters.com/

Impact 47.0% -60.8% -32.7% -15.2% -40.6% 21.1%

Figure 8: Sensitivity Analysis

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4.1.1. Sales Growth Rate According to the DCF model, the forecast of sales growth is very positive, as a terminal value of 8% SGR is showing a positive 47% impact on the sensitivity analysis. This means that the company will be responsive to its strategies for long term sales growth and the share price can fluctuate moderately with change in the SGR. 4.1.2. Operating Profit Margin OPM is highly affected by the companys operation as the sensitive analysis shows negative 60.8% with a 2% terminal OPM value and this will impact the share price drastically. The nature of the industry where Dixon Retail operates is highly competitive and can get impacted by recessionary forces in the market. Dixons failure in maintaining its operations cost in the past years shows that the OPM is highly sensitive to the long term strategy of Dixon Electric, and it is possible that Dixon Electric may run with Negative Profit margin. 4.1.3. Incremental Fixed Capital Investment With 4% terminal value on IFCI, the sensitivity analysis shows that the company will show a negative 15.2% growth in terms of their growth and expansion in terms of investment in fixed assets. It is clear that Dixon electric will have to cut down on expansion. 4.1.4. Incremental Working Capital Investment The nature of the retail business, demand a huge working capital and hence the terminal value is kept at 15%, however this is still giving a negative impact of 40.6% on the sensitivity in share price. Dixon can really struggle in managing their day to day operations with low cash and inefficient stock management.

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4.1.5.

WACC WACC is hugely impacted with high beta of 2.02; this has shown direct impact on

the share price as well as the share price is deteriorating. One of the reasons is the financial instability of Dixon Retail Plc. as it is making losses consistently. Considering the above results, this will be the right time for J Sainsbury to buy Dixon Retail Plc. as the share price of Dixon Retail Plc. is at the lowest at 14.20p as of 13-03-2012.

4.2. Value created with Synergy and Bid Price


A conservative approach is used to calculate the value created with synergies for J Sainsbury and Dixon Retail Plc. acquisition. Sales growth rate and Operating profit margin are expected to be 7.5% and 2% respectively at terminal value, considering the volatile nature of the Retail industry and the direct impact it has due to recession and other economic reasons. J Sainsbury is assuming a share price of 33.9p with synergies that will value Dixon Retail plc. at 122.4bn, however as mentioned earlier it is a very conservative approach as the value of synergies can be much higher considering the market share Dixon Retail plc. has under its wings.Fig.9 Below is the evaluation of Dixon Retail Plc. share price with synergies.

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DCF valuation-Dixon Retail Plc.With Synergies at 33.9p


Planning period 1 2 3 -3.0% 6.0% 35.0% 20.0% 30.0% 7.90% 12.0% 12.0% 1.0% 6.5% 35.0% 20.0% 30.0% 7.90% 12.0% 12.0% 2.0% 6.5% 35.0% 20.0% 3.0% 7.90% 12.0% 12.0% 3.0% 6.5% 35.0% 20.0% 30.0% 7.90% 12.0% 12.0% 4.0% 6.5% 35.0% 20.0% 30.0% 7.90% 12.0% 12.0% 5.0% 6.5% 35.0% 20.0% 30.0% 7.90% 12.0% 12.0% 6.0% 6.5% 35.0% 20.0% 30.0% 7.90% 12.0% 12.0% 8.0% 6.5% 35.0% 20.0% 30.0% 7.90% 12.0% 12.0% 4 5 6 7 8 9 10 -5.0% 0.0% 35.0% 20.0% 30.0% 7.90% 12.0% 12.0% -4.0% 0.0% 35.0% 20.0% 30.0% 7.90% 12.0% 12.0% 7.5% 2.00% 35.0% 10.0% 20.0% 7.90% 12.0% 12.0% 0.0% WACC calculator 8,154.0 1,294.0 1,025.0 0.0 3,610.35 Equity/Market Cap Long Term debt Cost of borrowing % Cash Tax Rate % Risk free rate % Equity premium % Beta WACC 7.90% 530.0 1025.0 6.8% 35.0% 4.0% 5.3% 2.02 Sensitivity analysis* SGR OPM CTR IFCI IWCI WACC Impact 12.5% -19.8% -10.7% -4.2% -7.8% 5.2% Terminal value FCF t+1 #

Figure 9: DCF Valuation post-bid


1224.9 33.9
* 10% adverse change of each Value Driver at a time

Value Drivers

Sales Growth Rate (SGR%) Operating Profit Margin (OPM % sales) Cash Tax Rate (CTR % of OPM) IFCI (% incr sales) IWCI (% incr sales) Weighted Average Cost of Capital Depreciation (% of sale) RFCI (= depr)

Growth in perpetuity

Inputs

Sales prior year Cash and marketable securities Market Value of Debt Value of Equity Options Number of shares outsdanding (mill)

Corporate Value Share price

Key valuation assumptions: 1. SGR in Y1-Y3 will be negative due to economic slowdown, but will improve and be consistent delivering ~8% growth. 2. OPM is expected to grow, a conservative figure of 2% is assumed in the Terminal value 3. IFCI is assumed at 20%, as post acquisition the focus will be on expansion 4. IWCI is assumed at 30% in order to ensure ample working capital for day to operations 5. WACC of 7.90% is highly due to Dixon's Beta being very high compared to the industry

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4.3. Bidding Price


Share price of Dixon Retail Plc as of 13-03-2012 was at 14.80p. J Sainsbury should consider the fact that this can be one of the best opportunities for it to acquire the group as the company is highly undervalued because of its financial instability. Keeping the above facts in mind, J Sainsbury will be bidding the Dixon Retail Plc. (Target) at a 60% premium with a share price of 23.68p. This bid price is a strategic move in order to ensure that Dixon Retail Plc. is in no position to reject the offer. Therefore the premium paid by J Sainsbury to the shareholders of Dixon retail in value will be 3.2bn. J Sainsburys bid might look very optimistic however there is possibility that the offer can be rejected by shareholders, nevertheless J Sainsbury will keep in mind that they remain flexible and offer a premium anywhere between 60%-80% of the current share price of Dixon Retail Plc. i.e.14.80p.

5. Riposte to the bid of Dixon retail plc.


The offer of Sainsbury to acquire Dixon Retail Plc at a share price 23.68p, with a premium of 32bn to Dixon shareholders the probability of bid being rejected is very unlikely. Dixon Retail Plc. will be left with the question that if they can bring this value to their shareholders if the acquisition doesnt take place. With the current level of operation and financial instability Dixon Retail will have seldom reasons to believe that. However, given the market share of Dixon retail Plc. it will be looking at the possible synergies it can attain together with J Sainsbury and create value for its shareholders. Cash rich J Sainsbury, with an exceptional turnaround time of it inventory and its process expertise in retailing will be of great value to Dixon Retail Plc., as they are struggling to get their operations cost lower and maintain enough working capital for their day to day operations. The high cost of capital of Dixon Retail Plc. due to high beta of 2.2, and its impairment to raise further cash can be resolved by this acquisition as J Sainsbury is financially very strong and can be used as an instrument for further capital investment for the growth of Dixon Retail Plc.

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This acquisition will make the group emerge as a leader in all the aspects of retailing, and will bring value in terms of bargaining power with their suppliers and buyers. And will also have high potential in order to create barriers to entry for new players like Amazon.com etc. This acquisition will also be a great learning opportunity for both the firm, in terms of culture and organisational values. Both the companies share very common values of giving the best to its customers, with highly reasonable price. 4.1 Success or Failure of the Bid: The success of the bid will be determined with the assumptions made in the acquisition coming true and create value to the group. If the following synergies, Economies of scale, earning potential, Infrastructure and technology and synergies in expansion work as assumed in the DCF model this acquisition will be regarded as a high success and will create high value to the shareholders. Failures on the other hand will be if Dixon Retail Plc. resists the learning and growth opportunity that it can gain from the acquisition and J Sainsbury trying to impose its organisational culture over Dixon Retail which will create an imbalance and may lead to disputes within the organisation and can lead to potential failure of the acquisition. 4.2 Value Conception to Shareholder: The market will show a positive response to the acquisition, as J Sainsburys shareholders have high confidence in the potential this acquisition can bring to them. The market share of these two firms together will create a monopoly for J Sainsbury in the UK retail sector. The positive sentiment of the market will show an immediate increase in J Sainsburys share price and with all the probabilities considered the shareholders will welcome J Sainsburys decision to acquire Dixon retail plc.

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6. REFERENCES
Brealey, R., Myers, S. And Allen, F. (2010) Principles of Corporate Finance, 10th edition, McGrawHill. Damodaran Online: Acquisition Valuation.[Online] Available at: <<http://pages.stern.nyu.edu/~adamodar/>> (Accessed on 13Mar2012) Dixon Retail Plc. Annual Reports (2011) Available at: <www.dixonsretail.com/dixons/.../11-07-07_DixonsAnnualReport>(Accesed on 13Mar2012) Dixon retail Plc. market share[Online]: Available at: http://tutor2u.net/ (Accessed on 13Mar2012) J Sainsbury Annual Report (2011) Available at: <www.j-sainsbury.co.uk/ar11/>>(Accesed on 13Mar2012) Reuters (2011) Financial Highlights Dixon Retail Plc, Reuters [Online].Available at: http://www.reuters.com/finance/stocks/financialHighlights (Accessed: 13Mar2012).

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