The potential private equity takeover of Wm Morrison Supermarkets PLC (LON:MRW) has fired up debate in the City.
The supermarket giant has rejected the unsolicited £5.5bn bid from US private equity firm Clayton, Dubilier & Rice on the grounds that it “significantly undervalued” the business.
Morrisons holds 10.1% of market share in the UK, according to the latest Kantar data, with sales totalling £3.1bn in the 12 weeks to 14 June, which was 1.5% lower than the same period last year but 8.9% higher compared to 2019.
However, CD&R may come back with a higher offer and some are even expecting Amazon, which is Morrisons’ wholesale partner, to start a bidding war.
“The sector generally looks undervalued, and private equity look to be interested in Morrisons partly because it has a lot of freehold property which they would ‘sale and leaseback’ to generate cash to pay back to themselves,” Andrew Koch, senior fund manager, active equities at Legal & General Investment Management, told Proactive.
“That’s not adding any genuine value, and the company could do that themselves. So I would personally not expect a bid to succeed at that level.”
Morrisons, one of the largest UK private-sector employers with 118,000 staff at almost 500 stores, has 87% freehold ownership across the whole estate.
In its annual accounts it compares the book value of stores to their recoverable value, which forecasts how much money it could make.
After a £1.2bn impairment in 2015, when sites were struggling with low-density sales, the company is now recovering after the pandemic boosted value for large superstores.
In the year to Feb 2021, Morrisons started to incorporate in-store picking revenues into its calculations of “value in use” for the first time
The result was a £49m writeback of past impairments. Small beans compared to the £1.27bn hit in 2015, but perhaps the start of a trend
— Jonathan Eley (@JonathanEley) June 20, 2021
CD&R is also likely to be attracted to the petrol station estate, which would make a nice combination to its portfolio company MFG, the leading UK forecourt operator with over 900 locations.
The situation presents many parallels with the recent acquisition of UK grocer Asda by the Issa brothers, owners of forecourt operator EG Group, as there is similar freehold property value extraction and potential synergies in the petrol stations segment.
The government is fretting already as the Business, Energy and Industrial Strategy Committee is preparing to contact the Competition and Markets Authority, The Telegraph reported.
A Labour MP also expressed concern as previous deals of this kind have led to job cuts.
“Our supermarkets that play a role at the heart of our communities need owners that put the long-term interests of the business and its employees first,” Seema Malhotra, shadow minister for business and consumers, was reported as saying by The Times.
“When Debenhams went bust we saw private equity firms walk away while employees lost their jobs and staff who have paid into the pension scheme were left out of pocket. Too often dodgy private equity firms load the companies with debt and leave while pocketing the dividends. This has to end.”
Private equity bid for Morrisons seems pretty divisive on my timeline…but what exactly is it about these debt-loading tax dodgers that brings out the cynic in people?
— Patrick O’Brien (@pat_gdretail) June 22, 2021
In fact, in the £6.8bn Asda deal, the Issas and TDR only had to put up £780mln each, while the rest was borrowed.
The risk in these deals is usually calculated based on the business being acquired – and supermarkets are currently among the most stable – while the current low-interest rates make the debt repayment more affordable.
In the case of Asda, the interest will be around £125mln per year, which can be covered comfortably by the £500mln of cash the grocer makes annually.
“Historically the UK supermarket sector has been viewed as a slow growth, highly competitive market. As such, it wasn’t seen as a natural source of takeover activity,” AJ Bell investment director Russ Mould.
“Mergers were more plausible, such as we saw with Sainsbury’s trying to marry Asda to gain scale and find a new source of earnings growth. But non-trade buyers swooping for deals didn’t seem like an obvious play until we saw the Issa brothers snap up Asda after the Sainsbury’s deal collapsed.”
More to follow?
Although it’s valued at £18bn, Tesco “is not too big to be subject to an offer” said analysts at broker Shore Capital.
These deep-pocketed investors have just started a new season of dealmaking, according to experts, after the pandemic delayed previous acquisitions and hampered new ones.
“Most of the frenzy is attributable to the resumption of risk-on behaviour, easy credit, substantial dry powder stores, and the handsome multiples that sellers can now command,” noted Rebecca Springer, analyst at PitchBook.
“While some PE firms are shopping in industries that are still awaiting a full recovery, most are on the hunt for high-quality assets with strong growth potential. It’s becoming easier to distinguish ‘COVID effects’ from underlying market defensibility and balance sheet quality through careful due diligence.”
Morrisons, which soared 34% on Monday after the news emerged, dipped 1% to 238.15p on Tuesday at noon.
–Adds Kantar data–