The FTSE 250 group recommended shareholders to approve a GBP6.3bn offer from Fortress Investment, then Apollo Global Management confirmed it’s considering its own approach, while rejected suitor Clayton, Dubilier & Rice may as well come back with a new proposal.
Fortress’s offer was 254p per share but the stock was trading at 266p on Monday afternoon, meaning the market suggests there’s scope for an increase.
Many are surprised that Amazon Inc (NASDAQ:AMZN) hasn’t put an offer down, considering it is Morrisons’ wholesale partner and already owns Whole Foods.
“I think the focus right now with private equity looking at UK grocery is really just that there’s a tremendous value proposition that’s to do with real estate, so it’s almost a real estate play, a real estate financing, rather than a pure grocery play,” said Steve Windsor at Atrato Capital, the investment adviser of Supermarket Income REIT PLC (LON:SUPR).
“The stock market doesn’t appreciate the fundamental corporate value of grocers like Morrison’s. The market cap of the UK grocers simply reflects a multiple of trailing underlying earnings (EBITDA) and fails to incorporate the hugely material value of the underlying real estate. You can make the same argument for Sainsbury’s (LON:SBRY) and Tesco (LON:TSCO).”
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 GBP1.2bn 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 GBP49m writeback of past impairments. Small beans compared to the GBP1.27bn hit in 2015, but perhaps the start of a trend
— Jonathan Eley (@JonathanEley) June 20, 2021
The property portfolio is worth more than the market cap of the company so private equity see a valuable investment proposition.
That’s exactly what happened with Asda when it was taken over by the Issa brothers and private equity firm TDR Capital.
The price tag was GBP6.8bn but the pair only had to put up GBP780mln each, while the rest was borrowed using Asda’s assets as collateral.
They might be about to see some returns already, after React News reported that Blackstone Group Inc has agreed to buy the warehouse properties for GBP1.7bn. The 25 properties will then be rented by Asda.
We are likely to see “the same copy paste” process when and if Morrisons ends up in private equity hands, Windsor said.
“You can almost oversimplify it as: buy the company with leverage, sell off a bit of the property, take the property sale proceeds as a special dividend and you then own the company for zero or very little cash in,” he told Proactive.
“Financing is very cheap at the moment for grocery assets, those Asda secured (by property) bonds are now trading at just above 3% yield , that’s pretty attractive to any leveraged buyer. It also makes supermarket property look even more attractive, leases are just another form of financing.”
Food tastes different
Investors have adopted a fresh perspective on the grocery sector, especially after the pandemic sped up the shift to online shopping.
“Grocery used to be perceived as a boring bit of the retail sector, it has always been cash generative but nobody really focused on it,” said Windsor.
“As online takes off, people are realising that actually these big grocery supermarkets are also really good logistic sites.”
The most attractive sites are large supermarkets with the capacity to send out home deliveries, as they reflect the future of food shopping: some of it is in person, some is online.
Jobs would be protected in this scenario, according to Windsor, as a new owner is unlikely to just turn existing sites into pure-play warehouses.
Unions and MPs have been expressing concerns over a potential Morrisons takeover, as previous deals of this kind – such as with Debenhams – have led to job cuts.
“Food retail is not an easy sector in which to make money and competition is only getting tougher. It will be interesting to see if Morrisons’ new owner, assuming a bid is successful, slashes the supermarket’s prices to gain market share. However, if it was that easy, widespread price cuts would have already been pushed through,” said Russ Mould, investment director at AJ Bell.
“At the end of the day, there is a balance between trying to attract customers and making sure the business still makes a profit. Morrisons doesn’t want its stores resembling a jumble sale with pallets acting as shelves and minimal staff.”
“It wants customers to have a good shopping experience and feel as if they are buying decent quality produce – and to do that, it cannot afford to be in the race to the bottom.”
Shares surged 11% to 266.23p on Monday afternoon.