British supermarkets are generally viewed as a sound investment for those wanting steady if not spectacular returns. Shoppers may regard them as essential, especially during the pandemic, but over the years their asset worth has not risen comparable to, for example, tech stocks.
This may be about to change because of the “bidding war” currently underway for supermarket chain Wm Morrisons. The fourth-largest chain in the UK after Tesco, Sainsbury’s and Asda, with 10% of the groceries market, Bradford-based Morrisons is being pursued by several American private-equity suitors.
Clayton, Dubilier & Rice, being advised by former Tesco supremo Terry Leahy, was the first above the parapet. It made an unsolicited bid that valued Morrisons at £5.5 billion, which was rejected by the board on June 17.
The board has now announced that it has agreed to recommend an offer from another US private equity group, Fortress, which values Morrisons at £6.3 billion. Fortress is owned by Japanese investment giant SoftBank, and would do the deal in partnership with Canadian pension fund CPPIB and a unit of US conglomerate Koch Industries.
But before shareholders decide whether to go ahead, Apollo Global Management, another private equity group, has said it is looking at making a counterbid. Morrisons shares are consequently up 11% at the time of writing. And meanwhile, Asda has just had its own £6.8 billion takeover deal by the Issa brothers and private equity group TDR Capital approved by the UK competition authorities.
So why the sudden activity, and what does it mean for the sector as a whole?
The Morrisons way
Morrisons, like most British supermarket chains, has a long pedigree. It was founded in 1899 by William Morrison as a market stall in the city of Bradford in the north of England. His son Ken took over in 1952 aged only 21, and oversaw the opening of Bradford’s first “self-service store” six years later.
The chain remained primarily based in the north of England until it bought Safeway in 2004. It went through some hard times after that takeover, issuing numerous profit warnings, but has since stabilised operations. It now employs almost 118,000 people and operates nearly 500 stores, 85% of which it owns outright (the average for the sector being less than 60%).
In what is seen as a very individual approach, Morrisons runs an integrated supply chain, for example owning food manufacturing facilities and a fishing fleet. I view the company’s approach as being similar to the Japanese quality philosophy in the way it ensures long-term relationships with suppliers and farmers.
This, along with the high store ownership, is likely to be what has made Morrisons attractive to private equity, at a time when the whole sector is viewed as undervalued – particularly following the pandemic. Supermarkets generate steady cash flow, and private equity investors like asset-rich companies with the potential for reducing costs and increasing sales.
Yet private equity has a bad reputation for extracting the maximum profit from companies by breaking them up and loading them with very high levels of debt. The quid pro quo is that these buyers would argue they achieve stunning returns for investors, although peer-reviewed research has raised doubts about this.
Inevitably there will be worries that Morrisons and Asda will suffer from this approach, thus undermining their ability to deliver value and quality to their customers. In this respect, department store chain Debenhams is a case in point. The trio of investors who bought Debenhams in 2004 tripled their money in three years by cutting costs, discounting products and greatly increasing debt. With the Debenhams brand taken over earlier in 2021 by online retailer Boohoo and the stores all closed, some would argue it never recovered from its private equity phase.
In the case of Morrisons and Asda, private-equity investors may be tempted to increase “value” by, as the vernacular goes, “stripping out” avoidable costs. This could mean fewer stores and reduced staff, plus potentially changing the quality of products.
Andrew Higginson, the Morrisons chief executive, has anticipated such likely concerns by stressing that Fortress has committed to keeping the headquarters in Bradford, safeguarding company pensions and supporting its commitment to pay all staff at least £10 per hour. Fortress, which also took over Majestic Wine several years ago, added that it had no “material” plans for sale and leasebacks of Morrisons stores.
The trouble is that commitments to maintain things like staff pay and conditions can be dispensed with if market conditions are thought to dictate. Cynics would point out that comparable guarantees were made by American food behemoth Kraft in its takeover of chocolate maker Cadburys in 2010. After a decent interval, and once attentions had shifted elsewhere, numerous commitments were dropped.
Time will tell if the same thing happens this time around – whether or not Fortress is the ultimate buyer. It is hard not to fear that staff are under threat, and customers could be facing less choice and increased prices. The risk to local communities is obvious. If the worst comes to pass, we all end up poorer.
On the prospect of anything being done, it is hard to see the government intervening in any takeover by any private equity investor. In the case of the Asda deal, the UK competition regulator did raise concerns that the new owner was also the owner of some Asda petrol stations. It agreed to the deal after the Issa brothers offered to sell some forecourts.
It is worth noting, however, that a proposed 2019 merger between Asda and Sainsbury’s was blocked by the regulator, which stated that: “Following our in-depth investigation, we have found this deal would lead to increased prices, reduced quality and choice of products, or a poorer shopping experience for all of their UK shoppers.”
Since the same concerns could equally be levelled at private equity, it is surely time someone asked why it never is.