A $9 billion buyout bid shames UK stock market

The latest private equity deal in the UK — the biggest in more than a decade — raises an awkward question for investors in the London stock market. How can the UK’s fourth-biggest supermarket chain be worth more to a consortium comprising Canadian pensioners and US buyout and real-estate investors than to the home crowd? It looks like the starkest evidence yet of private investors exploiting the widespread aversion to UK stocks.
The group that’s agreed to pay
6.3 billion pounds ($8.7 billion) for Wm Morrison Supermarkets Plc is led by funds run by Fortress Investment Group LLC, a buyout firm owned by Japan’s Softbank Group Corp. Alongside are the Canada Pension Plan Investment Board and Koch Real Estate Investments LLC, part of the business empire of the billionaire Koch family.
This does not look like a conventional leveraged buyout. The all-in price including assumed net debt is around 9 billion pounds. The consortium will fund that with just over 3 billion pounds of equity, the rest from new borrowings. To get a private equity-style 20% return would mean taking out 8 billion pounds from a sale after five years. That’s a tall order.
Morrison generates a lot of cash so part of the required uplift could come from paying off debt. At least 2 billion pounds of deleveraging looks plausible. But the acquirers would still need to sell the business for more than they paid. To do that would require both growing Ebitda and selling on the same punchy
8-times multiple of profit on this measure that Fortress says it’s offering. Good luck with that.
UK retail faces inflationary cost pressure that is hard to pass on to consumers due to intense competition on price. Maybe with private
equity’s relentless focus on performance, Morrison could lift Ebitda margins slightly from the current 6%. (Tesco Plc’s are expected to be around 7% this year.) But even if that happened, could the consortium really sell Morrison on the same valuation multiple? This sector is changing fast. Who knows how grocers will be valued later this decade if the sales migration online accelerates.
Against that backdrop, the investment makes more sense as a
lower-return, longer-term hold. Management would then be focused on defending Morrison’s annuity-like cash generation and improving efficiency here and there. But if that’s the case, couldn’t stock-market investors be persuaded to see Morrison the same way? There is nothing these buyers — essentially a joint venture between private equity, long-term investors and real-estate experts — can do that the company can’t do now.

—Bloomberg