A bidding war for Morrisons?

Supermarkets are typically associated with cutting prices wherever possible. For more than a decade, this operational mantra has been mirrored in the gradual downward drift in the sector’s share prices.

But that suddenly changed this week, after an unsolicited takeover approach for WM Morrison (MRW) pushed up shares in the Bradford-based grocer by more than 31 per cent to 234p. That was beyond the non-binding, 230p-per-share offer tabled by US private equity firm Clayton, Dubilier & Rice (CD&R) last week, suggesting the market expects a bidding war to emerge.

News of the original offer, which was put to Morrisons’ board on 14 June, broke over the weekend, prompting a rebuttal from the supermarket, which argued CD&R had “significantly undervalued” the business and its prospects.

Under the Takeover Code’s put-up-or-shut-up rule, the private equity group has until 17 July to make a firm offer. But there is already speculation that their interest will spark a bidding war. 

Potential contenders include US private equity firms Lone Star and Apollo Global Management. Both firms were in talks to buy Asda from Walmart (US:WMRT) last year, although were eventually beaten out by the billionaire Issa brothers and private equity firm TDR Capital, after they put in which gave Asda an enterprise value of £6.8bn. After the inclusion of £3.2bn in net debt, CD&R’s offer gives Morrisons an £8.7bn enterprise value. 

A private equity approach is also likely to reignite speculation that Amazon (US:AMZN) could enter the fold, given it has an established partnership with the grocer. The e-commerce giant has committed to supermarkets as a long-term growth strategy, having bought US chain Whole Foods for $13.4bn (£9.7bn) in 2017.

Earlier this year, we also suggested investors take another look at Morrisons’ bull case.

Though UK grocers’ weak growth, wafer-thin margins and dogged competition have tarnished the sector’s attractiveness as an investment in recent years, their reliable cash generation and strong asset bases are now seen as virtues since the start of the pandemic.

Sales for both Morrisons and the wider sector were juiced by grocers’ designation as essential retailers last year, although more than £300m in Covid-related costs to date show this has been a double-edged sword. What’s more, until news of the bid emerged it appeared investors viewed the past year’s surge in like-for-like sales as a one-off.

Analysts have also highlighted the simplicity of the sector’s business model as a key attraction to private capital. This is particularly true of Morrisons, which unlike rivals Tesco (TSCO) and J Sainsbury's (SBRY) is unencumbered by legacy bets on international markets, banking or non-grocery retail.

Second, despite suffering a recent shareholder rebellion over executive pay, chief executive Dave Potts and his team are well-respected in the industry. Notably, Potts and several members of his top team previously worked at Tesco under its former chief Sir Terry Leahy, who now serves as an adviser to CD&R.

Under Potts, Morrisons has focused on growing its in-store and online capacity. The latter strategy has accelerated since the pandemic hit, thanks to the Amazon tie-up, doorstep deliveries, a popular food box range, and a successful trial with the Amazon-backed last-mile delivery group Deliveroo. And while discounters Aldi and Lidl remain a threat, their deliberate under-investment in online channels could yet prove a weakness amid profound changes in weekly shopping habits.

But how real is the prospect of a counter bid? The answer partly depends on interested parties’ ability to raise enough cash to both win over shareholders and absorb all debts. For Amazon, this would unlikely pose a problem, though it would no doubt have different designs for the FTSE 250 group and the strategic value of its large asset base.

Indeed, CD&R or another private equity bidder may see a chance to repurpose a £7.4bn property portfolio. The chain’s net asset value of 175p per share could also sharply improve in the coming years as a negative working capital position unwinds and the group pays down its debts.

Theoretically, this would be easier if shareholder dividends were removed from the picture, though this is somewhat muddied given the tax structures and debt-loading practices favoured by private equity. At a 230p bid price, Morrisons’ enterprise value is also less than eight times’ this year’s forecast cash profits – low enough for directors to make a convincing case for the rejection, in light of long-term growth plans.

However, the prospect of the sale of such a key UK food supplier, taxpayer and employer is likely to draw heightened political scrutiny, meaning investors would be wise to temper their expectations of a payday.

Seema Malhotra, the shadow minister for business and consumers, highlighted the role Britain’s supermarkets played “to serve communities during the pandemic” and signalled her opposition to a takeover at the hands of private equity. “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,” she tweeted.

Nonetheless, this is a strong validation for a hitherto unloved investment story. Unsurprisingly, shares in Tesco, Sainsbury’s and Marks & Spencer (MKS) all rose on this approach, and on balance the prospect of a higher bid or bids seems likely. Buy.

Last IC View: Buy, 177p, 11 Mar 2021