By Marvin Stenersen (Stockholm School of Economics)
Unsplash - Kenny Eliason
Introduction
Over the Summer a fierce bidding war for the 122-year-old UK grocery chain Morrisons has dominated the UK Private Equity market, but now it seems like it is coming to an end. On August 20th Morrisons agreed to the latest offer of £7 billion from U.S. private equity group Clayton, Dubilier & Rice, dropping the lower £6.7 billion bid made from a consortium led by the Softbank owned Fortress Investment Group. It is expected that the board will approve the deal, however, the vote is not until early October, so the possibility of a higher bid remains as Fortress has, according to Reuters, “[...]the firepower to go higher.”
The deal comes on top of the faster than expected UK recovery where UK firms have been particularly attractive to takeovers, in a combination of reduced post-Brexit trade uncertainties and growing cash holdings by PE firms. Morrisons in particular with their unique vertical integration, strong brand and strategic Amazon partnerships in the UK grocery market has made them very attractive. They offer an entry into the growing UK online food retail market which is the second largest in the world in addition to an extensive real estate portfolio and supply chain with exposure to the growth of Prime and Amazon Fresh in the UK. Assets that CD&R is set to capitalize on.
The current offer of £7 billion from CD&R puts the value of Morrisons at 285 pence a share, giving the supermarket chain an implied enterprise value of £9.7 billion once the debt is factored in. The offer will be funded with more than £3.4 billion of equity whereas the £3.6 billion debt will be underwritten by a syndicate of banks. The bid represents a 60% premium to Morrisons share price before takeover interest emerged in mid-June 2021.
Overview of Morrisons (Target)
Morrisons is the fourth largest supermarket chain in the UK with a market share of 10.4% as of May 2019 of the over £200 billion large UK food market. Morrisons operates 494 grocery stores in the UK (2020 numbers) and has over 110 000 employees. For 2020 they reported revenues of £17.598 billion and an operating income of £0.254 billion, representing an EBIT margin of around 1.44% which is down from last year.
In addition to their physical stores they have since 2012 operated an online retail site Morrison.com. Their online retail site has grown during the pandemic and its reach has been expanded through increased fulfilment centre capacity and in-store and delivery solutions provided by their 8-year long strategic partner Ocado. Since 2020 Morrison have extended their home delivery offering and fulfilment centre reach to over 90% of UK postcodes according to their 2020/2021 financial report.
Morrison supplements their online and physical stores with a sizable vertically integrated supply chain where they manufacture over 50% of their products in contrast to many of their UK competitors according to Reuters. This has meant that since 2016 they have partnered with Amazon to supply their customers with Morrison products. This alliance has helped Morrison who has been a laggard in the online food retail market, with Amazon sales now representing 10% of their store sales where it is offered.
Overview of CD&R (Acquirer)
CD&R is a US-based private equity firm with over $40 billion under management as of March 2021. Their core strategy consists of striving to enhance the value of each business they acquire by implementing “a combination of long-term growth, productivity, capital efficiency, and strategic measures.” They have done this historically using among other strategies a reward sharing system with current management to align incentives.
They are also well known for working with the current management, something which has given them a very good reputation. The deal with Morrison is no different as they have committed to support current management strategy and not sell off real estate assets, but instead, help the firm grow.
This is according to Morrisons chairman, Andrew Higginson, a key reason for the broad support of the offer as it ensures that the “fundamental character of Morrisons” is protected for all stakeholders.
Synergies
CD&R is targeting a strategic partnership to develop Morrisons wholesale business and convenience store portfolio while supporting their growth in online food retail through their existing online site and their key supply agreement with Amazon. CD&R aims to support Morrison using their experienced managers, including the former Tesco CEO Terry Leahy. With the hopes that this will improve the position of the firm and open the way for growth.
CD&R senior adviser Terry Leahy believes that Morrison is well-positioned in the changing UK grocery sector with its good brand value and heritage according to a comment he made concerning the takeover. Leahy states that with CD&Rs support and expertise from among others the former Tesco CEO, that they will be able to help Morrison succeed in this changing market environment.
The “change” refers to among other things the increasing demand for digitalization in the UK which as of now the world's second-largest market for online food retail according to Reuters, a growing demand Morrison has historically lagged to capture due to their late 2012 online entry.
It seems likely then that the synergies from the deal will be gained in the use of the recapitalization of the firm paired with the expertise from the advisors at CD&R to help Morrison on their “New” Morrison initiative of developing their online offering attractiveness, their stores reach, all while broadening their business through strategic partnerships such as the supply agreement with Amazon as to make them better positioned to meet the change and to benefit from both a low-cost base by being vertically integrated and ability to current in-store and online-store customers on their platform and through amazon.
Risks and Uncertainties
The deal has yet to be closed and further bidding can continue until the vote in early October, however Fortress nor any other prospective party has yet to make any counteroffer as of the 5th of September 2021. Given the already high 60% premium it might seem unlikely but the previous demand has been large.
The margins in the grocery business are slim and this comes on top of the pandemic where the costs per unit of sale have increased as distribution and delivery costs have increased, and this has in combination with supply chain disruptions impacted the profitability of the firms negatively. Morrison has been no different, yet their broadening offering with supplying amazon, expanding online and store presence can prove synergetic going forward yet realizing these revenue enhancements and cost reductions can take time during which they already operate at increased costs.
The full impact of Brexit has yet to be seen as the pandemic has muddled the effects, while Morrison according to the CEO in a statement made in January this year, sources 66% of their supplies from the UK, what happens to the other 34% and how that will impact Morrisons’ current cost structure in the wake of tariffs and the current delivery shortage remains to be seen in full, so far however no significant impacts have been recorded according to Morrisons.
Summary
This is the latest large buyout transaction in the wave of transactions that have swept the UK in 2021. While the deal is not closed yet, the strategic commitment of CD&R to support and grow the business has given them unanimous board approval in a market famed for its asset sell-offs. Whether or not CD&R wins the bidding war remains to be seen till October however, as Fortress and other bidders might not have thrown in the towel just yet.
Works cited
https://www.bloomberg.com/opinion/articles/2021-08-20/morrison-takeover-barbarians-at-the-supermarket-should-tread-carefully (For the graph, Felsted, Andrea 20 Aug 2021, gathered 2020-09-05