Be brave, coach Jürgen Klopp shouted at the weekend and encouraged his Liverpool football team. But discretion ultimately was the best part of courage for two U.S. buyout groups fighting for Wm Morrison. Clayton, Dubilier & Rice won it about Fortress with a penny per share at £ 2.87, a business value of almost £ 10 billion. Shares in the UK supermarket chain fell almost 4 per cent on Monday.
Debate over the bid battle – resolved via a takeover panel auction – has been polarized in the UK. One camp laments the alleged undervaluation of shares by domestic investors. The other one is incredible about the sharp prices that American private equity pays. CD&R will have to print a lot of Morrisons. Lex expects that asset sales will be necessary to achieve a proper investment return.
Supermarkets have not earned a premium rating lately. Their return on invested capital has been declining for a decade and halved to 5.2 percent last year. The figure for Morrisons was even lower. Listed European supermarket shares trade at discounts of up to a fifth against the local market in terms of earnings.
CD&R has promised that it will not loot the Morrisons estate and will not make major cost cuts. It would therefore have to be smart to raise £ 2.5 billion or more through asset sales. It is necessary to achieve a typical annual internal rate of return of 20% over five years, thinks William Woods at Bernstein.
In 2027, it would also have to fetch a good selling price for its investment of no less than 6.5 times future ebitda. A 5.5-time exit shrinks back to the mid-teens.
Early cash reduces investment risk and should improve returns. Morrisons can sell a few gas stations, perhaps to the car fuel group owned by CD&R. But most are linked to stores, making it difficult to separate.
The demand for specialist warehouses has increased with the popularity of e-commerce sales. Maybe CD&R could sell some of Morrisons’ six distribution centers. It could also potentially sell stores, perhaps up to a tenth of the estate. It can bring in a third of the cash.
CD&R and Fortress may have cash to burn. But the risk of paying too much through an auction, traditional bonfires, appreciates their fervor. The winner will have to work hard to justify this deal. The fortress feels slightly relieved.
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