Morrisons: the perils of Private Equity
COVID-19 Market Update – 25/06/2021
11 minutes to read
Introduction
This is the 45th of a series of weekly notes analysing the state of the UK retail market in the light of the COVID-19 pandemic. This note focusses on two key themes:
- The implications of CD&R’s approach to acquire Morrisons
- Grocery market: further “normalisation”
Please do not hesitate to contact myself or any of my retail colleagues if you require any further information.
Key Messages
- Private Equity firm CD&R in unsolicited £5.5bn bid for Morrisons
- Bid rebuffed by Morrisons board
- CD&R has until 17 July to make firm offer
- Could spark interest from other PE houses
- Question marks as to the availability of debt
- Dangerous precedents of PE-ownership of UK retailers
- Ca. 85% of Morrison’s real estate is freehold
- Sale & leasebacks need to be strategic rather than wholesale
- CD&R advised by former Tesco CEO Sir Terry Leahy
- No transparency on his potential involvement if deal is reached
- Take home grocery sales down -1.6% in last 12 weeks
- Grocery spend still £3.3bn higher than 2019
- Many pandemic trends are reversing/unwinding
- Only 76% of hospitality venues are currently open
- Ca. 25,000 hospitality venues remain closed
- On-trade drinks still down -19% on 2019 levels.
1. The implications of CD&R’s approach to acquire Morrisons
In a week where Harlequins’ epic, record-breaking comeback win in the play-offs to reach the Rugby Premiership Final totally eclipsed every other news item on the planet, there were still some very interesting developments in the retail market, not least the surprise takeover bid for Morrisons.
The facts before the whys and wherefores. Morrisons was subject to an unsolicited £5.5bn bid from New York-based private equity firm Clayton Dubilier & Rice (CD&R) at the week-end. Of huge significance is the fact that the US buyout firm is advised by former Tesco CEO Sir Terry Leahy. Predictably, Morrisons rebuffed the approach, stating that the “highly conditional non-binding” 230p per share proposal “significantly undervalued” the company. CD&R now has until 17 July to make a firm offer for Morrisons.
Morrison’s share price surged on the news, rising 35% from 178p to 240p in early Monday trading alone. It is currently still around the 233p mark. Having been brought into play, there is ongoing speculation that other PE and even trade interest could be ignited. And this may potentially extend to other operators, Sainsbury’s especially. In the meantime, the shopworkers’ union Usdaw and the shadow minister for business and consumers have waded in and raised concerns about private equity ownership of UK grocers.
Fevered M&A activity in retail feels like a throwback to a bygone age, but I suppose we should be grateful for any change from the doom and gloom of CVAs and COVID. But that doesn’t necessarily mean it’s a positive state of affairs. And there are many more questions than answers.
Why the interest in Morrisons? First and foremost, it’s fundamentally a great business. It’s the UK’s 4th largest grocery retailer (with a market share of 10%+) and is trading well with a strong management team, led by the excellent David Potts. Detractors point to supposed strategic weaknesses such as over-dependence on big box supermarkets as opposed to convenience stores. and a small online arm that is reliant on 3rd parties such as Ocado and Amazon. But Morrisons has USPs as well, particularly its Marketplace fresh food concept and vertically integrated supply chain.
But to cut to the chase: any PE interest in Morrisons will undoubtedly centre on its real estate. For all its other merits, this is where “most value can be unlocked” = “where most fast bucks can be made”. Morrisons reportedly owns 85%+ of the freeholds of its property portfolio (stores, distribution centres, offices etc), partly a by-product of being predominantly a big-box operator. In simple terms, Morrisons trades mainly from big (30k sq ft+) superstores, which it owns.
The actual timing of the bid is perhaps more curious than it may appear. Sentiment towards supermarkets is clearly very positive at the moment, foodstores being perceived to be one of the few “winners” of the COVID pandemic. Strong consumer demand maybe, but hugely inflated cost bases tell a slightly more nuanced story. But if nothing else, few could question the resilience of foodstore operators, which has been proved beyond doubt over the past 18 months.
But wind the clock back five or so years, sentiment was completely different. As the UK grocery sector was supposedly on its knees (remember the horsemeat scandals?), many would not touch the sector with a barge-pole. Ironically, some analysts (I would love to name and shame, but won’t) boldy predicted that the “Big Four” would become the “Big Three”, with Morrisons being the one to fall by the wayside. For my money, anyone wanting to make a fast buck out of Morrison’s property portfolio would have been able to acquire Morrisons far more easily and cheaply then than they could now.
“The pros and cons of PE-ownership of retailers. Discuss”. A particular hobby horse of mine, as many will know. I have never been backwards in coming forwards in expressing how PE-ownership of retail operators usually ends in tears, sooner or later. Usually later. The list of retailer failures, recent and in the dim-and-distant past, often has a common denominator of PE ownership, current or historic. It is not conincidental.
But that is not to say that PE is intrinsically bad, by any means. But it is clearly far more suited to some markets (e.g. real estate) than it is others (e.g. retail and leisure) and a clear dividing line needs to be drawn between the two. To quote one of my mantras: retailers need to be run as retailers, by retailers, not as cash cows, by financiers.
Wearing a purely retail hat, the prospect of Morrisons falling under private equity ownership is not a good one for the prosperity and longevity of the business. It is very hard to see how any PE house could add any value to the business, or bring any improvement beyond short-term investment.
Would a sale and leaseback of the property portfolio really be that bad? It depends how deep it goes and whether sensible balances are struck. And this is where the retail and real estate hats start to conflict. Strategic sale and leasebacks remain an effective way for a grocery retailer to access capital quickly and are part and parcel of their modus operandi. But wholesale sale and leaseback of entire portfolios (or large portions thereof) has proved the undoing of many a failed retailer. Cash extraction for the PE owners, onerous long-term lease and rental obligations for the retailer. c.f. Debenhams.
The involvement of Sir Terry Leahy is an intriguing factor in the CD&R bid. For the uninitiated, he was one of the driving forces behind Tesco’s meteoric rise to the huge success story it became in the 1990s and 2000s, leveraging the groundwork laid by his predecessor Lord MacLaurin. For some, his reputation was temporarily tarnished on leaving Tesco in 2011, with many blaming Tesco’s subsequent travails on his legacy. But maybe he was just smarter than that, knowing when to get out?
Be that as it may, Sir Terry Leahy remains a true captain of the retail industry, of which there seem to be precious few these days. To revisit my previous mantra, there is a the prospect of Morrisons being under PE ownership, but still being run as a retailer (which it needs to be), by a retailer (which Sir Terry Leahy certainly is). But obviously much of this will depend on the level of involvement he would have in the day-to-day running of the business, if the deal were to come to fruition. And we have no transparency on that as yet.
Will the deal come to fruition at all? We can but speculate on this. From the murmurings, it seems likely that CD&R may return with an improved offer, but even then it might not be enough to secure a knock-out blow. Will it flush out other offers? Other private equity firms such as Apollo and Lone Star have been touted, but the question has got to be how easily accessible £6bn+ of debt is in this market? A degree of constraint, surely?
Will it spark a bidding frenzy across the UK grocery market? I remain to be convinced that it will. The notion of one acquisition kick-starting a wave of activity across the market feels slightly anachronistic in this day and age. More likely is that nothing will come from this bid at all and the whole tidal wave of activity predicted in many parts of the media will be little more than a storm in a teacup.
2. Grocery market: further “normalisation”
Away from all the M&A speculation, there was further evidence this week of the UK grocery market slowly returning to normal – less spikey demand, more frequent shopping trips, smaller basket sizes, declining online sales, renewed market share gains amongst the discounters. So much for “permanent changes to shopping behaviours”.
According to industry analyst Kantar, take-home grocery sales over the last 12 weeks (to 13 June 2021) declined -1.6% year-on-year. There was something of an inevitability in this, in that the sector faced two significant challenges in this period, one competitive (the reopening of hospitality) the other mathematical (sales surged +16.9% in the corresponding period in 2020).
In qualifying the numbers, Kantar pointed out that grocery sales in the past 12 weeks were still £3.3bn higher than in 2019 before the pandemic hit. Perhaps more interestingly, retailers were also increasingly benefiting from sales of goods consumed on-the-go, such as picnics and lunches eaten at work, which are not captured in these numbers.
The data also showed a return to more frequent grocery shopping visits, with average basket spend per trip down -13.6% year-on-year for the 12 week period. Online penetration plateaued at 13.4% in the four weeks to 13 June, still somewhat higher than equivalent “official” figure from the ONS (10.9%).
Conversely, the discounters continued to make market share gains for the period, as customers returned to stores and gravitated away from online, where neither Aldi nor Lidl have a presence of any note. Aldi was the fastest growing grocer for the period, with sales up +6.6% and a +0.7 percentage point increase in market share to 8.2%. Lidl achieved sales growth of 4.9%, while its market share increased by +0.3 percentage points to 6.1%.
The “Big Four” either increased share or held steady. Tesco recorded a fifth consecutive month of market share gain (+0.2 percentage points to 27.1%), while Sainsbury’s and Asda both improved at a similar rate (+0.2 percentage points to 15.2%, +0.2 percentage points to 14.1%, respectively). Morrisons stayed flat at 10.1%.
In contrast, the Co-op saw the biggest market share decline, falling back from 7.4% last year to 6.3% this period. Again, this reflects another lockdown trend gradually unwinding, with shoppers increasingly feeling less constrained to shop locally. Having enjoyed spectacular sales increases over much of the pandemic, Ocado’s sales growth has decelerated considerably to “just” +5.4%, while its share increased by +0.1 percentage point to 1.8%.
Despite pubs and hospitality businesses being allowed to reopen during the period, Kantar also noted that sales of take home alcohol jumped by £29m due to the late May bank holiday and the start of the Euros. This was echoed in another industry body’s figures this week. The CGA’s Drinks Recovery Tracker (which represents the on-trade) showed that average sales in the week to 12 June were still down by -19% on the same week in 2019.
The CGA figures underline how far the hospitality sector has to go in getting back on its feet. Drinks sales in pubs (-13% vs 2019) were better than restaurants (-30%), while bars are still lagging considerably (-48%). More sobering still (pardon the pun), CGA’s Market Recovery Report flagged that around 25,000 licensed premises were still shut at the end of May 2021. Some 76.2% of the UK’s licensed sites were trading by the end of last month, with the number more than doubling from April’s total of 32.9% thanks to the return of inside service.
In the words of Jonathan Jones, CGA’s managing director, UK and Ireland: “Last week showed us once again that there is a very close correlation between drinks sales and the weather. It was also a good guide to the level of sales that we can expect in the next few weeks. A strong Euro 2020 tournament for the home nations would undoubtedly boost sales, but the government’s four-week delay to the full easing of COVID-19 restrictions is a huge blow to drinks suppliers and operators ahead of what should have been a bumper period of trading.”
The Euros are in full flow. The Olympics follow next month. Wimbledon starts on Monday, But before all that, the biggest one of all, the Premiership Rugby Final tomorrow. COYQ.