Morrisons rival bidders may have little room to improve on Fortress bid

Deane McRobie, Ryan Gould, Claude Risner, Barbara Pianese
13 July 2021

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Bidders for UK-based grocer WM Morrison could find it difficult to justify a much higher offer than the 254 pence per share offer tabled by Softbank subsidiary Fortress, two sources familiar with the situation said.

Morrisons spurned the 230 pence per share offer from Clayton Dubilier & Rice (CD&R) on 19 June. The US-based private equity fund has since signed a non-disclosure agreement with the target to mull a better price, as reported. Private equity fund Apollo Global Management also confirmed it was in the preliminary stages of considering an offer.

Both CD&R and Apollo are seen as viable threats to Fortress's offer, one of the sources conceded, but maintained it would not be in their interest to pay much more than the premium tabled by Fortress. No one could say Fortress is getting Morrisons on the cheap, this source said.

CD&R has done enough work on Morrisons to understand what it could gain from an acquisition, the source said. The prospect of linking Morrisons with CD&R's Motor Fuel Group chain of petrol forecourts could justify it tabling a bid competitive with Fortress's, they said.

Morrisons has a duty to recommend to its shareholders a bid it feels is at least fair, and Fortress's 254 pence per share offer is in that ballpark, the second source said.

Fortress's offer represents a 42% premium to Morrisons' undisturbed share price and values the UK grocer at 8.3x EBITDA. Paying more than 8.5x EBITDA for a low-margin grocer would not be considered smart, the first source said, while the second source agreed that 8.5x could be considered a fair ceiling.

Based on its last closing price of 264.9 pence on Friday (9 July), Morrisons is trading at an EBITDA multiple of 8.6x, while J Sainsbury trades at 6.7x EV/EBITDA, Tesco trades at 8.5x, and Asda was bought out last year for 6.2x, according to Dealreporter analytics. On a forward-looking basis, using Fidessa's 2022 estimates, Morrisons, Sainsbury's and Tesco trade at 8.1x, 5.8x and 7x, respectively.

Meanwhile, Morrisons has a lower operating profit margin than its peers. For 2021, Morrisons, Sainsbury's and Tesco had respective operating margins of 1.7%, 2.44% and 3.1%.

Yet not all target shareholders are satisfied, the first source said. J O Hambro, which was reported last month to want 270 pence a share for its whole interest, remains underwhelmed, a source said. However, J O Hambro was reported last weekend to have hedged by cutting its stake from 2.97% to 2.33%, selling at prices between 233 pence and 267 pence a share. J O Hambro's ultimate asking price bases Morrisons' valuation on NAV, which is not appropriate for a grocer, the source said.

Several observers, though, pointed out that Morrisons' market value does not account for the value of its substantial freehold property portfolio. Some reports suggest Morrisons' real estate portfolio could be worth almost GBP 9bn, whereas Fortress's offer values Morrisons at GBP 6.3bn.

As of 31 January 2021, property, plant and equipment was valued at GBP 7.4bn, according to Morrisons' accounts. The freehold land and buildings were valued (net book amount) at GBP 3.4bn and GBP 2.3bn respectively, while the leasehold property improvements were valued at GBP 263m.

There is likely to be elevated interest in a potential sale and leaseback of Morrisons properties, one real estate adviser said. The assets appeal due to the resilience of the underlying business, they said: "The pandemic has reminded that these stores form a necessary function and the businesses have proved incredibly flexible in supporting the needs of consumers."

Though commercial real estate leases are generally shortening, this is not so for supermarkets, the source added. Institutional investors want 20-year leases with rent reviews and indexation, a second real estate adviser said. But, in general, the assets should appeal to a market starved of supermarket real estate, they said.

The majority of Morrisons' real estate is freehold, one real estate adviser said. But there will be securitisation on top of that, so the clean percentage of its estate will be a lot lower, they pointed out.

For its part, Fortress said in its offer announcement that it does not anticipate carrying out any material sale and leaseback of Morrisons' real estate holdings.

Yet a buyer could do more than just rejig Morrisons' real estate structure, said a sector adviser. Listed grocers have not done so well even in the pandemic, and many have been shown to be worth less than the sum of their parts. There is a case for restructuring these businesses' day-to-day operations, in which case private equity funds can create value, this adviser added. Morrisons' food supply operations, now vertically integrated with its supermarkets, could also be separated and sold to a private equity fund, a second sector adviser said.

Meanwhile, Amazon, which has a distribution deal with Morrisons in the UK and is the most tipped trade suitor, is unlikely to enter the fray, a third sector adviser said. The e-commerce giant is not known to enter bidding wars, and it would prefer Sainsbury's more capillary presence in the UK, he added.

Morrisons continues to have conversations with its shareholders about the offers on the table, a third source familiar with the situation said.

Morrisons, Fortress, CD&R, Apollo and Amazon declined to comment. J O Hambro did not respond for comment.