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Supermarket swap: Does PE hope to clear the shelves in the UK?

Anyone who has paid even a passing glance to the UK's financial press over the past three months will know that private equity (PE) is hungry for Morrisons, the country's fourth-largest supermarket. It's been big news—so much so that members of Parliament have questioned what it means for Britain's food security.

Even without this major deal—currently an ongoing bidding war between Clayton Dubilier & Rice (CD&R) and Softbank-backed Fortress and standing at £10 billion (€11.7 billion) including debt—M&A in the space is on fire.

Across Europe, €25.6 billion has been invested in grocers so far this year, nearly double the €14.5 billion invested in 2015 and €14.6 billion in 2017, both of which were peak years for the sector’s M&A. Most of this year’s M&A deal value is accounted for by PE picking up large players—and they now have their eyes on Sainsbury’s, the UK's number two grocery chain.

Pros and cons

For all their dependable cash flow (eating never goes out of fashion), these companies have lacked juicy margins and growth. But that is changing.

Companies are tilting away from the land-grab-at-any-costs expansion tactic of the past and are achieving results with online retailing, driven in part by the pandemic. Partnering with established e-tailing businesses has also been highly effective in achieving home deliveries with limited capex. Morrisons is a case in point, having teamed up with online retailing monolith Amazon for its deliveries.

Fuelling returns

For PE, there are other potential bonuses on offer. For example, CD&R owns petrol chain Motor Fuel Group (MFG). If it's successful in its bid for Morrisons, which goes to auction next month, it opens up the potential to sell Morrisons' petrol station assets to MFG.

It's a move out of TDR Capital's playbook. Following TDR and the Issa Brothers' purchase of the UK's Asda for £6.8 billion (€7.96 billion) from Walmart last year, it followed up in February by selling Asda's petrol stations to EG Group, also owned by TDR.

There are other assets from which to pick and choose. Supermarket property portfolios are hugely attractive to PE for two reasons. One, they are collateral to borrow against, meaning financial sponsors can lever these deals with maximum bank debt and contribute minimal equity from their own funds, which equals higher returns.

And there is also the potential to engage in sale-and-leaseback agreements in cases where a business has freeholds on its stores and logistics buildings. Around 85% of Morrisons' real estate is freehold. It's a controversial way of making quick cash, especially if the business later struggles to keep up with rental fees on the properties it no longer owns. For its part, CD&R has pledged not to engage in “material store sale and leaseback transactions”. The operative word here being “material”—that leaves much to interpretation.

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