Morrisons (LSE: MRW) is between a rock and a hard place.
Operational and financial hurdles, however, could be a blessing for shareholders if they help speed up a change of ownership at the fourth-largest grocer in Britain.
It Doesn’t Look Good
The competitive landscape is incredibly tough, as proved by Morrisons’ dismal figures reported today. Excluding fuel, like-for-like sales dropped 7.1% in the 13 weeks to 4 May.
Morrisons hasn’t been able to identify trends in the last four years. Its limited geographical reach is only partly to blame for its failure. Fierce competition for cheaper goods on the aisles has meant persistent market share erosion, but Morrisons has also underestimated the importance of a meaningful web presence. It has yet to get its online strategy right.
An oft-rumoured takeover holds strategic merits, although financially and economically a Morrisons take-out may be a hard deal to pull off. The Morrison family shouldn’t waste time.
Bargain Hunters
Enter private equity: a bargain basement deal could be in the making.
Morrisons’ equity has already lost £2.6 billion in value since the one-year high it recorded in September. Morrisons trades at a discount of 60% and 40% to peak- and mid-cycle multiples, respectively, for food retailers in the UK.
As a private entity, Morrisons won’t have to withstand public scrutiny, and that’s one of the main attractions of a buyout. Furthermore, under private-equity ownership, drastic action would swiftly ensue.
In January, activist investors including Elliott Management Corp, which owns less than 1% of Morrisons’ stock capital, argued for a value-enhancing deal based on the separation of real estate assets from the reminder of the grocer’s portfolio.
Spinning off property assets into a real estate investment trust is not something Morrisons is willing to consider. Rather, the grocer is widely expected to opt for a sale and leaseback of its property portfolio. Either way, the value of its core operations should be preserved.
Debt/Equity Mix
Morrisons’ balance sheet offers room for capital arbitrage, although the problem with leverage is that it would destroy value if the core operations weren’t promptly fixed.
LBOs must be backed by a large portion of debt to boost the internal rate of return of financial sponsors, but a drop in Ebitda has determined a spike in Morrisons’ net leverage, which stands at 2.4x on a trailing basis.
If Morrisons levers up just as it did when it acquired Safeway a decade ago, it’ll have to raise £2 billion of new debt. That won’t be enough to engineer a deal mostly financed by debt, however.
So, net leverage will have to be higher, unless a consortium – at least three private-equity firms would be needed to finance a Morrisons LBO — is willing to write an equity check for more than £3 billion.
Four Very Long Years
What a difference four years make.
In early 2010, when CEO Dalton Philips was appointed, profits were growing and management had the backing of shareholders. During his tenure, Morrisons stock has lost almost 40% of value and if it continues this way, it will have halved before the end of the year. Mr Philips is in good company (Philip Clarke, anybody?).
Tesco has also had its fair share of problems since the departure of Sir Terry Leahy in 2010, but as a market leader it can dictate prices, while its sheer size and diverse geographical mix allows it for more options. Moreover, Tesco’s web business is solid. If it weren’t for regulatory hurdles, it would make lots of sense to combine the two – and get new executives on board.