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Markets are speculative beasts. It’s in their nature to latch onto flashy upstarts and declare them the next best thing. They can reward darlings with meteoric price rises, and punish losers with equivalent falls.
What they tend not to do is get very excited about UK retailers. That’s certainly true of Morrisons, the UK’s fourth largest supermarket, better known for its bakery aisle than its volatile share price.
Nevertheless, Morrisons saw its stock rise a startling 34% yesterday to its highest level since 2018, off the back of a rejected private equity takeover bid from US firm Clayton, Dubilier & Rice (CD&R). Please remember past performance is not a reliable indicator of future returns.
The reason why investors have clambered into the stock is that they see potential here for a bidding war. CD&R offered to pay 230p a share in cash - a fair amount higher than the 178.45p at which Morrisons closed on Friday, but below the 240p at which it closed yesterday. That places the company at a value of £5.75 billion, well above CD&R’s unsuccessful £5.5 billion bid.
The implication is that the market expects a deal, and it believes it will come in higher than CD&R’s initial offer.
Morrisons is no glitzy start-up. It makes no claim to change the world with its innovative technologies. But there are reasons why it could look attractive.
Unusually for a UK supermarket, Morrisons owns much of its supply chain, a boon in a time when supply chains have been severely disrupted by Covid. It also owns around 85% of its stores, another plus for a private equity firm looking to cash in on assets. Moreover, its partnership with Amazon would appeal to any buyer.
It appears the Morrisons board recognises its strengths. In rejecting the bid, it claimed CD&R “significantly undervalued Morrisons and its future prospects.” It’s hard to see what the firm could add. Morrisons is a well-managed company that manages a solid balance sheet and has rewarded shareholders with £1 billion in dividend payments since 2017, even through the pandemic.
It is, however, unclear how far the Morrisons board will hold out. Analysts expect a successful bid to hover around the 260p a share bracket - not far off where Morrisons is trading now. Another offer from CD&R is likely. Morrisons could struggle to justify to the market how it intends to keep its share price at its newly elevated level.
Moreover, CD&R’s interest is hardly a flash in the pan. There have been plenty of high-profile merger attempts within the UK supermarket scene - remember Sainsbury’s unsuccessful attempt to marry with Asda? - preceding eventual takeovers. The latter has recently been bought in similar circumstances, while speculation currently swirls around the former.
If UK companies were ripe for takeover before the pandemic, they look even more vulnerable now. Private equity firms have swooped in on more UK companies in the last 18 months than at any time since the financial crisis. In 2021 alone there have been 113 announced deals, amounting to a combined value of £23.3 billion.
For much the same reason the UK stock market now presents an opportunity to stock pickers, it also looks attractive to private equity firms looking for a bargain. Brexit has long weighed on valuations, which were depressed further still by the pandemic. Whereas many other major global market stock indexes, such as the US and Europe’s, have risen well above their pre-pandemic levels, the UK’s FTSE 100 still trails below. The UK looks cheap, and vultures are circling.
They pose a threat to shareholders, employees, and the UK economy. Legal & General Investment Management (LGIM), Morrisons’ seventh-largest shareholder, has voiced its own concerns. The asset manager suggested CD&R would look to sell Morrisons’ property ownerships, before leasing them back. Doing so would provide a quick and easy return on CD&R’s investment, but add no value to the company.
Looking for assets to sell is a typical private equity move. Another is cutting costs, often through redundancies. For a sector which has had to deal with its fair share of troubles these past 14 months, employees at Morrisons will feel justifiably worried by recent developments. Regardless of how future takeover bids pan out, some kind of restructure is likely.
Labour has also voiced concerns, both for employee’s jobs, and also over private equity firms’ tendencies to pocket dividends and load acquisitions up with debt.
There are reports that Morrisons would seek assurances from any buyer that workers and its pensions scheme would be left protected. But there are few ways of looking at this that see a bidder running Morrisons any better than it is now.
These are challenging times for UK companies, and in particular its supermarkets. Buyouts may look attractive to shareholders in the short term, but their longer-term implications appear far more unsettling.
Five year performance
|(%) As at 21 Jun||2016-2017||2017-2018||2018-2019||2019-2020||2020-2021|
Past performance is not a reliable indicator of future returns
Source: FE, total returns in GBP as at 21.6.21
Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to a Fidelity adviser or an authorised financial adviser of your choice.
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