Only a hostile bid would threaten the legacy and values of Sir Ken Morrison

Only one outcome is certain from the three-way takeover battle for Morrisons – which is that the supermarket’s days as a listed company are numbered.

Apart from that, all bets are off.

The latest entry into the battle for the UK’s fourth largest grocery chain means that three very deep-pocketed players – Clayton, Dubilier & Rice (CD&R), Fortress and its partners and Apollo Global Management – are now contending to buy Morrisons.

Big money is at stake here.

The Morrisons board has agreed to an offer from Fortress and its partners which values the company at £6.3billion, but the buyer would also be taking on some £3.2bn worth of net debt, which would give Morrisons a total enterprise value of £9.5bn.

The Morrisons share price, which at one point this morning hit 269p, implies the market is expecting a higher offer.

The deal agreed with the Fortress consortium is effectively worth 254p-a-share, which trumps the earlier 230p-a-share offered by CD&R, previously dismissed by the board as far too low. One leading Morrisons shareholder, JO Hambro Capital, is on record as saying it wants 270p-a-share.

Yet the terms agreed with Fortress do not only set a floor in terms of the Morrisons share price. They also set a standard for other conditions that will have to be met by any buyer.

The statement issued on Saturday stressed how both the Morrisons board and Fortress “place very significant emphasis on the wider responsibilities of ownership of Morrisons”.

It added: “These responsibilities include recognising the legacy of Sir Ken Morrison, Morrisons’ history and culture, and the important role that Morrisons plays for all stakeholders, including colleagues, customers, members of the Morrisons Pension Schemes, local communities, partner suppliers, British farming and the wider British public.”

In practice, that means guaranteeing that Morrisons will continue to have a standalone head office in Bradford, that there will be no changes to the Morrisons pension scheme, continuing to pay Morrisons shop workers a minimum wage of £10 an hour, making no “material” changes to how suppliers are paid and sticking to an existing commitment from the company to a target to be the first supermarket that is completely supplied by net zero British farms by 2030.

These are important commitments that every buyer for Morrisons will now probably have to make as well.

There is one more commitment which, from a financial point of view, is probably the most crucial of all.

Morrisons owns the freehold of 85% of its assets – the very reason why it has attracted such interest from buyers.

It makes buying Morrisons with borrowed money and quickly paying down some of that debt by doing a sale and leaseback deal involving its property assets a very tempting way to proceed.

It is precisely how the brothers Mohsin and Zuber Issa and the private equity firm TDR Capital are going about their £6.8bn takeover of Asda. Analysts believe, though, that this approach will hamstring Asda’s ability to hold its own in a ferociously competitive grocery market in future.

Accordingly, Fortress and its partners have promised that, if successful, it “does not anticipate engaging in any material store sale and leaseback transactions”. It has been keen to stress that, since its £95m takeover of Majestic Wine at the end of 2019, it has retained ownership of a significant freehold store estate and has not sold any of Majestic’s freehold or long leasehold properties.

It has also stressed that, not only has it reversed planned job cuts at Majestic Wine, it has also opened new stores both last year and this year – Majestic’s first store openings since 2015.

It is an important commitment since, without the financial engineering of a big sale and leaseback deal, Fortress will have to retain ownership of Morrisons for longer than a private equity owner might typically do with a retail asset.

Alternatively, were Fortress to own Morrisons in line with what is typical for private equity ownership, it would probably have to settle for a lower financial return than would otherwise be the case.

This is a critical issue because, again, it is a commitment that any other would-be buyer of Morrisons will probably now have to make.

As Sreedhar Mahamkali, analyst at broker UBS, put it in a note to clients this morning: “CD&R will need to articulate a vision that is at least as supportive as [that of Fortress] to succeed in our view.”

That is not to say that a Morrisons under the ownership of Fortress or any of the other buyers will not be under a degree of financial constraint.

Mr Mahamkali said he expected Morrisons to be carrying net debt of £6.4bn under Fortress, roughly double the current level, which would have implications for the wider supermarket sector.

He went on: “Should the transaction be completed, with Asda and Morrisons in private equity ownership, the competitive landscape is likely to be more constructive for Tesco and Sainsbury and especially if the former two are constrained to invest for the future.”

Replicating the conditions for a Morrisons takeover set by the terms agreed with Fortress ought not to be a problem for Apollo. It is flush with cash.

During the first three months of the year alone, it attracted $13.4bn in new client money, meaning that, at the end of March this year, it was sitting on $49.7bn worth of so-called ‘dry powder’ to put to work.

Apollo came close to buying Asda last year and hired Rob Templeman, who famously oversaw a private equity-backed takeover bid for Debenhams in 2003, as an adviser. It is not known whether he is involved in the potential offer for Morrisons.

Three key players in any takeover, from whom the market is yet to hear, are the fund managers Silchester, BlackRock and Colombia Threadneedle. They respectively own 15.2%, 9.6% and 9.4% of Morrisons and so any would-be buyer will be looking to obtain their blessing.

Silchester, which was founded in 1994 by the former Morgan Stanley banker Stephen Butt, is a long-standing investor in the supermarket. It has owned a meaningful stake in Morrisons for at least seven years and, over that period, it has taken advantage of falls in the share price whenever other investors have tried to ‘short’ (betting on a fall in the share price) the stock. It doubled its shareholding in Morrisons in the autumn of 2019.

One player yet to put a foot wrong, to date, is the Morrisons board.

Andy Higginson, the chairman and David Potts, the chief executive, both worked at Tesco when Sir Terry Leahy, who is advising CD&R, was its chief executive – respectively as finance director and head of Tesco’s international operations.

It will undoubtedly have been difficult to put to one side their personal loyalty to and friendship with Sir Terry. Yet both men, as shown by the agreement reached with Fortress, have so far put the greatest emphasis on respecting the legacy and values of Sir Ken.

Both from the other side of the Pennines from Yorkshireman Sir Ken – Mr Higginson hails from Bury and Mr Potts from nearby Ashton-under-Lyne – have made clear their admiration for him on numerous occasions. The legendary grocer, for his part, was supportive of them both when they joined the business in 2014 and 2015 respectively.

Those values might yet be threatened, though, by a would-be buyer going hostile, in other words, making an appeal to Morrisons shareholders over the heads of the board.

That might free any bidder from the need to make the same commitments Fortress has made to the Morrisons board.

It would also challenge leading Morrisons investors to ask themselves whether they put a well-run business that cares about looking after its employees, suppliers, customers and pensioners above the lure of cold, hard cash.

Institutional shareholders talk increasingly about sustainability. A hostile bid for Morrisons would be an acid test of that.

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