There may be more reasons to buy Morrisons, but only one really counts as far as the private equity players currently circling it are concerned: its £6bn property portfolio.
Last week, the Morrisons board accepted a debt-financed £7bn bid from Clayton, Dubilier & Rice (CD&R), trumping the £6.7bn bid from rival Fortress Investment Group it had previously accepted and CD&R’s earlier £5.5bn bid, which it had rejected.
It is not just the 29.5m sq ft of retail and 10.5m sq ft of manufacturing and distribution space that CD&R is salivating over. Like the Issa brothers, who bought Asda in February, CD&R sees the chain’s petrol stations as the cherry on the top of the real estate cake. The question is: what will happen to Morrisons and its largely freehold portfolio if private equity has its cake and eats it?
Trustees from Morrisons’ pension funds warned this week such a deal could “materially weaken” the security of its pension schemes, which are currently in surplus but could face a shortfall of £800m if they are wound up or the retailer goes bust.
However, the loudest alarm bells are ringing over the potential fate of its undervalued property assets, and little wonder. The whole raison d’être of private equity firms is to strip and strip away, selling and leasing back assets and then getting out, usually just before the operational business has become fatally compromised – but not before racking up a whole heap of debt.
The omens are not good for Morrisons if it does fall into private equity hands, as looks increasingly likely, with Fortress reportedly mulling a further bid. Private equity firms are often described as vultures for good reason, and all too often if the businesses they swoop on are not carcasses already, they are once they’ve finished with them.
Take Debenhams. Most experts agree that the seeds of its downfall were sown when it was bought by Texas Pacific Group, CVC Capital and Merrill Lynch in 2003. As one senior industry source recently reminded me, the trio undermined the future of the business by leasing back all the properties at excessive rents for department stores that “could not sustain a valuation of very large upper trading areas” when, in reality, it was only the ground and maybe the first floor and basement that had any real estate value on the open market.
Hobbled by high rental overheads and the fact that virtually all the working capital had been sucked out of the business, to be replaced by over-leveraged borrowings from the banks, Debenhams swiftly found itself with inadequate capital to finance the necessary modernisation of the business.
What it did have was debt, a lot of it. By the time it returned to the stock market in 2006, it owed more than £1bn, compared with just £100m when it was taken private. The writing was already on the wall.
Fifteen years on, the trail of destruction left behind by private equity is littered with the carcasses of once-household names, and not just in the UK. In the US, a host of big private-equity-backed retailers have failed, including Toys ‘R’ Us, Sports Authority and Nine West.
There have also, of course, been success stories – and it should be noted that both CD&R and Fortress promised they would not sell off large chunks of Morrisons’ property empire – but don’t think the same fate can’t befall the UK’s fourth-biggest supermarket chain.