Barbarians at the Supermarket Should Tread Carefully

(Bloomberg Opinion) -- Wm Morrison Supermarkets Plc can sell itself as well as it can sell food.

Late Thursday, the U.K.’s fourth biggest grocer recommended a 285 pence per share offer from private equity firm Clayton Dubilier & Rice LLC, valuing its equity at about 7 billion pounds ($9.7 billion). It withdrew its previous recommendation for a 272 pence per share bid from a consortium led by Fortress Investment Group LLC.

The new offer stands at about a 60% premium to both the last closing price before CD&R’s interest first emerged in June and the average price in the three months preceding it. Any way you look at it, this is a good deal for Morrison shareholders.

Investors were clearly expecting a counterbid from CD&R — the shares closed at just over 279 pence on Thursday. They were right.

But how can CD&R afford to shell out more? The risk is that it overpays, which would make it more difficult to secure an acceptable return on its eventual exit.

The logic of a tie-up though makes sense. CD&R owns Motor Fuel Group, which operates about 900 fuel stations across the U.K. And Morrison has lagged rivals in its convenience store offering since an ill-fated experiment under former Chief Executive Officer Dalton Philips. By selling its food at MFG’s forecourts, Morrison now has a way to participate in this important channel, increasing sales through its wholesale arm.

That’s not the only reason CD&R may feel able to justify paying more. Terry Leahy, who was CEO of Tesco Plc, Britain’s biggest supermarket, from 1997 to 2011, is an adviser to the PE firm. If it succeeds in acquiring Morrison, he would likely chair the group. His experience should help to identify other opportunities to increase value.

He also worked well with David Potts, who is likely to remain as Morrison’s CEO, back when they were at Tesco. By 2007, the grocer was taking through its tills one pound in every seven spent in British shops. Together, they may be able to find operational improvements that help to bolster the return at Morrison.

Like Fortress, CD&R has said there will be no “material store sale and leaseback transactions,” meaning it doesn’t plan on selling, and then renting back, a large number of supermarkets. Morrison owns more than 85% of its property.

The new owner would still have some wiggle room. It could sell and lease back some of Morrison’s warehousing and distribution assets. Asda’s new owners, TDR Capital and billionaire entrepreneurs Mohsin and Zuber Issa, are close to selling off the supermarket’s distribution centers for more than 1 billion pounds, demonstrating the value that can be realized.

While CD&R is keen to stress its capabilities in operating businesses, rather than in financial engineering, if it could also leverage Morrison’s property more effectively, it may have an advantage here too.

But this may not be the final sale. Fortress said it was considering its options. On Friday, the shares rose above the new offer price to 292 pence. So some investors are clearly eyeing 300 pence.

The higher the level is pushed, however, the harder the new owner will have to work to make a return on its investment. Amid the frenzy, it’s worth remembering that running a British supermarket is a hard slog, with competition from capable rivals such as Tesco and J Sainsbury Plc, as well as the German discounters Aldi and Lidl.

For Fortress, the decision comes down to whether it would prefer to pay up and struggle later or walk away now. After all, Morrison is not the only choice on the supermarket shelf.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Andrea Felsted is a Bloomberg Opinion columnist covering the consumer and retail industries. She previously worked at the Financial Times.

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