British high streets have taken a battering over the past decade – first from online retail, then from the pandemic, and now from a combination of the two. What remains of the sector is being picked over by the investor of last resort: private equity. Morrisons is the latest acquisition target, the subject of a bidding war between three private equity firms. The sale may turn out to be only a temporary reprieve. Digging into the balance sheet of these investments exposes looming risks and hidden costs.
The Morrisons board recently approved a £9.5bn takeover by the private equity firm Fortress, an offshoot of Japanese-owned Softbank, Canada Pension Plan Investment Board and Koch Real Estate Investments. Fortress is at pains to reassure the government and farmers that it will be a “good steward” of the business, retaining its Bradford headquarters, safeguarding pensions and maintaining the £10-an-hour minimum wage for staff.
Yet these assurances run counter to the asset-stripping, debt-heavy private equity playbook, as modelled in another recent private equity-supermarket takeover. Last October, the petrol station billionaires Mohsin and Zuber Issa, together with TDR Capital, acquired Asda. The £6.8bn deal was reportedly financed with around £6bn of debt. Rishi Sunak was delighted, tweeting that it was “Great to see @asda returning to majority UK ownership”. The Issa brothers were handed CBEs on the Queen’s birthday honours list soon after.
Private equity makes for a good buyer in the short term if your goal is to protect market competition. Before the Issa brothers came along, Asda’s previous owner, Walmart, was trying to sell the store to Sainsbury’s. The UK Competition and Markets Authority (CMA) objected on the grounds that the sale would diminish competition and be bad for consumers. It approved the Issa brothers’ deal, but what the regulator’s remit does not expressly require is a review of whether the Issa brothers and TDR would be responsible owners.
Why might they not be? The first clue is how they financed the deal: by loading Asda with debt three times larger than the company’s earnings. The buyers put in only £780mn of their “own” money, although much of this seems to have come from an injection, via an offshore investment vehicle, by the Abu Dhabi Investment Authority and two more Canadian pension funds. The deal was also financed by the Issa brothers selling the Asda petrol station forecourts to their own petrol station company, EG Group. EG Group is the fourth biggest borrower of European collateralised loan obligations, a close cousin of the collateralised debt obligations that broke the financial system in 2008. The group itself has more than $9bn in debt, against $25bn in annual revenues. These are worrying ratios, even by private equity standards.
The high street is an attractive prospect to private equity firms because its fairly reliable cashflows can be used to service these debts and meet interest payments until the time comes to sell. Boots, Pizza Express, Byron and Gail’s have all been sold off to private equity firms in recent years. In April, the Issa brothers snapped up the “healthy fast food” chain Leon for £100m. Morrisons is particularly attractive because, unusually among supermarkets, it owns much of its supply chain – meaning it has more assets for a future buyer to sell off.
Eye-watering debts create pressure to squeeze underlying businesses. Across the UK, there are 840,000 employees whose ultimate employer is a private equity owner. Asda has 145,000 staff; Morrison’s counts 118,000. If either of these supermarket chains is sold off again, or asset-stripped, it will probably be employees who suffer the consequences. Sainsbury’s may be waiting in the wings.
The crux of the private equity model is that it is not actually “in” the supermarket business, or the restaurant business, or healthcare, or children’s social care, or any other sector where it may crop up. It is really in the business of engineering money and servicing debt. Private equity investors are expert at limiting their own exposure to risk, often paying themselves “special dividend” shortly after they take control of the target business, which covers the limited money they put in. Indeed, investors may effectively buy a company for “free”. Often, when fees, shareholder payments and a dividend for investors are taken out of the business, there is little fresh investment left.
What’s curious is that supermarkets are notoriously low-margin businesses. They have none of the hallmarks of high returns that private equity firms usually seek. One reason they now seem attractive is the contagion effect: with Asda under private equity ownership, its competitors may hope that new management will spend more time focusing on financial engineering than on competing, leaving more room to raise consumer prices. The prospects for Morrisons, in the eyes of private equity, start to look brighter.
Another is interest rates. With low interest rates across the world, investors are looking for new ways to chase returns. Before the pandemic, private equity companies were racing to spend $2.5tn of cash. Even pension funds – traditionally more conservative investors – are straying into private equity in a global hunt for yield. Low-margin businesses such as supermarkets, which have plenty of real estate to leverage, can start to look more attractive – especially if you can get out before all the debts fall due.
What is the alternative? The first is to empower regulators to block private equity from treating UK plc as an all-you-can-eat buffet. The business, energy and industrial strategy select committee has asked the CMA whether it requires new powers to do this. If investment is needed we must ask why banks aren’t lending; only £1 in every £10 lent by banks supports non-financial businesses. Another is to encourage firms to pursue alternative exit routes. Riverford Organic and Richer Sounds followed another grocer, Waitrose, in becoming employee-owned. For Asda, this could have been a return to its roots as a family-owned butchers and dairy cooperative, which still leaves its mark in its name: Associated Dairies. It’s still not too late for Morrisons.