Bidding War Unfolds for Morrisons as the Grocer Accepts GBP 6.3 Billion Offer From Fortress

On July 3 Morrisons agreed to a GBP 6.3 billion takeover by the Fortress Group. The offer is equivalent to a cash consideration of GBX 252 per share and a GBX 2 per-share cash dividend. Morrisons' board has already accepted the offer but the deal needs shareholder approval (at least 75%). This follows the recent proposed cash offer by Clayton, Dubilier & Rice Funds, or CD&R, a private equity fund, of 230 pence per share, which was rejected by Morrisons, as well as Asda's acquisition by the private equity firm TDR Capital and Issa brothers, completed in February 2021. According to multiple media outlets, US Group Apollo said it was considering an offer, but no approach has been made yet. We intend to raise our GBX 230 per-share fair value estimate to reflect the new cash offer. In our estimates, for a private equity owner the maximum bid cannot exceed the GBX 270 per-share level. This assumes the new owner will successfully monetize about 30% of Morrisons' freehold properties (primarily sale and leaseback of stores to reach about 55% freehold, in line with peers in the U.K. versus 85% currently for Morrisons); which could release an equivalent of GBX 70 per share (based on net book value of freehold land and properties in Morrisons' balance sheet as of fiscal 2021). Adding this to our DCF-derived GBX 200 per-share fair value estimate for the business (average top-line growth of about 1.2% and roughly flat margins over the next five years), we arrive at GBX 270 per share for a maximum offer. We believe even at these elevated levels, an experienced operator could still achieve good returns on capital invested: 1) by achieving structural cost savings (underlying operating margin of 2.9% currently versus about 4% for Tesco), 2) leveraging up the balance sheet (among the U.K. grocers we cover, Morrisons exhibits the lowest leverage/highest capacity to leverage: net debt/EBITDAR ratio of about 2.4 times versus 3.4 times for Tesco and Sainsbury's, excluding the banks).