ALEX BRUMMER: The folly of debt-fuelled private equity deals

Private equity deals done in the teeth of crisis have a habit of going horribly wrong.

When Clayton, Dubilier & Rice (CD&R) beat SoftBank-backed Fortress in the bidding war for Morrisons in 2021, its victory was hailed as a triumph for all involved.

CD&R had grand plans for transformation by expanding the grocer’s forecourt presence and opening convenience stores, releasing value from property holdings and repositioning it as a premium chain, making the most of ‘home-grown’ supplies.

It hasn’t worked out like that.

Tainted takeover: Morrisons has been required to jettison assets– and a £201m annual profit before the public-to-private buyout has been turned into a whopping loss of £1.5bn

The testosterone-fuelled bidding war, which ended with a Saturday blind auction conducted by the City referee the Takeover Panel, ended up with a near-£10billion valuation on the grocer (including debt).

No sooner than the deal was completed, the wheels came off. The period of super-low interest rates came to an abrupt end as the Bank of England slammed on the brakes amid the threat of double-digit inflation in the wake of Covid bottlenecks.

Then, a year ago, came the Ukraine war.

As energy prices rocketed, this gave a second leg to the cost of living crisis and already intense price competition among Britain’s Big Four grocery chains – Tesco, Sainsbury’s, Asda and Morrisons. 

What no one had anticipated was the aggressive expansion of the German no-frills chains Lidl and Aldi, with apparently limitless funds to grow market share.

The outcome is a financial and commercial disaster. Rocketing interest rates undermined the rationale of a debt-fuelled deal. 

It paid £593million of interest in the year to October 2022, leaving nothing in the kitty for the proposed expansion.

Instead of accumulating assets through potential forecourt deals, Morrisons has been required to jettison them – and a £201million annual profit before the public-to-private buyout has been turned into a whopping loss of £1.5billion.

Reporting periods and the units involved may not be strictly comparable. But there is no mistaking direction of travel.

Swelling interest rate charges and rising production supply costs meant that Morrisons, in spite of superior meat, fish and produce from its farms, factories and fishing fleet, lost market share, with Aldi and Lidl the winners.

If the timing is right, private equity, with its accounting data and marketing skills, has shown its ability to reposition enterprises and add enormous value.

Data service Refinitiv, F1 motor racing and Worldpay all come to mind.

There have also been horrendous outcomes. Private equity ownership contributed to the destruction of Debenhams.

Guy Hands’ badly timed takeover of EMI (in the eye of the great financial crisis) led to the Balkanisation of the UK’s greatest music production company.

And Blackstone’s in-and-out ownership of Southern Cross profited its investors and left care home residents high and dry. Morrisons is the latest addition to a disturbing parade of spoilt and destroyed enterprises.

Wilson lament

One would expect nothing less of Legal & General chief executive Nigel Wilson than to go out with a bang.

Not satisfied with generating £1.9billion of new cash in 2022 and lifting the dividend, Wilson has some sombre words for the Tories ahead of next week’s Budget.

He decried the perpetual drift of quoted firms from the City to New York and Europe, and expressed frustration at the UK’s low-growth, low-productivity economy.

Wilson has done his fair share to use L&G’s strong balance sheet to back innovation, with the Helix centre in Newcastle and development deals with Oxford University. He has set a sparkling example for the rest of the UK’s defensive-minded asset managers.

L&G’s badly judged association with the liability-driven investments at the core of last Autumn’s gilts market meltdown was a rare misstep. Everyone makes mistakes.

Audit trail

We are still awaiting the birth of the Tories’ new statutory Audit, Reporting and Governance Authority.

That has not stopped its ineffectual predecessor, the Financial Reporting Council (FRC), from toughening up its act post the Carillion collapse.

Its latest target is auditor PwC, which has been fined (its fourth since June 2022) over sloppy audits at engineer Babcock.

FRC activism has been seen recently at newbie financial group Revolut.

Better to act pre-emptively rather than after the Lord Mayor’s show.