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

Private equity deals done during a crisis have a habit of going horribly wrong.

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

CD&R had grand plans for transformation by expanding the forecourt grocer’s presence and opening convenience stores, unlocking value from real estate holdings and repositioning it as a premium chain, making the most of its “own” produce.

It didn’t work out that way.

The testosterone-fuelled bidding war, which ended with a blind auction on Saturday led by the City arbiter of the Takeover Panel, ended with the grocer’s valuation (including debt) approaching £10bn.

Once the deal was done, 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, the war in Ukraine came.

When energy prices skyrocketed, it gave a second leg to the cost of living crisis and the already fierce price competition between Britain’s Big Four supermarket chains – Tesco, Sainsbury’s, Asda and Morrisons.

What no one expected was the aggressive expansion of German no-frills chains Lidl and Aldi, with seemingly limitless means to increase market share.

The result is a financial and commercial disaster. Rapidly rising interest rates undermined the rationale of a debt-fuelled deal.

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

Rather than amass assets through potential service stations, Morrisons has to jettison them – and an annual profit of £201m ​​before the public-to-private buyout has turned into a massive £1.5bn loss.

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

Rising interest charges and rising production costs saw Morrisons lose market share despite superior meat, fish and products from its farms, factories and fishing fleet, with Aldi and Lidl the winners.

When the timing is right, private equity, with its accounting data and marketing skills, has demonstrated its ability to reposition companies and add tremendous value.

I’m thinking data service Refinitiv, F1 motor racing and Worldpay.

There are also terrible consequences. Private equity ownership contributed to the destruction of Debenhams.

Guy Hands’ ill-timed takeover of EMI (in light of the major financial crisis) led to the Balkanisation of the UK’s largest music production company.

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

Wilson complains

You would expect nothing short of a stunner from Nigel Wilson, CEO of Legal & General.

Not content with generating £1.9bn in new money in 2022 and raising the dividend, Wilson has some gloomy words for the Tories ahead of next week’s budget.

He denounced the continued drift of listed companies from the city to New York and Europe, expressing his frustration with the UK’s low-growth, low-productivity economy.

Wilson has done its part to use L&G’s strong balance sheet to support innovation, with the Helix center in Newcastle and development deals with Oxford University. He has set a shining example to the rest of the UK’s defensive-minded asset managers.

L&G’s ill-judged association with the liability-based investments that were at the heart of last fall’s gold-plated market collapse was a rare misstep. Everybody makes mistakes.

Audit trail

We are still waiting for the birth of the Tories’ new statutory audit, reporting and governance authority.

That hasn’t stopped its ineffective predecessor, the Financial Reporting Council (FRC), from tightening its stance following the Carillion collapse.

The latest target is auditor PwC, which has been fined (the fourth since June 2022) for sloppy audits at engineer Babcock.

FRC activism has recently been seen at the new financial group Revolut.

It is better to act preventively than after the mayor’s show.