European Event-Driven Analyst

Jesus Rodriguez Aguilar

Jesús is an Insight Provider (Event-driven) on the Smartkarma network, where he looks across sectors at opportunities arising from securities mispricing (both credit and equity), share classes, bid announcements, prospective bids, and special situations. He has served as Economic and Business Advisor at the Spanish Congress in Madrid. Prior to that, he has worked in the City of London: as a Credit Analyst at Bloomberg; Event-driven associate at former boutique European Research; and doubled as Special Situations and Equity-linked VP (convertible bonds) at Merrill Lynch. Jesús has an MBA from the London Business School, a BA (Hons.) degree in Economics from the Complutense University in Madrid, and a BA (Hons.) in Law from U.N.E.D., also in Madrid.

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Fortress's Recommended Cash Offer Trumps CD&R

Event-Driven

On Friday 6 August, Morrison agreed to an improved offer from the Fortress consortium that valued it at £6.7 billion. Under the offer, accepting Morrison shareholders will get 272p/share, which represents a 7% premium to the original Fortress offer. Morrison's EGM will now be held on 27 August. This is within the 270-280p range of my last recommendation. The new offer intends to lower the chances of a counteroffer by CD&amp;R.
On 9 August, the Takeover Panel extended the deadline for CD&amp;R to make an offer for Morrisons until 20 August. CD&amp;R is reportedly seeking financing/partners for a bid and had asked for more time to consider its options in response to the increased Fortress offer.
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Morrisons generates cash and is benefiting from WFH and higher demand due to home cooking. The balance sheet of the company, at 3.8x net debt/EBITDA and 2.8x EBIT/interest, is strong and has the backing of the freehold portfolio. Food retailers in the UK are behaving rationally and there  are no price wars looming. Private equity interest is due to largely low valuation of UK assets due to pandemic and Brexit.
As previously mentioned, Morrison is an already efficiently run business in terms of management of inventories and working capital and profitability comparable to that of Tesco and Sainbury's, therefore I see limited scope for value creation, other than financial, that is. On this basis I believe that it is unlikely that a financial buyer would be able to strip a substantial amount of cash out of Morrison.
According to my calculations, a 272p offer would rely on improving EBITDA margins (10-20 bps) and cutting Capex by a fifth (thus rendering the business potentially less attractive) and would reach an IRR of over 11% by year 8. Initial leverage would reach an uncomfortable 6.5x and debt/EBITDA would diminish to c. 4.1x by year 8. Exit multiple would be 8.0x, which I see as demanding. A higher IRR would imply a review of real estate (with sale&amp;leaseback, making the business more fragile, hopefully not "Punched" Taverns all over again), and a potential sale of the fuel business (which drives traffic into the stores).
I estimate that a counteroffer by CD&amp;R would have to be launched at 285p. IRR would be 12%, and would involve an exit multiple of 8.5x (this would mean a substantial re-rating vs. the previously considered 7.9x), cutting in Capex by a fifth, an EBITDA margin improvement to 6.3% (a c. 20 bps gain vs. Capital IQ consensus forecasts, with the necessary caveat that such a move may drive customers out of the stores and therefore loss of market share). Obtaining a higher IRR would involve substantial sale&amp;leaseback.
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On 9 August, shares closed at 278.8p. Gross spread is -3%. At the current market price, I would not wait for an increased offer price (which could come at 285p, just 2% higher than the last closing price) as the risk/reward is unfavorable now, in my view. Upside risk could come from a Panel-led auction, as it seems it will be the case for Vectura.
Recommendation is sell into strength.
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On Friday 6 August, Morrison agreed to an improved offer from the Fortress consortium that valued it at £6.7 billion. Under the offer, accepting Morrison shareholders will get 272p/share, which represents a 7% premium to the original Fortress offer. Morrison's EGM will now be held on 27 August. This is within the 270-280p range of my last recommendation. The new offer intends to lower the chances of a counteroffer by CD&amp;R.
On 9 August, the Takeover Panel extended the deadline for CD&amp;R to make an offer for Morrisons until 20 August. CD&amp;R is reportedly seeking financing/partners for a bid and had asked for more time to consider its options in response to the increased Fortress offer.

Morrisons generates cash and is benefiting from WFH and higher demand due to home cooking. The balance sheet of the company, at 3.8x net debt/EBITDA and 2.8x EBIT/interest, is strong and has the backing of the freehold portfolio. Food retailers in the UK are behaving rationally and there  are no price wars looming. Private equity interest is due to largely low valuation of UK assets due to pandemic and Brexit.
As previously mentioned, Morrison is an already efficiently run business in terms of management of inventories and working capital and profitability comparable to that of Tesco and Sainbury's, therefore I see limited scope for value creation, other than financial, that is. On this basis I believe that it is unlikely that a financial buyer would be able to strip a substantial amount of cash out of Morrison.
According to my calculations, a 272p offer would rely on improving EBITDA margins (10-20 bps) and cutting Capex by a fifth (thus rendering the business potentially less attractive) and would reach an IRR of over 11% by year 8. Initial leverage would reach an uncomfortable 6.5x and debt/EBITDA would diminish to c. 4.1x by year 8. Exit multiple would be 8.0x, which I see as demanding. A higher IRR would imply a review of real estate (with sale&amp;leaseback, making the business more fragile, hopefully not "Punched" Taverns all over again), and a potential sale of the fuel business (which drives traffic into the stores).
I estimate that a counteroffer by CD&amp;R would have to be launched at 285p. IRR would be 12%, and would involve an exit multiple of 8.5x (this would mean a substantial re-rating vs. the previously considered 7.9x), cutting in Capex by a fifth, an EBITDA margin improvement to 6.3% (a c. 20 bps gain vs. Capital IQ consensus forecasts, with the necessary caveat that such a move may drive customers out of the stores and therefore loss of market share). Obtaining a higher IRR would involve substantial sale&amp;leaseback.


On 9 August, shares closed at 278.8p. Gross spread is -3%. At the current market price, I would not wait for an increased offer price (which could come at 285p, just 2% higher than the last closing price) as the risk/reward is unfavorable now, in my view. Upside risk could come from a Panel-led auction, as it seems it will be the case for Vectura.
Recommendation is sell into strength.


Fortress/Morrisons: 272p Pre-Emptive Strike

Wm Morrison Supermarkets

Fortress/Morrisons: 272p Pre-Emptive Strike