News broke in early July 2021 that the supermarket chain Wm Morrisons had accepted a £9.5 bn takeover deal from a Fortress-led US buyout consortium (the “Consortium”) at 252p per share plus a 2p dividend*. This takeover agreement, were it to go ahead, would mean that Morrisons would become the second British supermarket to fall prey to a buyout in the past year after Asda was purchased by the Issa brothers for £6.8 bn. However, despite the reassurances given by Fortress that it would be a “supportive and responsible owner” owing to its acute awareness of the “wider responsibilities that come with ownership of a business with Morrisons’ history, culture and importance to British public,”the deal faces stiff shareholder opposition making its future delicately poised. This article will explore the reasons why the private equity industry has become ‘rampant’ within the United Kingdom, and whether its boom constitutes a failure for the public markets.
It is submitted that in this instance, while there is genuine concern owing to the potential for asset stripping of Morrisons’ real estate and threat to job security, the Consortium’s commitment to safeguarding pensions and a minimum £10 per hour wage indicates a genuine interest in beneficially overhauling the business so that Morrisons can start to fight back against digital insurgents like Amazon and Ocado. This could be a relationship that protects employees and ensures the business’s long-term survival. Finally, the scope for regulatory controls is questioned, ultimately concluding that any further regulation should be avoided at the moment to ensure that Britain continues to be presented as ‘open for business’ after Brexit.
(*Facts accurate as of 14 August 2021)
Favourable UK Market Conditions
The global private equity industry has been subject to a boom and, interestingly, this is a phenomenon particularly focused on the UK markets. This is manifested in both the fact that there has been a record 345 buyout bids registered for UK companies in the first half of this year and that the number of completed UK buyouts has increased by almost 60 per cent in 2021 compared with the same period in 2019, while across the EU it is up just 14 per cent. It is the reasons that underpin the buoyant domestic market that merit further exploration:
Low Interest Rates and Quantitative Easing
Two drivers in the structural shift towards private equity have been the low base interest rate offered by the Bank of England, currently a meagre 0.1 per cent, and the market distortions created by quantitative easing. The first impact of the use of these financial tools is that institutional investors such as pension funds are reluctant to invest either in commercial banks as money deposited there will generate minimal yield or bonds as quantitative easing has increased bond prices, also decreasing their yield. Instead, being eager for higher returns, institutional investors have altered their portfolios to plough money into buyout firms that promise greater returns and underpins why the private equity industry is sitting on a record $1.7 trillion of dry powder. The second and final impact is that, while depositing in banks is unattractive for the aforementioned reason, the low interest rate has made the borrowing that is central to private equity (for example in leveraged buyouts) cheaper thereby facilitating more deals and on a greater scale.
UK’s Liberal Attitude Towards Takeovers
Relative to other European countries, the UK is described as having a liberal attitude towards foreign takeovers. A particular contrast can be drawn with a country such as France where strict labour laws make mass lay-offs difficult (a common occurrence under private equity ownership where businesses are streamlined to reduce costs) and the government may take a firm stance against foreign acquirers. An example of this is the French government’s recent opposition to the €16.2 bn proposed takeover of supermarket Carrefour by a Canadian company, citing that the deal would threaten France’s food security. Although in the UK there also exists a clear legislative framework for government intervention in proposed acquisitions of UK companies by overseas buyers contrary to the Enterprise Act 2002, which provides ministers with the power to block deals on ‘public interest’ grounds (national security, media plurality and financial stability), the provision so far has not been used to block any of the 17 deals which have been investigated for these concerns.
Depressed Market Valuations Post-Brexit
Another reason for the US buyout interest is the depressed valuations of UK public companies relative to European listed companies. The reasons cited for the decreased valuations are the political volatility that led up to Boris Johnson’s election in 2019 and the difficulty that the UK had in reaching an acceptable future trading agreement with the EU, where talks continued until the eleventh hour. However, both these events are now in the past and so theoretically there ought to have been a ‘Boris bounce’ where, upon realising that there ought to be continuity and certainty for the foreseeable future, share prices would return to valuations seen before the 2016 referendum vote. Instead, market forces remain hesitant, perhaps because of the fractured position of Northern Ireland, and this continued reluctance has contributed to ensuring that there are still plenty of buying opportunities in the UK for private equity funds.
The UK’s fast vaccine rollout is the final piece of the puzzle explaining the trend. Testimony to the efficacy of both the vaccines themselves and the uptake, Boris Johnson’s Conservative government heralds that we have now moved into an era where, rather than ‘Stay[ing] at Home’ to combat its spread, the public must now learn to live with Covid-19 and be cautious at their discretion. The latest data suggests that daily deaths are remaining low and this provides confidence to private equity houses that there will be no more costly lockdowns.
UK asset manager Silchester, which owns more than 15 per cent of Morrisons, stated that it was not inclined to support the existing Fortress offer. The firm reported that its refusal to support the offer was because the timetable for securing shareholder support was too short, reasoning that this could potentially deter competing bids. Instead, it wanted Morrisons’ board to allow more time to respond to other parties who might offer better value to Morrisons’ public shareholders. Morrisons’ other large shareholders, Legal and General Investment Management, JO Hambro, and M&G Investments have all voiced similar objections. Given that the Consortium’s offer for Morrisons is structured as a scheme of arrangement, meaning that at least 75 per cent of those voting, plus a simple majority of the capital must vote in favour for the deal to go to completion, completion seems incredibly unlikely in the current climate. Morrisons’ shares continued to trade above the 252 p offer in anticipation of a further bid and the Fortress led consortium has since increased its offer for the supermarket chain to nearly £10 bn, offering 270 p per share plus a 2p per share special dividend, a seven per cent increase on its previous offer. Whether this increased bid price will be enough to achieve shareholder approval is yet unknown, although JO Hambro has previously said that “any offer for the group approaching 270p per share merits engagement and consideration”. Clayton, Dubilier and Rice, another buyout firm that has expressed interest in the supermarket, is also yet to announce whether it will place a competing bid in response to this latest offer.
A Failure of The Public Markets?
Morrisons is likely to become a paradigmatic example of the dramatic shift in corporate Britain in which a growing proportion of the economy is being shifted into private hands. This plays into the longstanding debate about whether Britain’s system of shareholder capitalism is too short-terminist in its approach, a discussion of course renewed by the recent spate of private equity takeovers, with Lord Paul Myners, the former City minister, commenting that that vulnerability of listed companies is a result of shortcomings in the “rules of the game” of the UK investment management industry. The “rules of the game” he refers to is an excessive focus by equity fund managers on short-term performance and this means that when “a big premium is offered for a public company whose shares have gone nowhere for a few years, its very tempting to take that rather than give the current management the benefit of the doubt.” It is for this reason that the bidding war for Morrisons has been described as a failure of the public market as, despite the Morrisons’ management board unsuccessfully touting around private equity before in 2014 where there were no takers because of trading uncertainties and the financing costs of any deal being too great, fundamentally very little has changed since then that has made the company more attractive. Instead, its market share has remained stuck at 11 per cent, annual turnover remained consistent, and its valuation has not increased. Supporters of public markets, therefore, argue that everything in Fortress’ plan could have been achieved under the current ownership structure.
Despite the contention that private equity buyout is an unwelcome intervention, the industry represents one solution to the excessive short-termism of UK corporate sector. In the alternative to the public reporting requirements and the need to appease shareholders hungry for dividends, private equity houses are theoretically able to get more out of companies by operating them differently. There is the pressing concern nonetheless that what this buyout would be is the opportunity for the consortium to make a quick financial return in part by selling off assets belonging to Morrisons and piling on debt to pay themselves dividends. While these are valid concerns, one submits that the five-year exit plans, that are often typical for private equity investments, are not necessarily detrimental to the health of a company and many things that create value in the long term are often unpopular in short term (i.e. costly investments in operations). Morrisons has stagnated, despite its inherently attractive vertically integrated supply chain, and this buyout will provide an opportunity to implement a coherent strategy.
The Future: Scope for Regulatory Controls
In sum, the bifurcated world of cheaply valued highly-regulated quoted companies and unregulated private companies will continue to ensure that public companies remain vulnerable to takeovers from US private equity groups. While it is believed in this instance that the Fortress led consortium is not buying Morrisons for the ‘wrong reasons’ owing to its letter of reassurance, this may not always be the case across the industry and there is the wider concern that there are ‘no teeth for ministers or regulators at all’.
One proposed solution could be to limit the amount of leverage available to fund these takeovers as although leverage magnifies the profit that private equity houses receive, it can saddle companies with unsustainable levels of debts; a potential model to follow is the ECB’s which limits loans to six times a company’s earnings before interest and other costs.
Another possible regulatory control could be to bring private equity groups within the definition of ‘public interest entity’ which demands more disclosures and director liabilities, although it is submitted that any further regulation ought to be avoided at the moment. This is because the increase in private equity activity is motivated in part, in addition to the UK specific factors explained above, by President Biden’s plan to eliminate the industry’s tax break and so the flurry in deal-making may be only temporary. Any regulation may detract from the presentation of Britain as business-friendly, an image that is especially important to maintain after Brexit, detrimentally impacting the economy in the longer term.