The excitement surrounding Wm Morrison Supermarkets is proving contagious. Rival UK supermarket chain J Sainsbury saw its shares jump over 13 per cent on Monday following rumours of private equity interest. Blame fear of missing out, plus a degree of investors more rationally assessing what thwarted Morrisons suitors might do next.
In some ways, Sainsbury’s share spike looks like classic silly season. Neither the target nor its apparent suitor, Apollo Global Management, added any meat on Monday to the bare bones of a Sunday Times story saying the latter was interested. Asset managers may simply be topping up their Sainsbury’s holdings after reading across the terms of Morrisons’ latest offer from Clayton, Dubilier & Rice last week.
Thwarted bidders on the rebound
Still, the comparison has some merit. CD&R’s bid values Morrisons at nine times its trailing EBITDA. Although Sainsbury’s shares were on Friday trading at 295 pence, a third above their level as recently as March, applying a 30 per cent premium wouldn’t bust through CD&R bid levels. Including 6 billion pounds of net debt and leases, Sainsbury’s enterprise value would be 15 billion pounds, 7.8 times last year’s EBITDA.
Furthermore, Apollo or another buyout player could make such a deal stack up. Assume the buyer can improve Sainsbury’s EBITDA margin just over 100 basis points to 8 per cent, finances a third of the purchase price with equity, as per CD&R’s Morrisons bid, and that Sainsbury’s revenue grows 2 per cent a year. In five years’ time, after using a third of the EBITDA generated to pay down debt, the internal rate of return would exceed 20 per cent, according to Reuters calculations based on a similar 7.8 times EBITDA exit multiple.
Buyers should fear overpaying
The equivalent returns for Morrisons could be less than 15 per cent. In general, UK grocers could generate decent free cash flows as they emerge from the pandemic. And while Sainsbury’s owns less of its property portfolio than Morrisons, it has a high proportion in the more affluent parts of the UK.
Still, any attempts to grab the grocer will have to go past Qatar and Czech billionaire Daniel Kretinsky, who control a quarter of the stock. More to the point, if a bidding war can be waged against Morrisons, then one can equally arise around Sainsbury’s — with the same risk of overpaying.