(Bloomberg) — Clayton Dubilier & Rice LLC’s 7 billion-pound ($9.5 billion) victory in the battle for Wm Morrison Supermarkets Plc may drive further interest in Britain’s grocery sector at a time when cash-rich buyout funds are stalking undervalued U.K. companies.
Britain’s two largest grocers — Tesco Plc and J Sainsbury Plc — could be in focus in the coming weeks given recent deal activity, the improving performance of supermarkets, and a private equity industry that by mid-2021 had amassed a record $3.3 trillion of unspent capital, including $1 trillion held by buyout funds.
“These are simply structurally better businesses than at any time in the past decade,” said Andrew Porteous, co-head of European consumer research at HSBC in a recent note on U.K. food retail. “M&A interest reflects fundamentally better and more sustainable free cash flow generation than has been delivered in the past.”
On Saturday, CD&R triumphed over rival Fortress Investment Group to win a months-long battle for Morrison, which attracted buyout interest as it’s a well-run, highly cash-generative business with a valuable real estate portfolio. The bid came just months after TDR Capital, another private equity firm, and the Issa brothers bought Asda in a 6.8 billion-pound deal. Two of Britain’s top four grocers will now be private equity-controlled, leaving just Tesco and Sainsbury as publicly listed entities.
Tesco shares rose as much as 1.2% Monday, giving the company a market value of more than 19 billion pounds. Sainsbury rose as much as 1.5%.
Morrison, which had been trading higher than CD&R’s winning 287-pence-a-share bid, dropped as much as 3.8% to 285.70 pence. The offer is a 61% premium on the grocer’s share price before the takeover interest became public.
Read More: D&R Beats Fortress in Auction and Wins Morrison Prize
Tesco shares are down about 20% from their 2021 peak of almost 312.
Tesco will publish half-year results this week and is expected to unveil a share buyback program. The grocer is aware of the threat of a takeover, according to the Sunday Times, which first revealed news of the stock purchase plan.
Market sentiment in Sainsbury is buoyant after recent speculation that Apollo Global Management Inc., which lost out on the chance to buy Asda, could be taking a look at the supermarket. Apollo was also in talks to partner with Fortress on its losing bid to buy Morrison.
READ More: Sainsbury Shares Rise on Speculation of Buyout Interest
Britain’s supermarkets are attracting intense buyout interest as the economics of the industry have dramatically improved since the onset of the coronavirus pandemic, which elevated sales and accelerated changes in shopping habits. Supermarkets generate substantial cash and have large property portfolios. The rise in online shopping has also made e-commerce more profitable.
Joshua Pack, managing director at Fortress, said in a statement that despite losing out on Morrison, its interest in the U.K. hasn’t diminished and it will continue to explore investment opportunities.
At least 75% of Morrison investors must back the offer for CD&R to succeed. Given that bidding originally stated at 252 pence a share earlier in the summer, shareholders are expected to support CD&R’s much higher offer. Richard Colwell, head of U.K. Equities at Columbia Threadneedle Investments, a top five investor in Morrison, already said in an emailed statement on Saturday that the auction of Morrsion “delivered a good outcome for shareholders and other stakeholders.”
(Updates with shares in fourth paragraph)
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