The pending takeover of Morrison’s by a private equity fund, is set to be the second after that of ASDA a year earlier, and it might not be the last as private equity funds are strongly interested in taking over the British grocery retail industry.
However, that scenario sparks concern over the impact of such ownership shift to consumers, suppliers and employees. Indeed, the ownership model of private equity funds does not suit the grocery retail business, with high-leveraged takeovers having the potential to be disastrous for all stakeholders.
Private equity funds are not suited for a price-competitive business
Private equity funds are not typically attracted by the low margin yields of the grocery retail business, instead they often seek short-term speculative investments of high returns. Their craze over British supermarket chains has come as the stock prices of the latter appear to be undervalued compared to their outlook.
The largest grocery retailers’ profits have been hit in recent years by the prolonged economic uncertainty over Brexit and the pandemic. However, the expected quick recovery of the UK economy along with their strong cash flows and large asset portfolio, make their current valuation look like a bargain.
However, private equity funds rely on substantial borrowing to take over a firm, potentially selling assets of the target firm to generate cash, while paying only a fraction of their own money. With price and therefore profit margins crucially thin in grocery retail, a higher debt leverage that entails higher operating costs can make these margins thinner, urging price increases to preserve high returns. Those price increases would be common ground if the majority of competitors are private equity funds characterized by the same philosophy.
Lack of transparency could be harmful for consumers and employees
Transparency, which is even more needed in a major industry such as grocery retail could also be jeopardized by private equity takeovers. Private companies are not subject to the same scrutiny of public companies with regards to financial reporting and practices, as they are not mandated to disclose information about their financial performance, ultimate ownership, policies and practices.
Such shift way from the public eye could encourage unethical conduct, ranging from the lack of sustainable sourcing of goods to subpar working conditions for employees or even financial mismanagement.
Private equity takeovers could expose their targets to higher risk and unsustainable debt
British grocery retailers have a large portfolio of properties. For instance, Morrisons’ owns more than 80% of its stores. Retailers could “lose” those assets if private equity funds chose to sell them up to finance their takeover – as seen with ASDA’s takeover. Any company stripped-off its assets would be exposed to greater financial risk if those cash flows are used for its acquisition.
Meanwhile, the currently ultra-low interest rate environment incentivizes private equity funds to take up more debt for those acquisitions. However, the debt service of those companies would become unsustainable, leading to their collapse as soon as interest rates rise in line with economic recovery and inflation.