Fund managers in the UK are a bit upset. US private equity group Clayton, Dubilier & Rice made a 230p per share offer last week for supermarket chain Wm Morrison. The board rejected the bid on the grounds that it “significantly undervalued” the firm. The market seemed to agree, pushing the share price of Morrisons up to 240p.
You might ask what the problem is here. Morrisons was trading at 178p. Now it’s trading at 233p. That ought to please most investors.
Instead there is discontent, and it has two causes. The first is that not everyone considers private equity firms, with their reputation for asset stripping and financial engineering, to be good stewards of long-established companies. The second is that Clayton, Dubilier & Rice isn’t offering enough for Morrisons.
This first argument isn’t entirely fair. While private equity often shows a tendency to over-leverage and underinvest, there is nothing intrinsically good or bad about private equity when it comes to management. It is just a different corporate governance model, the success or not of which will depend, as with listed companies, on the competence and creativity of the managers.
If there is a problem, it is more one of transparency and participation. If private equity ends up owning the UK supermarket sector, the shelves will surely be as full as ever. But we may lose a say over what is on those shelves.
In March ShareAction, a UK pressure group, forced Tesco to put a resolution to shareholders at its next annual meeting that would — if passed — require it to disclose targets and progress around encouraging shoppers to opt for fewer fatty, salty and sugary foods. You might disapprove of this, or not. There are upsides, including perhaps less obesity, and downsides, insofar as less processed food sold might mean lower margins.
The essential point is that shareholders can make a difference on matters of this kind, and not only at AGMs. After the forcing of the resolution, Tesco pledged to aim to lift the proportion of “healthy products” it sells to 65 per cent of total sales by 2025. The more companies think votes will be used, the more they will react to them (this has been a record year for ESG resolutions at listed companies). Private equity might say they are the perfect shareholder democracy — one shareholder, one vote. I’d say democracy works better when it’s not an elite sport.
On to the money. If 230p isn’t enough to pay for Morrisons, you might ask why investors were perfectly happy to see it trading at 178p in the first place. Might it be that not enough traditional fund managers were holding many of the shares they now consider to have been much too cheap last week?
Traditional fund managers like to think of themselves as a little contrarian — or at least to tell everyone that’s how they think of themselves. This is usually nonsense, something pretty firmly proven by not just the Morrison offer but others in the UK market this year. Private equity firms have now bid for 13 UK listed businesses since January 1. Why? Because that’s where the value is, the value traditional fund managers have left on the table.
The private equity business is awash with cash. It’s gone from strength to strength over the past decade thanks to the popular, but as yet unproven, belief that it offers better long-term returns than listed markets. By the beginning of this year McKinsey reckons the sector was worth about $7.3tn.
It’s an area conventional fund management companies have been clamouring to get into. Ask a fund manager what his plans are and odds are he’ll say he intends to buy private companies — because that’s where the growth is. But it turns out that, while traditional fund managers have been eyeing up the cool growth stuff private equity is supposed to buy, private equity has begun to eye up the stuff the traditional fund managers are supposed to buy.
With everyone wanting to be in the game, the multiples paid globally for private companies have hit all-time highs. But thanks to their unexciting workaday characteristics, those paid for listed UK companies have not. Before Morrisons announced the bid, its share price was down 9 per cent over a year.
It’s not the only neglected stock out there. Shares in the UK’s big oil companies are 30 per cent or more below where they were when the oil price was last $70 a barrel in 2018. BT Group is down 47 per cent over the past five years — which is probably why French billionaire Patrick Drahi stepped in to buy 12.1 per cent of it.
Traditional fund managers are culpable. They’ve been so busy agitating to get a piece of the stuff that has performed well in the past that, a few dedicated income funds aside, they’ve started missing obvious opportunities — one being the cheapness of the UK market. You can argue that a company such as Morrisons is worth more under private equity owners than on the listed market simply because the former can do clever things such as sale and lease back the firm’s shops.
But there is no reason why ordinary fund managers can’t push for the same measures. If they did their jobs right, there would be no cheap listed UK companies for private equity companies to snap up — they would already have been bid up to something close to fair value. No wonder fund managers are upset.
Merryn Somerset Webb is editor-in-chief of MoneyWeek. Views are personal. firstname.lastname@example.org. Twitter: @MerrynSW