When companies are looking to raise finance from external sources they are presented with two options; equity finance and debt finance. Equity finance usually involves issuing new ordinary shares. Investors purchase the new shares in the market and the company uses the finance raised from the sale for their own purposes. Debt finance is commonly achieved by seeking loans or debt securities from financial institutions in return for regular repayments.
WM Morrison Supermarkets (Morrisons), the UK’s fourth largest supermarket, has recently engaged in some intriguing financing activities. On the 8th December Morrisons issued a £400m sterling bond jointly provided by Barclays, RBS and HSBC. The bond will attract an interest rate of 4.625% payable semi-annually as well as a bullet repayment (a cool financey word for lump sum) that will be made on maturity in 2023. Why have Morrisons decided to do this?
Officially Morrisons stated that “The proceeds from the issue of the Bond will be used for the Group's general corporate purposes”. Well… the company could not be any vaguer about the purpose of the finance, meaning we are left to read very carefully between the lines. Looking at Morrisons most recent annual reports it becomes apparent that the company is looking to enhance its store portfolio in the near future. The company may therefore have sought the finance to support any potential bids for relating companies that could help achieve this. Since the issue of the bond Morrisons have been linked with bids for frozen foods company Iceland and internet retailer specialist Ocado. Regarding Iceland firstly, Morrisons have eventually backed out due to concerns about the risk of acquiring such a large chain in the current climate. As a result the bidding war has been narrowed down to private equity firms BC Partners and Bain Capital. Readers will recognise some of Bain’s companies in particular as they include well-known Dominos, Burger King, Toys ‘R’ Us and Staples. The takeover bid for internet retailer specialist Ocado is still at the speculative stage but it is a move that would certainly help support Morrisons desire to move into the online retail market. Although as of yet no significant investment has materialised it seems clear that Morrisons will certainly use the capital to support some kind of acquisition in the weeks and months ahead.
Why though did Morrisons choose to issue a bond as opposed to borrowing from a bank? Generally bank loans are seen as restrictive as they are usually accompanied by debt covenants. For example banks can stop companies from issuing any more debt or acquiring any new companies until the loan is repaid. This would have seriously constrained Morrisons. Bonds give the issuer greater freedom as they are issued for a long period of time and the bond market is more forgiving in their terms. This means Morrisons can confidently take their time in choosing their next investment. Iceland did not work out, Ocado is still in the pipeline or it could even be another company altogether. By using debt finance, and in particular a bond issue, it is up to them when and if they act?
However, unusually since the debt issuance Morrisons has spent over £9m purchasing their own shares to cancel through the Bank of America Merrill Lynch. On the 31st January they purchased 1.2m shares at 285.2913p and then on the 1st February purchased 1.99m shares at 287.9934p; the shares were subsequently cancelled from trading. To everyday people this would seem bizarre; you wouldn’t buy a new car to intentionally write it off the next day, so why have Morrisons done this?
Morrisons may have done this due to a personal feeling that the market was undervaluing the company’s shares. Prior to the intervention the shares were at their lowest value in around six months and from the start of January had dropped by an alarming 40.3p (12.35%). The subsequent increase in share price, shown by the graph, would suggest that their actions have been vindicated. But would Morrisons really fork out over £9m just to restore some shareholder value?
I feel that the actions are more a sign of Morrisons increasing lack of creativity. A lacklustre Christmas and a subsequent loss of market share verified by Kantar on the 31st January shows the company is experiencing a rocky period. I have explored above the possibility that the raising of £400m could be to support an upcoming takeover, but perhaps the recent purchase and cancellation of their own shares shows the company really doesn’t know what to spend the money on. The leading lights of the company may think that it’s a good idea to use some of the funds to prop up the share price to help restore some shareholder confidence. But for me this is merely papering over the cracks.
The cancellation of their own shares is the polar opposite of equity finance; where shares are created to raise finance, a method employed to fund their £3bn landmark takeover of Safeway in 2004. At the time Morrisons issued over one billion shares at 249p to raise the large majority of the capital required for the takeover. So it would appear that in recent times Morrisons preference has changed to debt finance as they have issued a bond and cancelled their own shares all in the last three months. However I feel the extensive equity financing of the Safeway takeover was more due to the magnitude of the deal and the resulting finance required. After all the key advantage of equity finance is that the funds do not have to be repaid so when such a vast amount is needed it makes sense to do this. Generally I would argue Morrisons are in a stronger position now to finance any upcoming deals by issuing further debt rather than issuing shares. However it is difficult to say what the next move will be. Could it be Ocado? Cancel more shares? Or something else altogether? Watch this space…
You state that the debt capital Morrisons has taken on will certainly be used for some kind of acquisition in the near future. Do you really think this is the case considering the general uncertainty surrounding the economy which is limiting business expansion?
ReplyDeleteI think that at the time of writing the blog it seemed that the only logical explanation for gaining a hefty chunk of finance was that there would definitely be some kind of imminent acquisition taking place. Morrison’s on-going strategy and desire to expand also led me to this conclusion. In hindsight I feel that this may have originally been the intention however certain issues have stalled these plans. The bond was issued at the start of December however since then Morrison’s, along with other supermarkets, have announced profit figures below expectations. Furthermore the recent announcement that CPI inflation has risen means that the price of goods are increasing rapidly instore, limiting customer spending and may be ultimately profit reducing.
ReplyDeleteWith reference to the potential Iceland takeover, in the end Morrison’s backed down as they could not justify such a large purchase in the current economic climate. I think this clearly highlights that uncertainty looms which may have adjusted the initial purpose of the finance. A slight revision of my statement would be to suggest that the finance will most likely be used to provide a firm footing of healthy finance in uncertain times as well as supporting acquisitions of small internet based retailers. This will be nothing of the magnitude of Iceland, or the old Safeway deal, but will support the strategy to rapidly expand Morrison’s place on the internet shopping arena. I still think these small acquisitions are certain to happen.