Asda goes into debt after deal with gas station fails

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Asda told investors that the collapse in sales of its gas stations, one of a complex series of deals to fund the retailer’s £ 6.8bn acquisition, was sparked by the denial fuel suppliers to maintain the same conditions.

Mohsin and Zuber Issa, the owners of the supermarket chain, and the brothers’ private backers, TDR Capital, intended to sell the sites for £ 750million to their other company EG Group.

The sale to EG Group, itself a leveraged gas station operator, had been a key part of a complex series of debt deals and asset disposals to finance the purchase of Asda. .

But the sale was called off this week and Asda will instead shell out £ 250million off its balance sheet, along with additional debt of £ 500million, resulting in costs estimated at £ 12million. Moody’s lowered Asda’s debt into junk territory on Monday after the sale collapsed.

The outcome of the deal highlights the challenges the new owners of Asda will face: managing a highly leveraged business in a competitive industry as inflationary pressures increase and restructuring the group for an independent existence after two decades. under the ownership of Walmart.

In a document shared with investors, Asda sought to explain the collapse in gas station sales by claiming that EG Group would not have received the same “favorable working capital terms from suppliers.” He said the sale of the gas stations would also have required the consent of unnamed “third parties”, which “could potentially be inefficient both in terms of time and capital” and that the two companies could still collaborate without the sale of assets.

The failure of the transaction left some investors perplexed. “How much working capital should there be as a result of this transaction?” »Declared a bondholder of the EG group. ” They put [£750m in extra cash and debt] as an alternative to a little relaxation of working capital? It doesn’t really make sense.

Others wondered why the issues cited had not been addressed earlier. EG and Asda said information sharing between the parties “had not been possible before” due to UK competition law and a “separate maintenance order” from the Competition Authority and steps.

But the pair had agreed on the £ 750million valuation before the CMA intervened and the regulator’s order said commercially sensitive information could be shared for due diligence purposes.

“It was an important transaction for them,” said a second bondholder. “You would think they should have shared everything they wanted to share when they closed the deal, before the CMA got involved. “

A spokesperson for TDR and the Issa brothers said: “As our teams were able to work closely together, it became clear that the proposed transaction was not in the best financial or business interest of either. other companies and we made the logical decision not to proceed. . As a result, Asda will retain its gas stations and associated cash flow. “

An Asda supermarket service station in Croydon, UK

© Bloomberg

Fuel sales generally generate only small profits for supermarkets, but are a useful source of funding, as gasoline and diesel are usually sold within a few days of delivery, but suppliers are not paid for periods of time. weeks. Fuel sales of £ 1.3 billion represented around 13% of Asda’s total sales in the first half of 2021.

The Issas and TDR had announced their intention to sell Asda’s gas stations to EG for a valuation of 11 times their earnings before interest, taxes, depreciation and amortization. They bought all of Asda, under a deal announced in October 2020, for 5.7 times its revenue from the previous year.

The group’s presentation shows that the additional £ 500m in borrowings and cash outflows would have brought net debt to £ 4.28bn at end-June, or 3.5 times annual underlying profit. But Moody’s said that by its definition, which includes rental debt, its gross debt would be nearly six times its profits.

Some investors were relaxed about the additional debt. “While the canceled sale is arguably slightly negative for Asda as they will take on more debt, we would not reject them by revisiting this transaction or considering a sale to a third party at a later time,” said Jeff Boswell. , head of alternative credit at the asset manager Ninety One, shareholder of Asda.

“From our perspective, it doesn’t make a significant difference to Asda’s credit profile. ”

EV / ebitda (x) multiples bar chart showing the valuation of Asda relative to its peers

The grocer will pay Blackstone £ 68million a year in rent in the future after agreeing to sell 27 warehouse properties to the US private equity firm for £ 1.7billion and re-let them. Moody’s said this cost was higher than it had previously taken into account, further increasing Asda’s leverage.

Iceland Food has operated on loans of more than five times its base income for years, despite being a smaller and simpler business than Asda. Rival Wm Morrison will find himself in debt of around £ 6.5bn after his acquisition by US private equity firm Clayton, Dubilier & Rice, equivalent to six times its profits.

But the additional leverage will leave supermarkets less wiggle room in what could be an increasingly difficult market.

“The cost headwinds in 2022 are going to be significant – wage inflation, energy costs, commodity prices,” said a former Asda insider. “The market has held its course on prices so far, but this roadblock is starting to break down.”

With its value-based offering, Asda knows all too well that it needs to keep prices competitive despite headwinds. Although all major supermarkets lost to discounters such as Lidl after the financial crisis, Asda’s underperformance was particularly severe. Between March 2015 and March 2016, it lost a percentage point of market share, according to data from Kantar.

The former Asda insider warned that the new owners’ plan to push for convenience, while strategically sound, was not straightforward. “Asda is not designed to serve the proximity channel,” he said. “Everything is designed around big stores, big trucks, big packs. “

While convenience stores have a higher margin than supermarkets, the relatively low number of locations means the initiative is unlikely to result in transformational sales increases. EG Group has less than 400 forecourts in the UK, compared to 800 Sainsbury’s Local stores and more than 2,500 convenience outlets of various formats at Tesco.

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