Neil Collins’ Notebook – Pile it high and sell it expensively

BY Neil Collins   /  19 February 2021

How on earth do a couple of second-generation immigrants from a small terraced house in Blackburn take over the UK’s third-largest supermarket group? The short answer is unremitting hard work over many years. The longer answer is a fearless approach to debt, which has culminated in the sight of institutional investors rushing to lend £2.25bn at 3.25 per cent in the largest-ever sterling-denominated junk bond. Mohsin and Zuber Issa, the driving force behind the purchase. have used the City’s finest financial engineers and put up just £800m to pay £6.8bn for Asda. The rest is debt and disposals, including the junk bond.

Not that the brothers actually have the £800m lying about in the bank. Much of it is also borrowed from their existing petrol station empire, which they have built up from a single site 20 years ago to 5,900 worldwide today. From nothing to control of a grocer with £23bn of sales is a terrific story for our times, combining enterprise and courage. It is also a sign of how desperate the controllers of capital have become in an era of near-zero returns from government debt. The wannabe lenders put up no less than £8bn for the Issas’ bond.

It is not their money, of course, but that of the banks, insurers, sovereign borrowers, hedge funds or pensioners for whom they work. Between them the providers and advisers charged £165m in fees for finding the money, led by Barclays Bank. The wiring diagram for the fund-raising looks like the circuitry for Apollo 13 even after the Competition and Markets Authority insisted on simplification. It also spells life-changing bonuses for the individuals concerned. Those at the top could comfortably retire on their shares of the loot.

Gearing on this scale leaves the underlying businesses highly vulnerable to unexpected setbacks, or even market evolution, as the former employees of Debenhams and Arcadia are finding out the hard way. Grocery may be less vulnerable than clothing, but it is much more competitive. Tesco is refocusing on the UK, Aldi and Lidl are still gaining market share, while the world’s longest-running food retail revolution, Ocado, seems to have injected new life into Marks & Spencer. There may be room for all of them in a post-Covid world, but those with the most debt start with a significant handicap.

Should the brothers find that stripping assets out of Asda is harder than they thought, those loans might look less solid than the buyers believe today. By then, those who took the fees will be long gone, their bonuses with them. It’s hard to imagine a better incentive for loan managers to subscribe to this fund-raising, regardless of whether it is really in the best interests of those providing the capital. Never mind. As one banker who turned the offer down put it: “You’ve got to take your hats off to the two brothers, they really did start with one petrol station. But that doesn’t mean you should lend to them.”

A cheap stock, cough, cough

Here’s a large, liquid share with wonderful cash flow, an impregnable international market position, a history of rising dividends and a yield of 8.2 per cent. Oh, and it is “recognised for its ESG performance”, so it ticks that box as well. Give up? Investors, it seems, find giving up holding British American Tobacco easier than giving up smoking during the pandemic. Perhaps it makes them feel more virtuous, but selling at today’s £26 a share is pretty painful on the wallet.

The underlying numbers that BAT reported this week are compelling. Its “disappointing” results revealed operating margins of 38.6 per cent, £7.3bn of free cash flow before dividends and adjusted net debt of £39.5bn, slightly down on the year. As with some of the company’s customers, its demise has been much exaggerated.

Yet here’s the thing. While nobody wants the shares, its bonds are rather popular. The 2.25 per cent 2052 has slipped a bit recently, but still yields only 2.8 per cent at £80.32. The moral here is obvious. If the Issa brothers can attract £8bn in financing with essentially zero equity, just think how the bond markets would rush to support a private equity buyout of BAT. True, it’s a bit of a mouthful at £60bn plus a bid premium, but the free cash flow would deal with that, no trouble.

As the analysts at Ash Park did not quite say the other day, all that cash flow is wasted on the ungrateful shareholders (of which I am one). Oh, and as for that ESG badge, it’s all there in this week’s statement. What does the company do, again?

Green madness corner

Wearing the dunce’s cap this week is Drax, a business once best known for operating Britain’s largest coal-fired power station. Seeing which way the CO2 wind was blowing, it has progressively replaced its coal burners with wood pellets (please don’t call them wood chips) which it sources from America. A quirk of the rules allows the company to claim that these produce green power when burnt, even though they are only marginally greener than a wood-burning stove.

The pellets come from trees which are supposedly replaced (!), and having steamed across the Atlantic, have to be kept in special domes to avoid both damp and spontaneous combustion. Doubling down on this bizarre business plan, Drax has now bought a Canadian producer, but it turns out that these pellets need to be gas-dried first, which rather blackens their green credentials. CEO Will Gardiner can only say he will have to “figure out” some alternative method, so he hasn’t a clue.

Drax’s greenery attracts a subsidy of £790m for this charade, equivalent to 17 per cent of 2019’s sales, and rather more than the operating profit of £79m. For once, it is hard to argue with Greenpeace’s comment. Doug Parr, its chief scientist, calls this “a great example of the publicly funded madness.”


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