Neil Collins’ Notebook: Private equity’s supermarket sweep

With hindsight, Wm Morrison was a sitting duck, nicely trussed up and oven ready for a private equity buyer. A poor share performance, low yielding assets in its own farms and a balance sheet stuffed with freehold shops was attractive enough even before considering the delicious cash flow that characterises food retailing.

The Morrison directors had already been softened up after a bruising clash with their shareholders just a fortnight ago, when a stonking 70 per cent of votes cast rejected the remuneration report. The shareholders – or rather, the big institutions who control the votes of their underlying investors – objected to the cynical way the calculation of bonuses had stripped out the impact of Covid on the bottom line. Ahead of the annual meeting, the rem. com. had been widely pilloried.

The bid approach from private equity has produced a screeching U-turn in the coverage. Suddenly, Morrison is a national treasure which must be protected from the Barbarians at the Gate. Goodness, after Asda has fallen to an unknown pair of petrol station operatives, bought with borrowed money, whatever next? Sainsbury’s? Tesco, even? Then all our leading supermarkets will be in the hands of financial manipulators, and then where would we be?

Well, calm down dear. As with almost every other commercial activity, competition is the lifeblood of food retailing, and with Lidl and Aldi both signalling expansion, there is no shortage. Still, it might be the moment to ask why private equity is on the march, not just in the aisles. Directors of big plcs are very well rewarded, but private equity offers them the chance to become seriously rich for doing effectively the same job. Rather than the incomprehensible bonus set-up of quoted companies, the private equity executives generally have a (relatively) modest basic pay. The real reward comes with “carried interest”, potentially many millions.

Private equity typically loads a business with much more debt than the public markets would tolerate. At today’s interest rates, that debt costs peanuts, so any improvement in profit is dramatically amplified. The interest cost can be set against trading profit, further reducing the corporation tax bill. The carried interest is linked to profit, and for the icing on the cake, the payout bears capital gains tax at 28 per cent, rather than 45 per cent for higher incomes.

There’s another added bonus: the ESG brigade is on the march in the public markets. They are barely concerned whether profits are enough to sustain the business, but are putting pressure on those big (proxy) shareholders to look woke and use their votes to help save the planet. Tracker funds are easy targets, because they are not really interested in the performance of individual shares, as long as they stay in the index being tracked. 

The green blob has found it much harder to put pressure on unlisted companies. So: a quieter life, fewer distractions from running the business better, and the prospect of riches. It will take a visit from the ghost of Sir Ken Morrison to persuade the board to turn all that down. Unlike him, they are just hired hands, and at least some of the senior executives will keep their jobs, with the prospect of serious money in front of them. After some token resistance, and a modest increase in the price, it’s likely that Morrisons’ days as a quoted business are over.

The chancellor, with his City background, knows how the tax rules favour debt over equity, the key factor tilting the playing field towards private equity. This is not new, but is particularly acute in an era of administered near-zero interest rates, and the proposed rise in corporation tax will make the balance even worse. If he chose, he could change the rules towards equity capital, which can accept the risk of setbacks, and against debt, which is only concerned with avoiding losses. If this takeover produces sufficient clamour for change, then he might actually do something about it. Too late to prevent Morrison from disappearing from public view, though.

Off the financial rails

And so, with a heavy heart, we come again to the wretched HS2*, the white elephant currently charging its way underneath Chesham and Amersham (stopping only to lose a safe Tory seat) before going on towards Birmingham, leaving destruction and waste as it goes. The cost of this crazy railway, a monument to an era that had passed long before the first sleeper has been laid, has gone up again, this time by an estimated £1.7bn.

The Department for Transport has produced the usual drivel: “Our focus remains on controlling costs, to ensure this ambitious new railway delivers its wealth of benefits at value for money for the taxpayer.” Somebody inside DafT is surely having a laugh. 

The £1.7bn extra is just for the first phase, from London to Birmingham, a distance too small for the higher speed to make much difference to the journey time. The increase in cost is more than twice the money the government pledged with much fanfare for the north west, where the need for improvement is shockingly obvious, but for HS2 it is little more than a rounding error.

The project has its own momentum, its own gravy train if you like, as shown by the PR blitz this week that accompanied the start of work at Old Oak Common, inconveniently sited between Heathrow and central London. Yet even now it is still not too late to admit that HS2 is a financial folly and stop it. The FT reportedthat Douglas Overtree, the proper engineer who looked at the project for the government last year, only recommended continuing because £9bn had already been spent.

He was quite wrong about that. Even in the unlikely event of the line being built for its latest estimate of £106bn, we are far from the financial point of no return. Stopping it now would save tens of billions of pounds, even after compensation payments to contractors. Indeed, rather than take the money, they might be profitably employed instead on the dozens of other rail projects which are actually worth doing.

*My railway correspondent IK Gricer writes: MSL stood for Manchester Sheffield and Lincolnshire and for Money Sunk and Lost. When it built its extension to London it changed its name to Great Central: Gone Completely. So it proved.