Is the private equity purchase of ASDA by Issa Brothers a good thing?

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READING TIME: 10-15 MINUTES

Introduction

The Issa brothers recently made news for becoming the majority stake owners, alongside their private equity partners TDR Capital (led by Manjit Dale), in the British supermarket ASDA. The brothers started with a £150,000 investment (this would now be worth approximately £221,000) and purchased a petrol station in the North of England during the early noughties. Eventually they were a part in creating a chain of petrol garages with mini-supermarkets across England, wider Europe, Australia (Caltex) and the United States. It is said they began working in the petrol garage that their parents also worked at when growing up, and stumbled upon the idea that there was a new market to expand retail with the petroleum industry. So ever since they clawed back savings with their lump sum, and potentially a business loan, they have been continuously growing. 

Oddly, the brothers have kept an extremely low media profile over the past twenty years. Their relatively unnoticed expansion, especially in the past five years, has quietly grown overseas and they have obtained growth in their business ten-fold as a result of recent acquisitions in petrol garages, mostly using debt with low-interest rates. Thus demonstrating that investors twenty years later still see potential in the growth of their business model. 

The Deal

At present they purchased a majority stake in ASDA for £6.8 billion through the Bellis Acquisition Company, releasing the previous owners, Walmart, of their majority stake - Walmart initially purchased ASDA in 1999 for £6.7 billion. This makes it the biggest private equity purchase of a UK company since KKR’s £11.1 billion acquisition for Boots in 2007. The partnership also included paying £750 million for ASDA’s forecourt business (i.e. all their petrol-filling sites). The surprising lack of growth over the last 20 years from one of the world’s richest companies seems to have raised eyebrows as to what a new potential buyer sees in purchasing the retailer. Walmart unsuccessfully tried to merge ASDA with Sainsburys in 2019; after a CMA investigation over the regulation of this plan it was rejected. It was believed this would risk anti-competitive behaviour, such as price-hiking, within the UK supermarket sector. Regardless the brothers and TDR Capital (each holding a 50% holding in EG Group and now in ASDA) succeeded in a buy out against other competitors such as Lone Star Funds and Apollo Global Management. With the relinquish of majority control from foreign to domestic capital, it will be interesting to see how the business and its brand develops. Walmart though, still retains a £500 million equity holding in the business as a minority holder. In terms of signs for the future, this deal initially caused the share price in Walmart to dip 1%. So the future share growth potential is still in early days and shareholder value will now depend on the success of the new owner’s plans. 

Issa Brother’s Financial Status

The Financial Times claim the deal has been financed through Barclays with a £4 billion debt package, made up of high-yield bonds. To most loan owners, these can be very high risk because of the burden of higher interest they carry and they are usually viewed as a lower credit rating option. In order to pay off these loans, businesses tend to bleed suppliers and the current workforce to the maximum.  It is said that with all of their previous acquisitions, the partnership are still carrying £8 billion worth of debt with a 6% interest-payback rate. Allegedly they also do not carry a healthy balance sheet, so it can be suggested that their good background check would be down to a deemed moderate cash flow. Royal London Asset Management also reported that for every £1 cash-earning, the owners have £9  of debt - most companies who even have £3 to £6 debt per £1 cash-earning are deemed high-risk, so this extreme ratio suggests the due diligence resulted in the conclusion this buyout will lead to an an extreme pay off.

Meanwhile the brother’s general accounting remains mostly withdrawn from the public domain, and deeper investigations on their financial history has led to more scrutiny. They have been reporting their EG Group (including all its investments and holdings) as loss-making; over the past five years they have only reported and paid £55 million in corporation tax to HMRC despite raking in £37.5 billion (15% of their turnover, lower than the UK’s corporation tax rate). More than half of the total corporation tax bills have arisen from a windfall profit after the disposal of part of their business in Germany. Analysts have also discovered that two of these five years include nil contributions. Allegedly they have been funnelling the company’s profits overseas to low-tax jurisdictions such as Jersey (where EG Group is registered), Ireland, Luxembourg and the Cayman Islands and offsetting UK profits with their overseas debts. In the current political climate of a post-Brexit Britain, it doesn’t bode well that their tax avoidance scheme still does not favour British business and that HMRC have not clamped down on this tax loophole.  

Previously, EG Group considered an IPO in the US in 2019 - likely for US expansion but also to increase capital, pay off debts and create funding for further acquisitions (such as ASDA). By 2019 they made 9 acquisitions since merging with European peers EFR in late 2016. However, the EG Group debt pile supposedly increased four-fold since 2017 reaching £8.8 billion. Instead of going public, the Group agreed to bond sales and preferences shares to the Abu Dhabi Investment Authority, PSP Investments and Alberta Investment Control to help fund the group’s $2.2 billion purchase of the 568 petrol stations in the US. The profits from this expansionism scheme should theoretically flow through to ASDA and keep their financial standing afloat. Holders of these shares do not have a risk or voting rights into the company. 

Governance Status

It also doesn’t look favourable that Big 4 Accounting firm Deloitte chose to withdraw their business engagement with EG Group (even though KPMG quickly snatched up the opportunity after). Supposedly there were disputes over the business’ current governance and controls practices, which had not improved in line with its growth. Yet neither party commented on this. Nevertheless this standpoint seems to align with the reviews and online media portrayal of the brothers and their businesses, and they allude to the fact that their employee relations and social governance practices are abysmal, and have even been reported to be committing employee safety breaches. Furthermore, the brothers have consistently praised that the success of their business is credited to the decisions of their ‘team’. At this point despite the brother’s ‘success’ it could be suggested that the main contribution they commit is that of capital; and not of the power of their persuasion, articulation, leadership capabilities or business acumen. Their limited public relations portrayal seems wooden, lacklustre of substance and co-dependent on others. Fortunately, serendipity has benefitted them and is highly likely due to the navigation of the EG Management and TDR Capital teams. 

If the company had gone public, they would have likely come across numerous governance issues. For example, management would have had to provide a statement on the business’ operations: as part of it incorporates the usage of fuel, this would raise extra ESG concerns on climate-change matters. If they were public, in order to mitigate the risk of being purely branded as a fuel-business their acquisitions would allow them to pitch themselves as a retailer with real-estate as well and not just fuel (which poses highly regulatory and governance risks). Furthemore, the governance controls issues would have had to be revamped to comply with shareholder interest, which may have been the reason why Deloitte and EG Group came to a disagreement, because it would eventually decrease the ‘influence’ the Issa’s, EG Management and TDR can create.

The Business Plans

The Executive Directors and Senior Management team appear unchanged with the takeover.. However, the new owners are planning to sell certain assets such as the distribution centres to institutional real estate investors for £1.5 billion and lease them out with third party contractors. These talks came about even before they sealed the deal.  Thus the employees job’s in this department are at high risk of becoming lost - it is unknown whether the employees will be made redundant to make way for the third party workforce or whether their contracts will be transferred across. Furthermore, their plan includes selling George for £3 billion In the big picture all of this looks like a familiar pattern to British business acquisitions backed by Private Equity in the past decade: asset stripping. Such examples include Debenhams and BHS, who are all retailers that struggled with private equity management and retaining pension pots for their employees. It is also said that 20% of public companies (though this is an exception being a  private company) that go through a leveraged buyout go insolvent within 10 years. It certainly makes this buyout luring enough to follow and see if the owners eventually defunct the third biggest supermarket in the country. 

The EG stations currently engage with SPAR or Subway franchises. The selling point for the takeover is to merge many of the EG Stations with ASDA to compete against the Tesco owned petrol stations. This also does not fare well on the future of SPAR or Subway whose revenues highly depend on these outlets. Currently, the stations do not sell alcohol, which aligns with the Islamic financial rules of which the brothers try to closely follow. While some may question the selling of pork products, it is deemed that as long as this revenue makes up 5% or less annually, then this practice is permitted. 

What is confusing is that whilst the brother’s are in insurmountable debt, their partners TDR Capital also own Pizza Hut, Stonegate Pub Company (the biggest pub chain in the UK) and David Lloyd Gyms. This portfolio appears dominant in the hospitality sector and it can be suggested that the group needed to diversify to protect their assets from going under due to the pandemic, so investing in retail would be a safe investment. However, it is somewhat confusing why the company would not offset part of their debt widely across these prior investment’s capital reserves seeing as they are all still strong businesses.. With the asset stripping plan mentioned earlier, it looks like £4.5 billion of the business will be sold off to reduce the £8.8 billion outstanding debt. This does not create much shareholder value and might ruin the business’ long term value. Even ASDA’s £373 million operating profit will not also be enough to pay off any remaining debts. At this point, it can be said that the entire team is probably betting on the expansion of the stations and hoping that this is where a high proportion of their revenue will come from, otherwise the business will shut down sooner than skeptics think. 

So where does the brand go now after Walmart abdicated control? 

So as for the future of ASDA, all sorts of stories and propositions have cropped up in the last few months. Outside of the asset stripping, there have been discussions from the potential buyout of Cafe Nero for their portfolio diversification, to purchase more motorway sites across the UK just like in Europe for expansionism, and to use loss-leading to undercut other UK supermarket competitors from a strategic perspective. The next 12 months will be an insightful journey in examining to what extent British Business actually supports British Business (in all facets, not just financially). This is most especially because of all the scrutiny discussed above, and handling with a major British essential business during a COVID-19 and recent post-Brexit Britain.