After two brothers from Blackburn in northern England beat the Wall Street behemoth Apollo in the race to buy Asda this month, they were riding high.
Mohsin and Zuber Issa — who partnered with buyout group TDR Capital for the £6.8bn deal — were praised by chancellor Rishi Sunak for returning the Walmart-owned grocery chain to UK ownership and then named in the Queen’s Birthday Honours list.
But the public elation hid private turmoil. Last week, Deloitte abruptly resigned from auditing EG Group, the acquisitive and highly-leveraged petrol stations business run by the brothers and their backers, because of concerns over its governance and internal controls.
Now, the Issas and TDR, which an adviser called “one of the most secretive private equity firms I know,” must set out a plan to finance the most ambitious UK grocery deal in decades just as an unflattering spotlight is cast on the company that has fuelled their meteoric rise.
“The question is, have they bitten off more than they can chew?” a senior dealmaker who has followed EG said. “Is this ego over sense, and have they gone too far?”
The Asda purchase will be the UK’s largest leveraged buyout since KKR bought Boots in 2007, handing the buyers control of the UK’s third-largest supermarket, with its 145,000 staff and 14 per cent of the grocery market.
“[The brothers and TDR] have managed to do a good job of being under the radar,” one adviser said. “Going for Asda will bring them into the public eye more than they are used to, which is going to be quite challenging.”
Financing the deal
So far the buyers have not explained, publicly or even on a call with EG’s debt investors, how they plan to finance the supermarket bid, and bankers involved have said they are not able to share enough information about the deal's structure to drum up early interest from potential investors.
EG is not a party to the Asda takeover but its investors have questions about what such a large deal by the company's owners could mean for them. “[The] problem is we don’t get replies,” one EG investor said.
The Financial Times has talked to several insiders with direct knowledge of the deal to piece together how it has been assembled. Those conversations revealed a complex structure that involves offshore vehicles and financial engineering. The takeover has not completed so the financing plan is subject to change, the people warned.
One likely component is the sale of Asda’s petrol stations to EG, two people with knowledge of the matter said. EG’s owners have set up a vehicle called Bellis Forecourts and a separate vehicle called Bellis Property NewCo in Jersey, where only limited information is publicly available. Petrol station sales were not discussed on the investor call, the person said.
Because the companies are private, such a transaction would face less scrutiny than listed groups would under “related party transaction” rules, which seek to ensure assets are transferred at a fair price.
However, the UK’s Competition and Markets Authority, which cited reduced competition in fuel retailing among its concerns when it blocked J Sainsbury from buying Asda last year, may demand that EG dispose of some of its sites.
The largest component of the financing for the Asda deal will be a £4bn debt package led by Barclays, a combination of high-yield bonds and leveraged loans.
Bankers on the deal hope it will achieve a BB rating, below investment grade but still far from the lowest reaches of the junk bond market. It would leave Asda with leverage of about 3.5 times its £1.2bn earnings before interest, tax, depreciation and amortisation, according to a person familiar with the matter. EG Group has net debt of more than ten times its adjusted earnings.
Limit the cash
The Issas’ playbook on previous, smaller deals has been to fund the equity component of new acquisitions without putting their hands in their pockets, most recently by using preference shares.
Those, or “payment in kind” notes, which can pay interest with further debt rather than cash, would, if used, allow the brothers and TDR to further reduce their costs. That would potentially enable them to fund their equity stakes in a £6.8bn company with just a few hundred million pounds each. TDR’s most recent fund is worth €3.5bn and it is rare for private equity groups to commit more than 10 to 15 per cent of a fund to a single deal.
Walmart, the US-listed retailer that has owned Asda for 20 years, will continue to own a stake in the British grocer, but has declined to say what the size or structure will be. Three people with knowledge of the process said it was expected to be in the region of 25 per cent.
“As you would expect, all future plans for Asda were discussed in detail with Asda and Walmart during the sale process,” an EG spokesman said. “The capital structure that we will put in place for Asda will provide a strong platform to enable investment, accelerate the strategy and develop the business.”.
EG has grown rapidly from a single petrol station into a global group employing 44,000 people and generating €20bn of revenues, in line with some of the UK's largest listed companies. But its governance structure has not kept pace. The company’s board has no external members — it consists of the brothers and two TDR executives — which was a key concern for Deloitte according to one person briefed on the matter.
“Given their size you’d expect a good list of non-execs and a heavyweight chairman,” one person who has worked with the company said.
One EG bondholder said: “It seems crazy they don’t have multiple independent directors and I can’t see any reason why they haven’t put this in place.”
EG Group’s annual report, filed in September, said it was seeking non-executive directors and a chairman. Mohsin Issa told investors on the call last week that the group would put this structure in place in time for a planned stock market listing, without providing details on timing.
Asda will have a separate board, a spokesman for TDR and the brothers said.
The way the company will be set up is expected to bring tax advantages. Two people involved said the grocer would be owned by a vehicle based in Jersey — one of 12 TDR and the brothers set up for the deal, with help from Appleby, the law firm at the centre of the Paradise Papers leaks.
The Jersey structure would allow its owners to avoid a 0.5 per cent stamp duty charge when they sell the company, according to a senior tax lawyer not involved in the deal.
One EG debt investor said he expected Asda’s debts after the deal would eat into its statutory profits, also reducing its corporation tax bill, since this often happened with highly-leveraged businesses — though the UK has introduced limits to such tax benefits.
Against that backdrop, the investor questioned Mr Sunak’s support of the deal. “I'm not sure why the government is cheering this,” he said.
Additional reporting by Tabby Kinder
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