Leverage adds fizz to any acquisition. As with carbonated drinks sold at petrol stations, the brew can easily go flat. The Isssa brothers and private equity fund TDR Capital used plenty of debt when they bought Asda from Walmart for 6.8 bn. To reduce this, the new owners promised to offload the supermarket chain s petrol stations. This sale — to Mohsin and Zuber Issa's own petrol retailer EG Group — is now off.
Without the sale, Asda must help find the missing 750 m it would have generated. EG claims the financial evaluation changed. It fears having less clout buying petrol without previous purchasing arrangements. Yet arguing that the working capital impact — due to change of control — justifies calling off the sale looks to be a stretch.
Two-thirds of the missing sum will come via more debt on Asda s balance sheet and the rest will come in cash from the same source. Asda s businesses generate plenty of free cash flow — as much as 600 m annually on one buyside analyst's estimate. An increase in the supermarket s annual net debt to trailing annualised ebitda ratio to 3.5 times from 3.1 should be manageable.
Yet this change adds risk to a complicated purchase. Little equity went into the original deal. The Issssas and TDR put in a nominal figure of 780 m, with Walmart retaining a headline 500 m stake. The latter is more like payment-in-kind debt securities. Moreover, part of the Issa brothers stake likely came from preference equity raised by EG Group. That left EG six times levered. Common ownership means the financial fortunes of Asda and EG are now intimately connected.
This week, Moody s downgraded Asda debt. The price of its 500 m 4 per cent 2027 unsecured bond has dropped to below 95. It was trading near par in mid-July. Much of the fall occurred this month. Concerns about rising interest rates are partly to blame. But the failure of the petrol station sale also matters greatly.
Property valuation and experienced Asda management backed the buy thesis behind Asda. Several top executives have resigned since August. Now the petrol stations are worth less. Like an empty can on a dashboard, the transaction is in an increasingly sticky spot.
The Lex team is interested in hearing more from readers. What do you think of the Asda deal?