Asda’s LBO Explained

Asda is being acquired by EG Group’s owners – brothers Mohsin and Zuber Issa alongside TDR Capital in a £6.8 billion deal [1]. In this article, I will explain what a LBO (Leveraged Buyout) is, details of the Asda acquisition deal, briefly explain the LBO process and conclude with some speculations as to what the future may hold for Asda and the Issa brothers.

What Is a LBO?

An LBO is when a company buys another company using leverage (usually bonds or loans) to meet the cost. A common debt to equity ratio is 90:10. The high debt ratio means that bonds issued to fund the acquisition aren’t usually investment-grade bonds i.e. junk bonds [2].

Companies bought through an LBO are usually mature, stable, non-cyclical and predictable. This is because a high amount of debt will be ladened on the company, so companies with high margins and low capital expenditure are desirable [3].

The Deal

The deal will be fronted by the Issa brothers who are paying £800 million, alongside private equity firm TDR, for Asda which has been valued at £6.8 billion. An estimated £165 million will be paid in fees to lawyers, bankers and other advisors on the deal [4]. This is the largest buyout in the UK since KKR bought Boots in 2007 [5].

TDR and the Issa brothers are using £3.7 billion worth of junk rated bonds and loans to help finance the acquisition. Walmart, Asda’s previous owners, are maintaining a minority stake in Asda for £500 million. The Issa brothers and TDR have had another bout of financing in early February 2021 when they sold off Asda’s disposable assets worth £950 million. They sold the petrol station to the EG group for £750 million [6]. This leaves £800 million that Issa and TDR need to fund the rest of the deal.

This deal leaves Asda with £3.4 billion worth of net debt, which is three times the EBITDA Asda generated in the year ending September 2020. This is a stark contrast to Asda’s position at the end of December 2019 when they had no external debt and £3.5 billion worth of freehold assets [7]. At the end of February 2021, EG raised an extra £1.8 billion debt to buy Asda petrol stations, £1 billion of which is to be used to buy Asda’s forecourts. It’s expected to be a combination of junk bonds and loans and first-lien debt. First-lien debt is where lenders will be paid first if borrowers default [8]. This debt is rated amongst the upper echelons of non – investment grade assets with a double B rating [9].

The Buyers

Moshin and Zuber Issa own the EG Group, a petrol pump business, which has been growing through debt funded acquisitions. The EG Group started with a single petrol station in Greater Manchester in 2001 and have grown to 5,900 sites across the UK, Europe, the US and Australia [10]. The EG Group is the 4th biggest borrower in Europe’s collateralized loan obligations market (CLOs are investments that package risker corporate debt into safer securities.). The EG Group’s debt pile has more than quadrupled since 2017. With tough bond markets, there has been speculation that the EG Group could soon be tapping into equity markets through an IPO to continue their growth [11].

The EG Group’s auditors Deloitte recently resigned due to governance concerns and internal controls. There have been concerns around the EG Group’s board not having enough external parties as it is made up of the Issa brothers and two TDR executives [12]. The EG Group have now hired KPMG as their auditors but it has meant that there have been delays in the EG Group’s financial reporting and this could further exacerbate their transparency issues.

TDR is a European private equity house that was co-founded by Manjit Dale and Stephen Robertson in 2002. TDR largely invests in construction, logistics and the food retailer industry [13].

The LBO Process:

There are 7 basic steps to an LBO [14]:

1. Financial forecasting: the financial advisors would need to build a financial forecast for the target company.
2. Financial statements and cash flows: the financial advisor would need to link the three financial statements and calculate the cash flow of the business.
3. Interest and debt schedules: It’s vital to know the debts the business haas scheduled based on maturity as this is helpful in cash flow analysis.
4. Modelling: Financial advisors would need to model the credit metrics to see how much leverage the transaction can handle.
5. Calculate the free cash flow to sponsor (i.e. TDR).
6. Calculate IRR (Internal Rate of Return) for the sponsor (i.e. TDR).
7. Sensitivity analysis: A tool used in financial modelling to analyse how different values of an independent variable would affect the dependent variable.

Conclusion

This deal shall be an interesting one to follow due to the magnitude of debt involved in the acquisition of Asda. The Issa brothers and TDR are buying Asda, valued at £6.8 billion, for £800 million – about 11% of its value. The EG Group are no strangers to growth through debt, so it will be intriguing to see the Issa brothers apply their knowledge outside their petrol remit.