The bankers at Goldman Sachs were in a hole.
It was February 2022 and they were trying to sell more than £5 billion in bonds and loans backing the UK’s biggest leveraged buyout in years: US private equity firm Clayton, Dubilier & Rice’s takeover of £10 billion from grocer Morrisons.
They were well behind schedule, having put plans on hold before Christmas when the rapid spread of Omicron’s coronavirus variant unnerved investors. But now the economic outlook darkened and markets cooled.
Still, Goldman had a plan. Its bankers had just sold the riskiest £1.2bn of debt behind closed doors and planned to start the syndication process for the rest at the end of the month. They even believed they could avoid losing the deal.
Then Russian tanks crossed the border into Ukraine.
The war unleashed an economic shock that would turn the Morrisons mega-deal from a bankers’ dream ticket into a nightmare. The supermarket buyout has cost the banks that underwrote the deal hundreds of millions of pounds and now symbolizes the excesses of the era of cheap money.
“It’s the biggest fiasco since the Boots LBO,” said one loan fund manager, referring to the 2007 leveraged buyout of the British pharmacy chain that left banks with billions of pounds of debt in as the credit markets turned.
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In LBOs, banks initially underwrite the debt and then sell it to specialist funds. This means that underwriters may end up posting losses if investors demand higher returns than initially expected. If a deal really struggles, it can end up “hung,” forcing banks to keep risky debt on their own balance sheets.
In an era of abundant liquidity, very few trades went wrong and bankers became more comfortable with risks. As competition intensified, ever smaller margins of safety were left.
Now, as central banks raise interest rates to try to control inflation, banks are scrambling to sell the deals they signed before the market rebounded. Many are suffering huge losses in the process.
But among the mass of European deals that could turn serious, the impact the banks could have on the Morrisons debacle puts it in a league of its own.
The group of 16 insurers has already made a gross loss of more than £200m selling debt this year, according to calculations by the Financial Times. Marking the remaining unsold debt on the market leaves a gap of more than £400m.
Goldman Sachs headquarters in New York. Almost as soon as Goldman’s bankers began executing the deal they had dubbed “Project Magnum,” things began to go wrong © Spencer Platt/Getty Images
A warning from the story
When leverage piles on top of a business with thin margins and large fixed costs, there is the potential for disaster.
In 1989, at the height of the first LBO boom, the investment firm Isosceles took over the Gateway supermarket group—later renamed Somerfield—in a multibillion-dollar deal that was attacked almost immediately, as the ‘market exuberance gave way to recession.
But 30 years later, memories of the debacle had faded. With private equity riding a wave of cheap money, blockbuster grocery shopping made a comeback.
First, TDR Capital and the billionaire Issa brothers bought Asda for £6.8 billion in 2020. Junk bond markets allowed the buyers to put up only a small portion of their own money to complete the transaction, raising eyebrows of purchase to its profitability. offers could be
Months later, CD&R made its move on Asda’s rival, Morrisons.
In a nation of grocers, an American private equity firm that bought a beloved grocer caused an uproar. Morrisons had been a listed company since the 1960s, listed a few years after Sir Ken Morrison transformed his father’s Bradford market stalls into a fully-fledged supermarket business.
But CD&R had a knight of the realm on board to smooth the process: Sir Terry Leahy, the former head of Tesco, was a long-time adviser to the US company. And while Morrisons management fiercely protected its independence, its share price had languished for years, making a high enough offer hard to resist.
In the parlance of the city, Morrisons was now “in the game”. After the retailer rejected CD&R’s £8.7bn approach in June 2021, the US firm found itself in a firefight with SoftBank’s investment group Fortress.
While CD&R hired Goldman as an adviser and sought traditional buyout financing, Fortress sought to raise debt backed by Morrisons’ property. However, as the deals got bigger and bigger, the leverage limits that specialist real estate lenders are comfortable with were soon reached.
“We couldn’t stretch the financing any further,” said one person involved in the Fortress bid.
When CD&R won in October, Morrison’s price had reached £10 billion. Its banks, led by Goldman and BNP Paribas, along with Bank of America and Mizuho, were now on the hook for a whopping £6.6bn of debt. The banks declined to comment.
Goldman had even more exposure through £1.3 billion of risky debt as “preferred shares”, split equally between its in-house fund and private equity firm Ares Management.
“It was an aggressive deal in a hot market,” said a senior debt banker. “You can see why it happened: for years there was no reward for being conservative.”
Given the risks, Goldman had set the deal’s “caps,” the maximum interest rate the borrower can pay, at uncomfortably tight levels. In Morrison’s prime sterling bonds, if investors demanded yields higher than 5.5 percent, banks would start to pile up losses.
There was no room for error.
Project Magnum
At Goldman, leveraged finance bankers rule the roost. CEO David Solomon cut his teeth working for junk bond king Michael Milken. The bank’s chief financial officer, Denis Coleman, previously led the same European debt unit that signed the Morrisons deal.
But almost as soon as his bankers began executing the deal they had dubbed “Project Magnum,” things began to go wrong.
Goldman had promised CD&R they could sell most of the debt in sterling, hoping to mimic Asda’s £2.75 billion junk bond, the biggest ever sold in the currency, months before. But in October Asda’s bond yields rose to within striking distance of Morrison’s deal limits. And investors were hoping to get the new bonds at a better price than Asda’s.
Undeterred, Goldman embarked on a “pre-marketing” exercise the following month, aiming to lock in large orders from major investors before releasing the deal to the wider market. They left empty handed.
While bankers told investors the deal would leave Morrisons with more than four times net leverage, this was based on a very tight earnings number that reversed the grocer’s hit during the pandemic . Even some seasoned debt investors, usually used to private equity firms flattering performance, were underwhelmed by the scale of the adjustments, which lifted Morrisons’ £745m annual ebitda to £1.2bn of pounds of the so-called “structuring ebitda”.
However, while fund managers gave Project Magnum a wide margin, bankers are yearning for a share of the deal’s hefty fees. In the final months of 2021, 12 banks opted to join the original syndicate, taking exposure from Goldman and the other three banks. down to just 10 percent each. Some lenders joined as late as December, even after the failed pre-marketing effort.
“Of all those involved in this fiasco, these are the ones who should really suffer,” said one banker, who declined to join the union at this stage.
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“Very Little Goldman”
Goldman has escaped similarly tight quarters in the past.
In 2020, when the coronavirus pandemic turned markets upside down, Goldman had been roped in for Europe’s biggest bridge loan, backing the €17 billion purchase of ThyssenKrupp’s elevator division. While many predicted huge losses, the banks emerged unscathed after Goldman managed to privately place some of the riskiest debt before waiting for markets to recover.
Its bankers hit the same playbook with Morrisons, selling £1.2bn of junior debt to the Canada Pension Plan Investment Board at a discount in January. Although the banks suffered a loss of almost £50m, the move eased some pressure and the union believed the fees from the deal would outweigh any impact on their balance sheets when they had sold the rest.
As they prepared to launch a public debt offering, Vladimir Putin launched a full-scale invasion of Ukraine. Credit markets sank even deeper into the red, extinguishing hopes of further losses.
In addition to the stress of the wider market, Morrisons’ business was on the front lines of inflationary pressures and the cost of living crisis unleashed by the war. Project Magnum’s earnings adjustments, which had previously seemed merely audacious, now seemed to investors completely freed from reality.
In May, Goldman and the other banks were able to transfer £1.5bn of the deal’s top-tier bonds to a select few investors, taking a hit of more than £150m in the process. The hope was that the market would recover when they sold the remaining £2.2bn of loans. In contrast, Morrisons bond prices fell further shortly after the sale.
Many debt bankers argue that there was little Goldman could do when markets started to turn given the scale of the deal, likening it to trying to turn around a supertanker.
“None of us are happy to lose money on a trade like this, but especially considering the size, I really think it’s de-risked incredibly well given the market,” said one of the…