How high will Morrisons’ share price go in the bidding war?

Two US private equity groups are battling to buy WM Morrison Supermarkets (LSE: MRW). Since the news broke in June, Morrisons’ share price has risen by nearly 60% to 281p, at the time of writing.

The bidding war has lifted Morrisons’ stock by 45% over the last 12 months. But the shares are now trading above the most recent bid of 272p. The market is expecting a higher bid, but it’s not guaranteed. Here’s what I’d do next in this situation.

A bidding war

When US private equity firm Clayton, Dubilier & Rice (CD&R) launched its original bid for Morrisons back in June. The informal offer price was 235p, including a final dividend. When I crunched the numbers, I thought this was too cheap. My sums suggested a fair price for the UK’s third-largest supermarket would be 260p-270p per share.

Funnily enough, that’s where we are today. The latest offer — from US group Fortress — is for 270p per share, plus a 2p special dividend. So, 272p in total.

Under UK takeover rules, CD&R has until 20 August to make another offer for Morrisons. With the shares trading at 281p, as I write, it’s clear the market expects a higher offer. I think that’s possible too — but how high should CD&R go?

Morrisons’ shares: what’s the right price?

My original valuation of 260p-270p was based on a buyer only making small changes to Morrisons’ financial structure.

I admit I was hoping that whoever bought Morrisons wouldn’t need to sell off its freehold property and load the group up with debt — techniques that are often used by private equity to boost the returns they can generate.

However, I think that if the price tag rises any further, then buyers are likely to use more aggressive methods to make money from the deal. To estimate a possible winning price, I’ve revisited my numbers.

My sums suggest that if a buyer is happy to sell some of Morrisons’ freehold property and increase debt levels, then a bid of 300p could be justified. That’s a level Morrisons’ share price last hit in January 2012, when profits were much higher.

What I’d do now

I’ve often admired Morrisons’ business and its previously cheap share price. But somehow, I’ve never got around to buying any of the stock for my portfolio.

For me, it’s too late to buy now. In my opinion, any further upside is likely to be small compared to the risk of a share price plunge if the takeover fails.

However, if I did already own Morrisons’ shares, I’d probably continue to hold in hope of a higher bid. The only reason why I’d sell some of my stock today would be if I definitely wanted to lock in a profit from this holding.

The reality is that the takeover could still fail. If it does, I think Morrisons’ share price could fall back to 200p, or even lower. I’d still be happy to hold the shares for their dividend income, but I’d guess not all shareholders would be comfortable with this.

The post How high will Morrisons’ share price go in the bidding war? appeared first on The Motley Fool UK.

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Roland Head has no position in any of the shares mentioned. The Motley Fool UK has recommended Morrisons. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.