Last week, Morrisons — the UK’s fourth-largest supermarket chain — received a buyout offer from a US private equity firm. When the deal was announced, shares across the sector, including the Tesco (LSE: TSCO) share price, rose as investors speculated that another company might also attract attention.
Tesco is the largest supermarket retailer in the country, but that doesn’t mean it’s immune from a buyout offer. In fact, the company looks ripe for a takeover.
Tesco share price takeover
Before I continue, I should say that this is only speculation. There’s no guarantee an offer will emerge for the company. At the time of writing, no offer has been made, and there are no rumours that one may arrive.
Still, that doesn’t mean one won’t happen.
Morrisons appears to have attracted takeover interest due to its strong balance sheet, property portfolio, and cash generation.
These are all qualities Tesco has as well. What’s more, I could argue that Tesco has a better management team, stronger brand, and more room for growth than its smaller peers.
The stock also looks incredibly cheap, especially when compared to its US peers.
Management is targeting an annual free cash flow of £1.2bn. Compared to its market capitalisation of £17.3bn, this implies the company is trading at a free cash flow yield of 6.9%. Retail giant Walmart is trading at a ratio of 5.5%, suggesting Tesco is about 20% cheaper.
Morrisons isn’t the only UK retailer that has received a takeover offer recently. Last year Asda was acquired for £6.8bn by petrol station entrepreneurs the Issa brothers and private equity firm TDR Capital.
I think these factors support my thesis that the Tesco share price is cheap and could receive a buyout offer.
With a market capitalisation of £17.3bn, however, the company’s size may stand in the way, although it may not deter the largest buyers. Including debt, buyers may have to pay £30bn for Tesco. That might seem like a lot, but private equity fund managers raised €120bn in the first half of 2021 alone.
Having said all of the above, even if an offer for the retailer does emerge, there’s no guarantee it will get past the Competition and Markets Authority or government. There have already been calls for the government to intervene and stop a potential Morrisons takeover. Any offer for Tesco would likely face the same criticism.
What does this mean for shareholders? Well, it is clear to me that the Tesco share price is undervalued. Moreover, based on recent activity, it seems that private equity investors can see a lot of value in the UK supermarket sector, and I think it would be foolish to overlook this activity.
As such, I would buy the stock for my portfolio. Not only does it look cheap, but the stock also offers a dividend yield of 4.5%.
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Rupert Hargreaves has no position in any of the shares mentioned. The Motley Fool UK has recommended Morrisons and Tesco. 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.