In recent months, the UK retail grocery sector has been ripe with acquisitions. Two of the ‘big 4’ supermarkets – Asda and Morrisons – have been bought by private equity (PE) firms. This has largely been spurred by the sector’s resilience during the pandemic.

The interest in Morrisons led to its share price rocketing. It was purchased by CD&R for just under £10bn, including debt. This equated to a 287p per share offer, over 60% higher than the pre-acquisition announcement price.

M&S (LSE: MKS) has proved itself as one of the hottest FTSE 100 stocks this year, delivering over 80% year-to-date returns. In mid-August, on the Morrisons news, the M&S share price jumped over 25% as investors saw it as another potential target. If this did occur, I think we could see the share price of the FTSE 100 stock explode.

Acquisition case for M&S

In my opinion, there are three key factors that highlight M&S as an attractive investment opportunity for a private equity firm.

The first is strong cash flows. The PE model rests on using large amounts of debt to fund an acquisition (called a leveraged buyout). The aim is to pay down this debt using the cash flows produced from the acquired company, building the PE firm’s equity stake in the company. The company can later be sold and the difference in starting and ending equity value is the return on investment. In order for this model to work, the company needs strong, stable cash flows. M&S has just that, delivering £296m cash in 2021.

Them there’s its large property value. One thing that’s particularly attractive about M&S and many retail grocery firms is the large amounts of property they hold. For example, at present, M&S has an estimated £1.8bn worth of property. This is attractive for PE firms because this property can be sold to help fund transaction costs.

The low-interest-rate environment is a broader factor that makes PE investment very attractive. This makes raising capital and sustaining debts very cheap. This is critical for PE firms as their whole acquisition model relies on using large amounts of debt.

Potential risks

Although the above factors highlight the attractiveness of M&S shares, there are still risks that must be considered if I were to consider a purchase. One such risk is the fact that although current interest rates are very low, many investors are expecting them to rise very soon to combat rising inflation. If this is the case, then it will make it harder to raise capital and PE investment will be less attractive.

M&S has already increased its online delivery presence through its 50% stake in Ocado. The pandemic has vastly accelerated the shift to online grocery shopping. While this is encouraging, it also means that M&S will have to compete with a much wider range of grocery delivery firms moving forward. It will have to successfully navigate this competitive landscape if it wants to carry on delivering good results. 

I think M&S is one of the most attractive FTSE 100 stocks for a PE acquisition that could drive a steep share price rise. But acquisition talk aside, I think M&S’s strong results and online presence could make it a great investment opportunity for my portfolio as an independent company. Those features that make it attractive to PE firms, make it attractive to me too!

The post Could this FTSE 100 stock explode in 2022? appeared first on The Motley Fool UK.

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Dylan Hood has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.