(Bloomberg) — Wm Morrison Supermarkets Plc surged above the value of Clayton Dubilier & Rice LLC’s 5.5 billion-pound ($7.6 billion) bid, indicating the private equity firm may have to pay significantly more or fend off rival offers for Britain’s fourth-largest grocer.

The supermarket operator, which employs close to 110,000 people in Britain, has already rejected the 230 pence-a-share proposal that was disclosed over the weekend, setting the scene for a short but potentially heated takeover battle. Under U.K. takeover rules, CD&R has 28 days to make a firm offer or walk away.

The stock’s 33% gain early Monday lifted the grocer’s market value to 5.7 billion pounds. Morrison had a market value of 4.3 billion pounds before the bid.

“I am surprised CD&R came in so low, but maybe they are just trying to draw them into a debate over monetizing assets before the real bid comes,” said Tony Shiret, retail analyst at Panmure Gordon.

CD&R’s approach reflects continued private equity interest in Britain’s supermarket sector, following a 6.5 billion-pound deal by TDR Capital LLP and the Issa brothers to buy a majority stake in Asda, the U.K.’s third-largest grocer, from Walmart Inc. Other private equity funds, including Lone Star and Apollo Global Management Inc., also placed bids for Asda at a time when supermarket valuations are languishing despite a boost from pandemic-related stockpiling and dining at home.

The ease with which the Issa brothers and TDR financed the Asda transaction, including raising the largest-ever sterling junk bond, could also make the economics of funding a Morrison deal attractive, Shiret said.

“Morrison’s is a simpler business than Asda and has more saleable assets,” he said.

The proposal values Morrison stock at about 29% more than Friday’s close, already a potentially significant premium for shareholders who’ve been sitting on one of the worst investments in European food retailing. Over the past four years, the stock has dropped 26%, the biggest decline among the 20 companies on a European index of drug store operators and grocers.

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Shares of rival British supermarket chains also rallied. J Sainsbury Plc jumped as much as 5.7%, while Tesco Plc added as much as 3.2% in London trading.

Silchester International Investors, one of Britain’s biggest boutique asset managers, is the largest shareholder with a 15% stake. Representatives for CD&R and Morrison declined to comment.

Morrison’s 250 million pounds of notes maturing in 2029 fell more than 12 pence to 110 pence on Monday, their biggest daily drop since issuance all the way back to 2014. Bondholders’ only protection against a takeover is a put option in case of a change of control but this doesn’t kick in until bonds hit face value, leaving them vulnerable to further losses. Morrison’s other bonds, which are indicated closer to face value, are also slumping.

Though the U.K. grocery business is hyper-competitive and profit margins are thin, Morrison is considered asset-rich. It owns most of its nearly 500 stores, while many rivals have carried out sale-and-leaseback transactions to generate cash. Morrison’s freehold property portfolio — a U.K. designation for ownership of underlying real estate, not just the walls of a home or store — is valued at close to 6 billion pounds, above the company’s market capitalization.

That could be a conservative valuation as grocers, including U.K. market leader Tesco, have recently been writing back some previous impairments made on property after recording material improvements in the sales and cash flows per square foot in stores generated during the pandemic.

Tesco Link

Following a turnaround led by Chief Executive Officer Dave Potts, Morrison also has a net pension surplus of 718 million pounds and low underlying debt. It remains a highly cash-generative business with growing e-commerce partnerships with Amazon.com Inc. and Deliveroo Plc. Unlike rivals, Morrison also has a large wholesale division, as it makes much of the food it sells.

CD&R is no stranger to British retail and works closely with former Tesco CEO Terry Leahy, who drove that grocer’s expansion at the turn of the millennium. The private equity firm, which focuses on targets in North America and Europe, manages more than $35 billion of stakes in 100 companies. It invested in B&M European Value Retail SA, a U.K. discounter, before taking it public in 2014.

CD&R is also behind Britain’s Motor Fuel Group, which has about 900 gas stations and convenience stores across the U.K., sparking speculation it could seek to install Morrison outlets on such sites. However, the grocer abandoned a trial partnership with Motor Fuel in 2017 and instead signed a 10-year deal with rival Rontec.

German Discounters

British grocers have not always rewarded investors. The financial crisis in 2008 led to a collapse of earnings and capital returns after the country’s largest supermarkets were caught short by bloated store portfolios, the growth of German discounters Aldi and Lidl, and the rise of online shopping.

Since then, the grocers have cut costs extensively and shed property holdings. More recently the economics of supermarkets have improved as the surge in online shopping during the pandemic has driven margin improvement in e-commerce and slowed the growth of discounters, which do not have significant online channels.

Despite this recovery, Borja Olcese, an analyst at JP Morgan, questioned the strategic and financial rationale of the CD&R approach, given that many of the industry’s structural challenges remain.

“We struggle to see the path to achieve meaningfully higher exit multiples in a few years time,” he said in a note.

(Adds share price and employee numbers in 1st and 2nd paragraphs, bond trading in 10th paragraph)

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