Choppy float shouldn't scupper Ocado

By Alex Brummer, August 19, 2010

Successful stock market flotations are difficult at the best of times.

But the reception for internet grocer Ocado - which came to the market late last month- was peculiarly frosty. And this despite the fact that the company was brought to the market by some of the most respected investment banking names in the City.

The initial public offering (IPO) has been a salutary experience for the group's chief executive Tim Steiner.

Steiner is a former bond trader at Goldman Sachs who left a decade ago with colleagues Jason Gissing and Jonathan Faiman (who has since moved overseas) to establish Ocado.

Initially, backers of the float sought to place a value of at least £1.2bn on the company. Yet despite the backing of the eight banks led by UBS on the prospectus, a humiliating effort to attract private investors and a publicity blitz, the eventual valuation turned out to be closer to £700m and the newly floated shares have struggled to find support on the London Stock Exchange.

Ocado has been affected by the sceptical attitudes towards ‘retail’ floats

The sour response is surprising given the array of names on the prospectus, which included three of the most prestigious names in investment banking: Goldmans, JP Morgan Cazenove and UBS, in addition to Barclays Capital and HSBC. It doesn't get much better than that.

Ocado and its management is still puzzled by the generally hostile reception to the float in the media and from some of the independent brokers, like Shore Capital, which were dismissive of the company's business model. It attributes the lacklustre response to the float to the behaviour of a few hostile hedge funds and a failure to understand the business model.

On the other hand, the company is encouraged that some of Ocado's original holders, including the giant US fund management group Fidelity - which likes to take big strategic stakes - and the Rausling family, which made its fortune in Tetrapak packaging, saw it as an opportunity to increase their holdings.

For Tim Steiner, who's own post-float stake is worth £50m, the important thing was that the IPO allowed the company to raise £200m of new equity. This provided the online grocer with the wherewithal to take Ocado on to the next level. This means increasing its turnover to £1bn, expanding the Hatfield distribution centre and building a second plant near Coventry in the middle of the country.

Part of the problem for Ocado are the sceptical attitudes towards "retail" floats. In the "noughties", a number of retailers, including Debenhams, were first bought by private equity houses and then resold to the public markets at inflated prices, landing large fees for the sponsors and leaving investors nursing losses.

Faith in even some of the best known investment houses has been weakened and there is a strong suspicion that they are more interested in collecting up-front fees - higher the bigger the commission received - that the quality of the company they are selling.

This has helped to feed a culture of scepticism towards floats in the financial press, which plays a large role in shaping the mood surrounding new companies coming to the market.

My own suspicion, having talked matters through with Ocado and other leading grocery retailers, is that even though there have been some spectacularly successful online retail flotations including Amazon - with a stock market worth of $57bn (£36.5bn) - Asos and Net-A-Porter, it is not clear this can work in the grocery trade, where the big boys such as Tesco and Asda are so dominant.

Yet there is a world of difference between what Tesco, for instance, is doing and Ocado. Tesco has adopted a stores-based model for distribution.This means supermarket employees hand-picking goods from the shelves (as if they were customers) or from so-called "ghost stores" - warehouses set up in the same way. It is a model which is expensive - other areas of supermarket activity are increasingly mechanised - and often produces second-best results such as semi-skimmed milk when full fat is ordered, and so on.

Ocado begins from an Amazon-style base. It used computerised and robotic technology to do the picking, it offers far greater flexibility in delivery times, delivers fresher food and is much more accurate in meeting orders.

What it lacks, at present, is the
buying power of a Tesco, so most of the time it rides the Waitrose ticket (the John Lewis pension fund is an investor), including the Waitrose own label.

It is also seeking to broaden its product range to 1,000 with new items, including kosher meat, supplied on sealed pallets by Gilberts.

So can it work? One of the disappointments for investors at the time of the float is that the company - which is currently growing turnover at a 30 per cent clip - has still to report an operating profit.

All the indications are, however, that things may begin to change in 2011 and the group could be on trap to grab an ever larger share of Britain's huge grocery market. It does not see itself as a rival to Tesco but as an
up-market online grocer which can offer a superior service to busy households.

It is quite possible that the stock market has assessed Ocado wrongly. It would not be the first time that this has happened.

Last updated: 11:16am, August 19 2010