Gourmet Grocer Ocado's Initial Offer May Be `Act of Faith' for Investors

Ocado Ltd. has become the U.K.’s fastest-growing online grocer by enticing London shoppers with its vans of gourmet food. Luring investors to an initial public offering may be a tougher sell.

Ocado plans to sell shares to generate a market value of at least 1 billion pounds ($1.5 billion), said a person familiar with the matter, who declined to be identified because the plans aren’t yet public. That’s more than double what it was worth in a transaction 17 months ago.

“It would undoubtedly be a considerable act of faith to invest in the company,” said Clive Black, head of research at Shore Capital in Liverpool, England. “Ocado is in a good spot strategically, but it’s an unprofitable business.”

Ocado, founded by three former Goldman, Sachs & Co. bond traders in 2000, mainly delivers products within the London area and southeast England from the Waitrose upscale grocery chain. That makes it too limited and too pricey to compete with Tesco Plc, which peddles 47-pence white bread loaves and diamond-chip earrings for 15 pounds all over the country, said Sanford C. Bernstein Ltd. analyst Christopher Hogbin.

“Tesco has a more profitable business, it’s four or five times the size and it offers a lower price point,” said Hogbin, who rates Tesco “outperform.” “Unless consumers are willing to pay the premium for Ocado, it’s hard to see it as a big competitive threat.”

John Lewis Investment

John Lewis Partnership Plc, which owns Waitrose, started investing in Ocado within months of the grocer’s inception. Seventeen months ago, after a fair-value assessment, John Lewis transferred the stake to its pension fund in a transaction that valued Ocado at 441 million pounds.

Ocado has hired JPMorgan Cazenove Ltd., UBS AG, and Goldman Sachs Group Inc. to oversee the sale, three people familiar with the matter said.

The company would use proceeds from a share sale to fund growth in the U.K. and abroad, Finance Director Andrew Bracey said in an interview March 22. The company may sell shares after the U.K. election next month, he said.

The fight for the online pound is the next battlefield for U.K. grocers as the market is expected to double in the next five years, while the overall industry will expand about 20 percent, according to food market researcher IGD.

Procter & Gamble

Al Gore’s Generation Investment Management and Fidelity International invested in Ocado in a 50-million pound fundraising last year. Procter & Gamble Co. holds 1 percent of the shares. A group of investors including Goldman Sachs, UBS AG and Lloyds Banking Group Plc, own 36 percent.

Ocado’s plan to sell shares doesn’t change the purpose of P&G’s investment, which is to track customer behavior, spokeswoman Jennifer Chelune said. Generation Management and Fidelity declined to comment on their investments. Goldman Sachs, UBS and Lloyds Bank also declined to comment.

The online grocer’s operating loss in 2009 narrowed by 33 percent to 14.4 million pounds, it said March 22, while revenue increased 25 percent to 402 million pounds. Tesco, which Verdict Research estimates has the largest share of U.K. Internet grocery sales with 28 percent, had 136 million pounds in profit at the online division in the year ending February.

“I’ve always been a slight cynic of standalone warehouse distribution firms for retail because it’s better, like Tesco, to have the customer knowledge and to know your product,” said Richard Champion, who helps manage $2 billion, including Tesco stock at Principal Investment Management in London.

Automated Sorting

At Ocado, “there is no material Ebitda in the business,” said Tim Green, who helps manage 21 billion pounds at Brewin Dolphin in London, including Tesco stock. “You can’t justify a billion-pound valuation on no Ebitda, whatever the rate of sales growth you boast about.”

Ocado is not without potential, some analysts said. The retailer is the only U.K. online grocer to have an automated sorting system, while Tesco handpicks its deliveries from its supermarket shelves.

Investors will have to decide whether to value the company as a U.K. food retailer or an Internet company with 10 years of intellectual property, said Andrew Kasoulis, an analyst at Credit Suisse AG in London.

“The debate that ‘Goodness me, it’s loss-making’ isn’t particularly a guide to how the market may value it going forward,” he said.

Amazon.com

Amazon.com Inc., founded in 1994, didn’t generate an operating profit until 2002 and posted net income a year later. The company listed in May 1997 at $18 a share and is now valued at $150.09.

Ocado, which offers whole, free-range duck for 14.68 pounds, is broadening its Everyday lower-priced range from 50 products to several hundred items such as bread and ready-meals, Ocado’s Bracey said. J Sainsbury Plc, the third-largest online grocer, has more than 650 budget-priced products in its Basics range.

“We compete with Tesco and Sainsbury all the time and in London we have significant market share and that market share is growing,” Bracey said. “We are price-matching Tesco on branded goods and we are the same price as Waitrose on other products.”

Some also doubt Ocado’s ability to sustain its partnership. While John Lewis and Waitrose look to Ocado to distribute their products in the London area, they deliver on their own to the rest of the country. The company has a contract for John Lewis and Waitrose to supply Ocado with products until 2013.

John Lewis Chairman Charlie Mayfield said on March 12 that the company is “very confident we can continue to work together to gain share.”

Investors may opt to wait to see more proof on Ocado before deciding to jump in, Brewin Dolphin’s Green said.

The price will come across as too heavy,” he said. “They are going to have to demonstrate a hell of a lot of performance on the back of Ebitda that hasn’t become material.”

To contact the reporter on this story: Sarah Shannon in London at sshannon4@bloomberg.net; Chris Staiti in London at cstaiti@bloomberg.net.

Bloomberg reserves the right to remove comments but is under no obligation to do so, or to explain individual moderation decisions.

Please enable JavaScript to view the comments powered by Disqus.