Ocado Transforms to Technology From Grocery With Morrison Deal

Ocado Group Plc Chief Executive Officer Tim Steiner yesterday began to demonstrate to investors that his business is what he’s been telling them for the last three years: a technology company that also delivers groceries.

Ocado surged as much as 47 percent to a record in London after the online grocer unveiled a partnership with William Morrison Supermarkets Plc that will boost its coffers by 170 million pounds ($259 million). The deal relies on Ocado’s warehousing processing and logistics expertise helping Morrison to make a belated entry to the U.K. Internet grocery market.

Valuing Ocado has been a dilemma for analysts since the company sold shares in a July 2010 initial public offering. Having not made a profit since being founded in 2000, investors had to base decisions on potential rather than any traditional investment yardstick. As recently as 17 months ago, the stock fell as low as 52 pence as the company said a reduction in forecast earnings could lead to a breach of debt covenants.

Ocado has been “consistently underestimated” by the investment community, said Tom Ewing, a fund manager at Fidelity Investment Services in London, which held a 4 percent stake at the end of March. By focusing on long-term goals rather than the next quarter’s revenue, the company “has developed world-leading technology” and “stands to be a key beneficiary of consumers’ relentless pursuit of value, convenience and range.”

Yesterday, the shares rose as high as 296.8 pence, the highest since they were sold to the public at 180 pence a share. They closed up 36 percent at 274.1 pence, also helped by the disclosure that sales growth exceeded 15.5 percent in the second quarter, accelerating from 14 percent in the first.

‘Consistently Underestimated’

The deal with Bradford, England-based Morrison will wipe out the company’s debt and leave it with cash for expansion.

The agreement won’t prevent the Internet grocer striking similar deals with non-food retailers in the U.K. or international peers, CEO Steiner said in an interview.

“We can do other deals outside of grocery in the U.K., we can do any deal we want outside the U.K.,” said Steiner, one of three former Goldman Sachs Group Inc. bond traders who created the company. “We can operate a business with somebody else if we wanted, most importantly we can do this internationally.”

According to Ocado, the agreement will contribute “a mid-teen million-pound improvement” to net income, comprised mainly of benefits from service fees and cost-sharing arrangements.

Fidelity’s Ewing and Exane BNP Paribas analyst Andrew Gwynn said it’s too early to say how the deal will influence earnings estimates for Ocado.

Price Ratios

Based on current estimates, Ocado trades at a price-to-earnings ratio of 193 times for 2015, more than Amazon.com Inc.’s valuation of 44 times for the same year.

“In terms of valuing it, you obviously have to look at the earnings they could generate,” said Gwynn. “We already have them on 30 times pre-deal earnings by November 2017, so already very high. This deal certainly brings them closer to their ambition to be seen and valued as a technology company rather than just being viewed as an Internet grocer.”

Under the agreement, Morrison will gain half the capacity of Ocado’s Dordon warehouse in central England, which opened this year. Ocado will receive 165 million pounds up front, mostly from selling the site to Morrison and leasing it back.

The online grocer will also assist with developing the Morrison website, picking goods at the warehouse and installing its proprietary routing systems in Morrison delivery vans.

Ocado said the tie-up won’t have an effect on its agreement with the competing Waitrose chain that allows it to use the Waitrose brand on its website and vans until 2020.

Gaming Software

The online grocer uses video-gaming software to provide a computer-generated display of the automated processes taking place inside the Dordon warehouse and at its first distribution center in Hatfield, southeast England. Unlike competitors Tesco Plc and J Sainsbury Plc, Ocado picks and dispatches orders from centralized warehouses rather than at local stores.

Not all analysts believe that the Morrison deal necessarily means a potential new stream of revenue from other retailers.

“We don’t think that Ocado’s technology and warehouse capabilities have global appeal to other food retailers, nor could they be easily transferred to other retail categories,” said Philip Dorgan, an analyst at Panmure Gordon & Co. in London with a sell recommendation on the shares.

Still, Fidelity’s Ewing, who has supported Ocado since the IPO, says he is a “happy and committed” shareholder.

“I don’t think people have fully realized yet how online has revolutionized retail,” Ewing said. “And the biggest part of retail is food retail.”

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