Online grocery seller Ocado is shaping up for flotation, but it's up against some stiff competition.
What is Ocado? Unless you get your shopping delivered from Waitrose, you could be forgiven for not having heard the name.
Ocado, which was founded in 2000 and started trading in 2002, was formed by three ex-Goldman Sachs bankers in partnership with Waitrose, which is itself part of the John Lewis Partnership. The idea was to sell Waitrose food products online -- something like Tesco (LSE: TSCO) and its online ordering and delivery service, but with a bit of the more upmarket Waitrose feel to it.
Coming to market
And now, 10 years on, Ocado is planning to float on the stock exchange and raise money for expansion (and allow its current owners to raise a bit of money for themselves). Ocado currently operates from its own dedicated warehouse just north of London, and some of the new capital will be earmarked for the creation of a second one.
Of the approximately 250 million shares expected to be offered for sale, around 100 million will be new shares, with the remaining 150 million being sold by existing shareholders. The John Lewis Partnership pension fund is likely head the list of owners divesting themselves of some of their shares, and is expected to cut its current 26% stake by half.
According to the prospectus, released on Tuesday, the shares are expected to be priced between 200p and 275p. That would value the whole company at somewhere between £800m and £1.1bn, placing it firmly in the FTSE 250. Conditional trading of the shares is expected to commence on 26 July.
Big expansion plans
Ocado is expecting to raise about £200m from this float and this, together with some other funding facilities it has, will be used to construct a second dedicated warehouse (£210m) and expand the capacity of its first warehouse by 70% (£80m).
Ocado's first warehouse has recently been fulfilling about 88,000 orders per week (at £115 per order) and the proposed expansion will lift its capacity from 105,000 to 180,000 orders per week. The second warehouse could take about two years to complete and would initially be able to handle a further 120,000 orders per week, although there would be scope to expand it to 180,000 in due course.
In other words, this round of fundraising could approximately triple the capacity of the business from 105,000 orders a week to 300,000. To put that in perspective, since 2000, Ocado has raised £265m in equity funding, has around £45m in net debt and owes a further £65m through finance leases.
Past results
The task now facing potential investors is to decide whether the current offer represents fair value. And that's not an easy task, especially as the company has yet to earn a penny in pre-tax profits and is not expected by analysts to make it into the black until at least 2011. The prospectus also highlights the fact it "may need to raise substantial additional funding from 2012".
In its last full year of trading ended December 2009, the prospectus tells us that Ocado achieved total revenues of £402m, leading to a pre-tax loss of £25m. But that represented the latest step in a series of year-on-year improvements, as we can see in the following table:
| Year | 2007 | 2008 | 2009 | 2010
Q1 |
|---|
| Sales (£m) | 273 | 321 | 402 | 110 |
| Pre-tax loss (£m) | (40) | (33) | (25) | (4) |
The first quarter of the current year resulted in £110m of revenues, generating a loss of £4m, and if we simply multiply that by four we get £440m in sales for the full year and a £16m loss. Things should be better than that though, as we should see more growth in the remaining three quarters. Provisional figures for the first half of 2010 show sales of £246m, up 30% on the first six months of 2009.
Extrapolating all these figures forward does roughly suggest a break-even point in another couple of years, although for how long sales will continue to grow at the same rate is by no means apparent. But there clearly is a big potential market out there -- in its last full year, Tesco's online business turned over £2.1bn and generated a profit of £136m.
Who, Amazon?
But having said that, there are other successful online companies that would find it relatively easy to move into groceries and provide some stiff competition.
In fact, Amazon has chosen today to enter the fray with its own UK groceries division, offering 22,000 top-brand grocery items, and including bulk-buying of basic commodities and a range of specialised products. With Amazon already being well served with warehouses and delivery centres across the UK, and having all the cash it needs to grow its new grocery venture, this has to be seen as a blow to Ocado's hopes.
The expected Ocado valuation of around £1bn, coupled with 2009's full-year sales figures, suggests a Price to Sales ratio (PSR) of between 2 and 3. But if we look at supermarkets like Tesco, which run very low-margin businesses, they traditionally operate on a PSR of significantly less than 1.
That doesn't take into account the much higher growth rate we expect from a relative newcomer like Ocado and the higher margins that may be achievable due to the efficiencies of running an online-only delivery business. Continued growth around the 20% mark should also bring that PSR ratio down fairly quickly -- but it does look like there's a fair bit of growth already built in to the expected asking price. A lot of fund managers have been quoted as saying much the same thing, suggesting that Ocado might struggle to raise the money it's looking for.
To buy or not?
Is this a good time for flotations? Generally, companies try to offer their shares when markets are buoyant and they can get the highest possible prices for them, not when, as we see now, we're in a bit of a bearish spell.
As Ocado is coming to market in current conditions, it might be because it simply needs the money now in order to keep up with its expected growing demand, and it can't really afford to wait for better market conditions -- which, with no great economic growth expected any time soon, might easily not be for another couple of years. But the offer doesn't look like it's bargain-priced to me.
Will I be buying in? Well, I'd have to spend a fair bit more time with the 280-page prospectus, but on this first examination, and especially in the light of the newly-announced competition from Amazon, I'm pretty sure my spare investment cash will be staying where it is.
Ocado (LSE: OCDO) is due to begin trading on July 21.
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