What is Ocado’s secret sauce?
Several big, established and profitable companies (Merlin and New Look for example) have been forced to abandon IPOs over the past year in markets a lot less volatile than now, yet this later day Webvan is pushing ahead with its flotation.
On Tuesday morning, Ocado, which sells Waitrose food online, revealed the indicative price range for its IPO. The shares will be priced between 200p-275p, valuing the still loss-making company at between £800m-£1.1bn. (Of course the range can be adjusted before trading gets under way on July 21).
Ocado will issue up to 257.7m shares, including up to 102.5m new shares, raising £200m. Investors and management would also sell up to 155.2m shares, including 10m options or warrants, that may be exercised before listing.
One of the sellers is UBS, joint sponsor to the offering. It is looking to offload over 40m shares, although Goldmans Sachs, another bookrunner, is not selling.
From an Ocado press release:
Certain of the Banks have the following interests in the Offers:
· Goldman Sachs International holds 870,300 Ordinary Shares and 3,333,300 Preference Shares which it will not sell pursuant to the Offers;
· Michael Sherwood, who is Co-Chief Executive of Goldman Sachs International, holds 166,700 Preference Shares, which he will not sell pursuant to the Offers;
· UBS Holdings Cayman Limited and UBS AG (both affiliates of UBS Limited) have an aggregate holding of 13,600 Ordinary Shares and 39,230,000 Preference Shares. They intend to sell up to their entire holdings of the Shares pursuant to the Offers and the Over-allotment Arrangements;
The banks advising on the float will collect fees of £15m.
So, how will they justify a valuation of up to £1.1bn for a company that is yet to make a profit and needs £200m to build another warehouse, or customer fulfilment centre?
Fund management sources say the Ocado pitch runs something like this:
– Ocado is poised to benefit from the structural growth in online shopping.
– Rising order volumes will unlock operating leverage and productivity gains.
– Non-food and the possibility of overseas expansion offer further growth potential
Key, however, is on-line grocery penetration.
Assuming online penetration rises from the current 2.5 per cent to 15 per cent by 2020, Ocado has two warehouses up and running and takes 15 per cent market share, the price tag can apparently be justified.
All sounds very dot.comedy doesn’t it? If the market will grows by xx per cent a year and if we can take xx per cent market share then we will be worth xxbn and make xxm.
But if online grocery penetration is just 5 per cent by 2020 the figures look very different and Ocado’s equity would probably be worth less than £500m.
To put things in context, the online grocery market in the UK was worth £3.7bn last year and the Institute of Grocery Distribution expects sales to total £7.2bn by 2014, implying a growth rate of around 15 per cent annum.
However, not everyone is convinced by these forecasts.
Ambrian’s non-conflicted retail analyst Philip Dorgan reckons online food retailing will never reach the penetration of other sectors such as entertainment, electricals or books.
We estimate that the online food retail market was worth £3.9bn in 2009 and will grow rapidly to £6.5bn by 2012. We believe that it could grow to be the largest online sector in time. However, we do not expect penetration to reach anything like that of other sectors such as entertainment, electricals, or books. Electricals’ current market share is around 20% and we would be surprised if online food retailing gets to half this level in the next ten years.
While food is the second largest online sector by sales, it is also a very big sector and only 3.2% of the food retail market has to date moved online. While we expect to see strong growth, economics online are tough and the low underlying profitability of food retailing makes this doubly so.
As such Dorgan doesn’t think a £1bn valuation is at all reasonable, especially when rising costs and competition are taken into consideration. He reckons a fair market value is no more than £500m.
Ocado clearly needs funds. It always needs funds, but this time it needs a lot. Capital expenditure over the next five years will be 5x that spent over the last five. Existing holders want to cash in as well, so this all adds up to a placing of around £400m, hence the racy valuation. The obvious question to ask is — why has there not been a trade buyer? One obvious answer is that the economics don’t stack up.
Indeed.
Although could a buyer emerge if, for the sake of argument, Ocado floats, issues several profits warnings and its share price then tanks? In that sense Ocado would indeed be Webvan 2.0.
Webvan 1.0 is now owned and operated by Amazon. Will Ocado be owned and operated by Waitrose come 2015?
The Ocado prospectus will be available here later today and Dorgan’s full note is available in the usual place.
Related link:
Party like it’s 1999 (updated) – FT Alphaville