By James Davey
LONDON (Reuters) - Britain's Marks and Spencer and Ocado launched an online food joint venture on Wednesday, belatedly giving M&S a home-delivery service while netting $1 billion (£753 million) for its fast-growing technology providing partner.
M&S, Britain's best-known stores group, has lagged rivals in tapping into Britain's fastest growing grocery area, which industry researcher IGD expects to expand by 52 percent over the next five years to £17.3 billion.
Under the deal, Ocado's retail arm will become a joint venture with M&S, which will pay £750 million for its half share. M&S will defer 25 percent of the payment, which it will finance through a £600 million rights issue and a 40 percent dividend cut.
Although online supermarket pioneer Ocado has just a 1.3 percent share of Britain's grocery market, its £7 billion-plus stock market valuation has been driven by its bespoke technology, which is giving retailers the infrastructure and software to compete with tech giants such as Amazon.
Shares in M&S closed down 12.5 percent reflecting the equity increase, the dividend cut and concerns it had overpaid, while Ocado's was up 2.9 percent. Both rose sharply on Tuesday after the companies confirmed talks.
"Raising £600 million to invest in a joint venture which may or may not work seems an extravagant use of shareholders' money," Paul Mumford at Cavendish Asset Management, an M&S investor, said of the deal.
M&S chief executive Steve Rowe dismissed any suggestion that Ocado had got the better of a deal that values the joint venture at £1.5 billion.
"We think we're paying a fair price," Rowe told reporters.
And Ocado co-founder and CEO Tim Steiner said Rowe had taken an "incredibly smart risk" and said "if anything we should have charged them more" when asked about the price paid by M&S.
Rowe, who has been CEO since 2016 and is a former head of the food business at M&S, said he had not "dilly-dallied" when it came to tackling the growth of online food sales.
"The joint venture with Ocado is a long term proposition ... is transformational and does add shareholder value," he added.
Rowe highlighted £70 million of annual synergies for M&S within three years and an annual run rate of revenue from the joint venture of £1.6 billion, before it is offered to 12 million existing M&S food customers.
M&S sells wine, flowers and clothes online but does not offer a full delivery service for its food, putting it at a disadvantage to rivals such as Tesco and Sainsbury's. It will now also become a technology customer of Ocado.
"Not only have M&S paid a lot of money for 50 percent of the new JV entity, that new JV will also feed the hungry (Ocado) technology business," said Bernstein analyst Bruno Monteyne.
FILLING A GAP
The venture will trade as Ocado.com from September 2020 at the latest, following the termination of Ocado's agreement with upmarket grocer Waitrose, which has supplied a large part of the products sold by Ocado since its inception in 2000.
Waitrose, owned by the John Lewis Partnership, said it will focus on its own online business, which it is aiming to double in size within five years.
Ocado, founded by three former Goldman Sachs bankers, including Steiner, struggled for years to make a profit but has been transformed by deals with retailers including U.S group Kroger Co and France's Casino.
Fraser McKevitt, head of retail and consumer insight at Kantar Worldpanel, said that currently 36 percent of Ocado's sales are own-label groceries – both from Waitrose and its own lines. Of this less than a third are Ocado products.
"So Ocado needs to consider how to plug this gap and ensure shoppers aren’t left disappointed," he said
Some analysts are wary of the M&S brand's ability to make the online economics work, given its bias to convenience shopping and special occasions.
Rowe, who only last month said M&S' basket size was not appropriate for a full online grocery service, noting 41 percent of its customers shop for "today/tonight", struck a different note on Wednesday.
"We think our products, combined with Ocado's own brand and their extensive range of other branded products completes that basket," he said, noting the joint venture will offer more than 50,000 different grocery products.
Analysts at Peel Hunt said the key questions were how M&S product would be received by existing Ocado customers and how quickly M&S core food shoppers would log on.
"We are positive on both questions," they said.
For Ocado, the deal is a boost after a devastating fire this month at its flagship robotic distribution centre.
Steiner said the fire had not raised concerns internally that there was a fundamental issue with Ocado's design.
"I know the precise cause but I can't say yet," he said.
(Reporting by James Davey; Editing by Keith Weir, Mark Potter and Alexander Smith)