Compass in dire need of direction as vacuum at top alarms investors

'Critics have lambasted the company's aggressive business model'

The final straw came on Friday when Compass suspended two key executives, including its UK chief executive, in response to allegations of corruption relating to its contracts to feed United Nations peacekeepers. Sir Roy Gardner, the chairman elect who joined the board as a non-executive director barely three weeks ago, is said to be "apoplectic" about the latest scandal to embroil the company. Investor confidence in Compass's embattled UK business, the source of two of its three profits warnings, is in tatters.

The UN has suspended Compass's military supplies division as a service provider pending an investigation into how the group obtained sensitive information to secure a three-year contract to supply 15,000 peacekeepers in Liberia.

One of the group's top institutional shareholders said yesterday: "The company appears to be out of control. It is hard to remember another company this size going through this type of turmoil. There is a huge management vacuum.

"The market wants to see the back of Mr Bailey. Or the chairman designate put the business up for sale."

Controversy and Compass have been close bedfellows since an inconceivably complicated deal created the group in its current form five-and-a-half years ago. Even then, few shared the group's conviction the merger with and subsequent demerger from Granada made sense; even fewer do now.

The top duo - the chairman, Sir Francis Mackay, and Mr Bailey - have destroyed shareholder value. Even the promise of their combined departure next year has failed to placate investors unhappy at having not one but two lame ducks running the company.

Richard Singleton, the director of corporate governance at F&C, another big shareholder, said: "Compass serves as a useful reminder of the importance of good corporate governance." Sir Francis stepped up to the chairmanship after three years as chief executive and five as deputy chairman. He promoted Mr Bailey to chief executive in July 1999. "All the company's problems reflect its lack of controls, whether business controls or moral controls," Mr Singleton said.

Only speculation that the private-equity boys were circling prevented Compass's shares from dipping further yesterday. Although turning round the vast business, which has more than 400,000 employees in 90-plus countries feeding people in all walks of life, is a big ask, few believe it is too big a task to deter potential predators. Especially given shareholders are hardly in a position to hold out for a gilt-edged offer. "250p to 270p would do it," one said. The shares closed at 179.75p yesterday, up 4.75p.

Although investors want the board to complete the management shake-up as soon as possible, Sir Roy cannot replace Sir Francis until Centrica unearths his successor as chief executive. Company insiders claim this is delaying the search for Mr Bailey's replacement. Until Sir Roy, the senior independent director, knows what sort of a man he wants under him, the group cannot even appoint headhunters. That said, the question of Mr Bailey's early departure is a matter of "when, not if", according to one investor, who said: "Having nobody there would be better than him."

Although Compass claims it has tried hard to win investors round, observers believe it has always done too little, too late to inspire any trust. For years the group was blinded by its desire to grow underlying sales by 6 to 9 per cent a year. It obsessed about this goal at the expense of its margins and allowed its most capital-intensive operations, such as its Moto service stations, to swallow truckloads of working capital.

Critics have lambasted the group's "aggressive business model, aggressive management and aggressive finances", arguing the acquisitive catering company had simply been buying growth. It was the group's first profits warning in September 2004 that opened the City's eyes to the minefield of unexploded bombs that was its business model.

Its contracts to feed UK schoolchildren were proving less profitable than anticipated; ditto its contracts to feed troops in the Middle East. Cash was pouring out of the business. In response, the group ushered in a new era of generating free cash and boosting its return on invested capital. It took an axe to its UK profit margin. But profits warnings two and three followed swiftly.

It is the group's UK arm, home to its embattled Scholarest education operation, that is the source of most of its trading woes. On top of the Jamie Oliver-led tirade of publicity against the unhealthy dishes it was happy to feed schoolchildren, it has had to cope with a litany of issues from pricing pressures to subdued trading. Even the London bombings hit the group, which feeds thousands of people on the move via its Upper Crust, Café Ritazza and Harry Ramsden's franchises.

In short, the group's claims that being the world's biggest contract caterer is a source of untold riches are falling on deaf ears. The buying benefits from being one of the UK's biggest purchases of, say, Nescafé, are not coming through. Compass has opted to sell one of its most capital-intensive divisions - Select Service Partner, which owns the Moto service stations in the UK and operates cafés and mini-markets at railway stations and airports.

The £1bn business has already attracted attention from the fast-food entrepreneur Lawrence Wosskow, who bought Little Chef for £52mast week. The sales memorandum for SSP is being sent out next month. It will hand one-third of the proceeds back to shareholders. The sale is expected to improve the group's return on capital employed by 30 basis points.

Meanwhile, Compass has appointed a top City law firm, Freshfields, Bruckhaus, Deringer, to investigate the relationship between its ESS military supplies division, which was run by Peter Harris, the UN and an intermediary called IHC. Although it says the volume of business is negligible at less than 0.5 per cent of its revenues, analysts believe the potential damage to Compass's reputation is anything but.

With the company's close period approaching before its preliminary results, the City will get fewer answers to its questions than normal. Mr Bailey has repeatedly brushed off suggestions there is anything amiss at the company he has worked for since 1993. As recently as May he declared: "I'm still as positive on Compass as I have always been."

If only shareholders shared his optimism.