Going south: Can Compass regain its sense of direction?

Three profit warnings and one scandal - the go-go caterer may have bitten off more than it can chew
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The Independent Online

The FTSE 100 giant, based in the distinctly non-global Chertsey, in Surrey, is the world's largest caterer. It provides workers, soldiers, travellers, tourists, sports fans and schoolchildren, and many more besides, with food and drink. Growth has been phenomenal and it now operates in more than 90 countries, employing over 400,000 people.

And yet, in the past 12 months, Compass has lost its bearings. Poor performance at the UK business, which contributes 23 per cent of turnover and 37 per cent of operating profits, has prompted three profit warnings. Directors have quit, investors have been angered and, earlier this month, just when you thought it couldn't get any worse, it emerged that military supplies arm Eurest Support Services (ESS) had been caught up in the United Nations oil-for-food scandal.

So how did it get into this mess? Most blame two factors: an over-aggressive growth strategy and the complex and fragile merger with Granada in 2000.

Ratcatcher Rentokil Initial is not a company that one, ideally, would associate with a caterer. Yet one man links them: Sir Gerry Robinson. Rentokil's unsuccessful stalker created Compass when he led the management buyout of Grand Metro- politan's catering arm. He left in 1991 for Granada, where he expanded the media business into hospitality and, nine years later, the two companies merged.

Yet the £18bn deal, which reportedly netted Sir Gerry around £8m, mainly through share options, was greeted with horror. Investors fretted that the virtually debt-free Compass would be dragged down by the slow-growing hotels business. Cynics also claimed that Compass chairman Sir Francis Mackay was helping old friend Sir Gerry without long-term thought for the business.

"Some of the issues that have emerged relate to the business being squeezed too hard when the merger was first put together, to achieve the promised improvements in profitability and cashflow," says one analyst, who asks not to be named.

"To an extent, they have lived off the provisions of that merger and there's only a limited amount of time you can do that for."

In 2001, Compass was relisted as a separate company after demerging Granada Media (now part of ITV) and selling the hotels business. Yet four years on and the City is once again up in arms. Chief executive Mike Bailey and Sir Francis have spent hundreds of millions acquiring businesses, while at the same time driving sales growth and squeezing costs. But the strategy came unstuck when, in 2004, a supplier ended up in financial difficulties, which in turn hit Compass.

Stockbroker Panmure Gordon recommended selling out of the stock earlier this year. In a research note, it argued: "The Compass culture has in the past been what can best be described as aggressive. The management team is forceful in its presentations, the business model is aggressive with its suppliers and the accounting has been aggressive in its recognition of profit."

As a result, it added with some prescience: "There is a suspicion that the financial results overstate the underlying performance of the business."

An analyst at a rival broker comments: "An over-aggressive management has milked the business too hard."

Sir Francis is retiring and last month Mr Bailey, 57, announced he was leaving too. But their legacy has been marred, not just by a questionable growth strategy and a dire last year in charge, but also by concerns about corporate governance.

Richard Singleton is director of corporate governance at F&C, a shareholder in Compass, and compares the group to Wm Morrison. The supermarket chain had an arrogant approach to the City - something that was tolerated when it was prospering but lambasted when its performance faltered.

"When anything is going well, there's a tendency not to look at everything with as much care and thoroughness," he says. "If you don't have the best corporate governance, if you don't keep on checking things, if you don't have idiotically strict control systems, the problem is that something will sneak up on you."

The management's image has also suffered as a result of concerns about how Compass secured a deal worth $62m (£35m) a year to feed and water 15,000 UN peacekeepers in Liberia. The company has said it is co-operating with the authorities, and that it has hired law firm Freshfields Bruckhaus Deringer to review the relationship between ESS, the United Nations and IHC, an intermediary which helps companies secure UN contracts. Independent accountants Ernst & Young - Compass's usual auditor is Deloitte & Touche - have also been brought in to work alongside Freshfields.

And two executives have been suspended: Andy Siewart, business development executive; and Peter Harris, the former head of ESS but more recently UK chief executive and someone once tipped to take over from Mr Bailey.

UN contracts contribute less than 0.5 per cent of revenues but Compass's already weakened reputation has been dealt a heavy blow. So the big question now is whether it can be fixed. The problem here is, with Mr Harris's suspension adding to a series of senior departures, that there appears to be a vacuum at the top of the group.

"There are undoubtedly some good businesses there, and there are a lot of assets and skills," argues Mr Singleton. "There's expertise and huge customer numbers. There's real value. A good chief executive, whom people have confidence in, would be a very good start. And a strategic review of the way forward would be the second big thing."

Insiders say the group is "very aware" of the City's concerns and is concentrating on return on capital and cashflow. The spending spree has been curtailed, and the SSP business - owner of Moto service stations as well as the Upper Crust and Harry Ramsden's chains - will be sold as part of a refocusing on catering contracts. The estimated £1bn price tag will go towards paying down debt of £2.5bn, though a chunk will also be returned to shareholders.

As for the Freshfields review, there will be an update at the final results on 29 November. But there is no guarantee the report will be made public, which is not in line with what insiders claim is a new spirit of "increased disclosure and transparency".

There have also been rumours of a takeover, with most believing that this is why the shares - down 27 per cent over the past two months - have not fallen further. But any bid would have to cover Compass's pension deficit of around £420m.

Ever since Sir Gerry and Sir Francis sat down and decided what a clever idea it would be to combine their companies , Compass has suffered. Growth may have been strong, but three profit warnings and one scandal later, many are left hoping that this will be its nadir. Whoever is named as Mr Bailey's replacement, ensuring that hope becomes a reality will be a hard task.

HOW THE GROWTH STORY ENDED UP LEAVING A BITTER TASTE

1987: Gerry Robinson leads management buyout of the catering arm of drinks group Grand Metropolitan to form Compass.

1988: lists on London market.

1991: Mr Robinson leaves for Granada. Finance director Francis Mackay takes over and launches a five-year acquisition plan.

1995: becomes world's largest caterer after buying France's Eurest International.

1999: Mike Bailey appointed chief executive, Francis Mackay as chairman.

2000: merges with hotels and media business Granada to create Granada Compass. Granada Media is spun off.

2001: a number of Granada's hotel businesses are sold off and Compass relists.

2003: sells last hotel business, Travelodge, for £712m.

2004: warns on profits after contracts to feed schoolchildren and troops in the Middle East fail to perform as expected.

March 2005: Jamie's School Dinners airs on Channel 4. Compass's Scolarest, a supplier to school canteens, criticised.

April: second profit warning.

July: Peter Harris, head of military services arm ESS, appointed UK chief executive.

September: Third profit warning. Mr Bailey announces resignation.

October: Former Centrica boss Sir Roy Gardner becomes chairman elect. Confirms it is co-operating with authorities over investigation into UN contracting procedures. Lawyers appointed to conduct internal probe. Mr Harris suspended.

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