Has Ocado found a mate in Morrisons?

Morrisons is wooing the online grocer for its technology knowhow, but James Thompson considers if it could also have marriage in mind

It has long been speculated that the seemingly unlikely bed-fellows of the supermarket Morrisons and the online grocer Ocado could wander up the grocery aisle together. But many had not expected the Northern supermarket to confirm details of its possible matrimonial vows with the premium food specialist, which delivers Waitrose and own-brand groceries, as soon as yesterday.

Certainly, the massive spike in Ocado's shares on Thursday suggested that many investors had been taken aback by the news that a long-term loving relationship could be on the cards. Confirming their dating, the Bradford-based Morrisons stressed it was only discussing with Ocado a potential tie-up that could see it license the home shopping firm's technology.

Dalton Philips, the chief executive of Morrisons since March 2010, said: "There have been discussions [with Ocado] around intellectual property – essentially their technology and operating practices. They are discussions around a possible commercial relationship."

The UK's fourth-biggest supermarket stressed that the discussions do not involve Morrisons "acquiring either the whole of, or an equity stake in, Ocado". But the 32.6p, or 24 per cent, rise in Ocado's shares to 170p yesterday suggested that the City was licking its lips about some possible corporate action between the two grocers.

The prize at stake is big, as food sold online accounted for £5.6bn of £163.2bn of total grocery spending last yearand is forecast to double to £11.1bn by 2017.

Morrisons was adamant yesterday that it will launch food online before February next year, irrespective of the outcome of its talks with Ocado. But a possible tie-up, where Morrisons licenses Ocado's technology, could plug a gap in the supermarket's online capability.

Dan Coen, a director at the advisory firm Zolfo Cooper, said a potential joint venture with Ocado would give Morrisons "a ready-made platform for a successful online business".

Ocado, which floated at 180p in July 2010, has been criticised for never having made a pre-tax profit in its 11 years of operations. But it has superb technology, particularly its bespoke software that helps it to deliver groceries with laser-like accuracy.

However, some analysts are puzzled at why Morrisons is taking so long to launch in a market where Sainsbury's went live in 1996 and Tesco followed the year after. In fact, Morrisons spent £32m, including taking a 10 per cent stake in New York-based Fresh Direct in 2011, to examine online grocery offers across the pond.

Clive Black, an analyst at Shore Capital, said: "Morrisons is struggling to launch an online grocery capability, and why is it delaying launching it until 2014?"

Mr Philips remained tight-lipped on his online food plans, but the launch is likely to combine staff picking groceries for internet orders in-store with dot.com-only facilities, which are used to fulfil grocery orders but don't have any customers, in Yorkshire and around London.

The big question is whether Morrisons would ever consider acquiring Ocado. Dave McCarthy, an analyst at Investec, said: "If Ocado was struggling and failing, then it could be a natural fit."

The price tag would now be huge, as its share spike yesterday gives Ocado a market capitalisation of £845m.

Furthermore, any company that acquired it would have to pay a £40m poison pill to Waitrose. This is because its agreement with Waitrose can be terminated if a rival acquires 50 per cent of Ocado's shares, or control of the board. Mr Black said: "I don't think the market would take it well if Morrisons bought Ocado.The fundamental flaw with the Ocado model is it is centralised fulfilment for a fragmented market, delivering to customers over long distances."

For Ocado, the chance to drive additional revenue from licensing its technology would seem to make sense, but analysts are not convinced.

Mr McCarthy says: "Ocado has talked about selling its intellectual property [IP] to an overseas retailer before, but not to a UK competitor. You would not see Tesco selling its IP to Sainsbury's or Asda. It tells you a lot about how Ocado sees its future."

Alongside confirming its discussions with Morrisons, Ocado reported that its sales grew by 14.4 per cent to £185.5m over the 12 weeks to 24 February, and said its second distribution centre, in Warwickshire, had opened on time and budget. But analysts believe a possible eventual acquisition by Morrisons could be fraught with risk for Ocado.

Mr Black says: "I think Ocado would lose between 70 and 80 per cent of its customers. A key reason why they shop with Ocado is for the Waitrose brand and food. And Morrisons is not Waitrose."

Maybe it's not ultimately a marriage made in food heaven.

Morrisons' gloom: Profits fall

Morrisons posted its first fall in annual profits for seven years yesterday, and revealed a further surprise deterioration in underlying sales, down by 4.1 per cent in its fourth quarter.

Pre-tax profits fell 8 per cent to £879m over the year to 3 February, the first decline since 2005-06, when Morrisons was recovering from its troubled acquisition of Safeway in 2004.

Dalton Philips, the chief executive, said it had been hurt by not selling food online and its relatively small number of convenience stores, although it will have 100 by February. He said: "We are a hugely profitable retailer – significantly more than the second [Asda] and third [Sainsbury's] biggest retailers in the market."

Dave McCarthy, an analyst at Investec, said: "Morrisons is losing out to the discounters more than most because of its Northern bias. And Morrisons' management have admitted they have scored some own goals with their promotions not being good enough."