Jeremy Warner's Outlook: Another shocker from Wm Morrison, but Sir Ken sails on, determined to vindicate himself

Green's dividend stunner at Arcadia
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The Independent Online

Roll up for Sir Ken Morrison's amazing disappearing profits show. This starts with two reasonably sized businesses making perfectly respectable profits, then with a wave of Sir Ken's magic wand, they disappear in a puff of smoke. Nobody can quite work out where they've gone or how he's done it, but yesterday's attempt to explain this sleight of hand is hardly going to disqualify him from membership of the magic circle. His secret is safe; we remain as bewildered as ever.

Wm Morrison's descent into loss is one of the most astonishing stories of corporate mismanagement and botched integration in years. The merger of Sir Ken's eponymous supermarkets chain with Safeway promised so much, not least the creation of a viable fourth force in supermarket retailing with the scale to compete with the likes of Tesco and Asda. On the face of it, this was one of those deals where one and one could indeed be made to equal three. Instead it has so far been made to equal precisely nothing.

That the architects of this case study in how not to merge two businesses remain largely in situ is almost as big a mystery as the disappearing profits. It was acknowledged properly for the first time yesterday that Bob Stott, the chief executive, would go, but there's no news on the successor or even whether he would be in place for the start of the planned "optimisation programme" in March, whatever that might be.

As for Sir Ken's own successor as chairman, he'll be taking care of that personally in his own good time, thank you very much. The deputy chairman, David Jones, needn't bother himself with the matter. Clearly the board is still as much at war as ever.

Mr Jones, who announced his retirement as chairman of Next on Wednesday, regards it as a matter of personal duty to sort out the mess at Morrisons before he finally bows out of corporate life, but the omens don't look good.

Safeway stores seem to do well on conversion to the Morrison format. Yet the original Morrison estate is doing less well, with like-for-like sales in a state of gathering collapse. In the third quarter they were down 5.2 per cent, against just 2.7 per cent in the first half. The problem Sir Ken has run up against is that as more Safeway stores are converted, they cannibalise the sales of the existing Morrisons chain.

It was Sir Ken's birthday yesterday, and at 74, he shows no sign of flagging. To the contrary, his intention is to stay on long enough to vanquish his critics and rewrite the history books. If he left now he'd be for ever seen as the once proud regional retailer who failed to make it into the national big league.

Morrisons' curiously resilient share price demonstrates a lingering hope that this merger can eventually be made to work. Nothing it has done over the past two years would lead you to reach that conclusion, yet the underlying logic and rationale remains as robust as ever. It is just the execution that has been found wanting.

The question shareholders have to ask themselves is whether Sir Ken's continued presence at the company is more likely to hinder than to speed the recovery. If the former, then they cannot afford to be sentimental.

Green's dividend stunner at Arcadia

Congratulations to the irrepressible Philip Green for another impressively buoyant set of results from Arcadia, the Topshop to Dorothy Perkins retail chain - this against some of the toughest high street trading conditions in years.

Nobody can help but marvel at the seemingly effortless way in which Mr Green extracts value from brands previously dismissed by the City as a busted flush. With Topshop in particular, Mr Green has managed to create something special - the latest fashions at affordable prices.

Yet it is the £1.3bn dividend payout, 92 per cent of which goes to Mr Green and his family with the balance to Bank of Scotland, which has captured everyone's imagination. This must make Arcadia, bought for just £850m three years ago from disillusioned City investors, one of the most high-return investments of all time.

The purchase price included just £10m of equity, with the rest made up of various forms of debt. In just three short years, that comparatively small equity investment has been made to pay back £1.3bn in cash, which to save you doing the maths is a rate of return of 130 times. And Mr Green still owns the business on top.

Fast back to Mr Green's purchase of Bhs five years ago and the numbers look more impressive still. Mr Green put up just £15m of equity to buy Bhs. Including yesterday's dividend from Arcadia, he's now, from that original outlay, managed to pay himself back the thick end of £2bn while at the same time retaining ownership of both businesses. Few billion-pound fortunes can have been made so swiftly.

How on earth has he done it? Retail flair is certainly part of the answer, but not in truth the major part. Mr Green's skill has rather been to ride the private-equity boom, which has allowed financiers such as himself to replace equity with debt and reap the rewards. Arcadia generated net cash in the year to the end of August of £404m, which is a lot but plainly not enough to cover a £1.3bn dividend.

Instead, the money comes from bank borrowings, secured against the assets and the cash flow of the business. It is bankers and other debt holders who have paid him the dividend. As a consequence, they also assume the risk of the company being unable to repay its debts, a reminder of the old adage that when you owe the banks a few grand, you've got a problem, but when you owe them several billion, it's they who have the problem.

In fact, Mr Green insists, the business is still pretty conservatively geared, since even after the payment of a £1.3bn dividend, it generates enough cash to cover its debt-servicing costs seven or eight times. Many other private-equity takeovers in the retail sector, such as Debenhams, are much more aggressively geared.

Even so, there are limits to what can be extracted from these companies without fundamentally damaging the business. Mr Green hasn't paid himself a dividend from Bhs this year, presumably because the banks won't let him.

The taxman may be getting equally alarmed. Mr Green is not a tax exile, but his wife and family, in whose names the businesses are registered, are. In theory, then, the Green family don't have to pay a penny of UK tax on their £1bn-plus dividend.

Furthermore, the extra debt-servicing costs incurred in gearing up the company to pay the dividend will reduce the pre-tax profits of the company, which in turn reduces the amount of corporation tax the company pays. Clever or outrageous? It depends on your point of view, but the Revenue will certainly regard it with suspicion.

As for whether Mr Green might return for a third tilt at Marks & Spencer, who knows, but even he acknowledges the difficulty of repeating the fabulous returns made out of Arcadia and Bhs. The shareholders are less keen to sell, the bankers less keen to lend, and the pension fund trustees more acutely aware of their rights when clever financiers such as Mr Green come calling. The new pensions regulator wants to curtail attempts to replace the protective cushion of equity capital with debt.

Mr Green's last bid for Marks & Spencer involved proportionately far more equity than characterised by his earlier Bhs and Arcadia buys, and was therefore for him personally higher risk for less certain rates of return.

You don't build a fortune as rapidly as Mr Green without taking extreme risks, but there comes an age and point of enrichment where risking all, even for some great and long-coveted prize, no longer seems worth the gamble. Is Mr Green already in that space? He's mad enough to want to have another go, but I suspect his acquisition making will be more of the bolt-on variety from here on in than the land-grab ambition of another M&S. We'll see.

j.warner@independent.co.uk

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