Jeremy Warner's Outlook: Empire-building Pernod takes aim at Allied

Yell prices referred - Norgrove's challenge
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The Independent Online

Pernod Ricard has been stalking Allied Domecq for longer than anyone cares to remember, but as the smaller of the two companies with apparently formidable competition concerns to answer, no one took it too seriously. Now it has joined forces with Fortune Brands of the US in a combination that seems to address both these issues. By dividing up Allied's brands between them, the two should be able neatly to sidestep competition regulators while at the same time breaking the company up into more affordable chunks.

Pernod Ricard has been stalking Allied Domecq for longer than anyone cares to remember, but as the smaller of the two companies with apparently formidable competition concerns to answer, no one took it too seriously. Now it has joined forces with Fortune Brands of the US in a combination that seems to address both these issues. By dividing up Allied's brands between them, the two should be able neatly to sidestep competition regulators while at the same time breaking the company up into more affordable chunks.

Yet the more interesting issue is why Allied finds itself the hunted rather than the hunter in what may prove to be the last big consolidation left for the international drinks industry to do. After a disastrously executed sell-off of the company's pubs estate, during which directors were made fools of by the intervention of the financier Hugh Osmond, Allied has in recent years found its feet again under the steadying influence of Philip Bowman. Although a long way behind Diageo in terms of size, the company has proved a dab hand in expanding into wine, which some might think in these health-conscious times a better bet than spirits. Yet now Allied seems perfectly content to roll over and be carved up for breakfast, provided the price is right.

Why is this? One reason is simply that it is still possible to buy Allied, whereas it is probably not possible with Pernod Ricard, or almost any other second-tier international drinks company. France remains highly resistant to her companies being acquired by foreign concerns, even when they are not family run, as Pernod still is, and despite the wealth-destroying example of Vivendi Universal, its investors seem to he happier with empire-building endeavour than their more hairshirted, Anglo-Saxon counterparts. Mr Bowman would dearly love to buy Pernod himself, but even if he could, it's expensive for what it is, and his shareholders would never allow it.

Instead, he finds himself the object of everybody else's desires, which is a happy position to be in. As the last girl on the dance floor in a mature industry where cost-cutting consolidation is perhaps the only path left to decent levels of bottom-line growth, it's not just Pernod and Fortune who are going to be interested. Plenty of twists and turns are promised before this particular dance is over.

Yell prices referred

For some reason, nobody in the City bothered to think that the Office of Fair Trading, which has been investigating the printed directories market (aka Yellow Pages) for about nine months now, would actually want to do something about it. All the City forecasts for Yell have assumed that the present price cap of RPI minus 6 would continue into the indefinite future. With yesterday's reference to the Competition Commission, it's a racing certainty that the regime is about to become a good deal harsher. Down 10 per cent yesterday, the shares will remain under a regulatory cloud until the issue is settled. Yell expects the Commission's investigation to take anything up to a year.

Is the OFT justified in taking action? Yell is the dominant player in printed directories, and despite the introduction of new competition in recent years, both from Yell's original owner, BT, and from Trinity Mirror, its market position has yet to be significantly dented. As evidence of the lack of effective competition, the OFT contends that prices have failed to shrink by any more than the regulatory minimum ever since the price cap was imposed.

This is disputed by Yell, but never mind. At 37 per cent, the rate of return on sales is still at a level that few other businesses can aspire to. Return on sales for a comparator basket of companies in newspaper publishing and advertising averaged just 2 to 6 per cent between 2001 and 2003.

All evidence, according to the OFT, of monopoly, sustained not so much by abusive behaviour as what competition lawyers sometimes call the "network effect". The more businesses that advertise in Yellow Pages, the more valuable such advertising becomes, as the directory acquires must-use status. As the OFT points out, this is a particularly difficult barrier to competition to overcome.

As ever in such cases, Yell invites us to think of the market for such advertising as much wider than printed directories. In fact, Yell insists, it competes against other forms of local and national classified advertising, including newspapers and local radio. Strangely, the OFT scarcely even mentions the most significant competition of all, which is increasingly delivered via the internet on Google and MSN.

True enough, by imposing a harsher price cap, the Competition Commission would clobber Yell's fabulous returns, but it would make little difference to the rates paid by individual advertisers, where the savings, even for a very small business, would be of marginal significance. Yell's chief executive, John Condron, is acutely aware that growing competition from the internet and the two new entrants make his UK returns indefensible, which is why he's been busy buying up similar businesses abroad where the margin is capable of improvement. A market-driven solution to Yell's monopoly is fast evolving. The Competition Commission inquiry looks an unnecessary waste of time and money.

Norgrove's challenge

Ministers were never entirely clear what they wanted out of the new pensions regulator, other than a cure-all for the problems of the final-salary pensions industry. In the absence of guidance, it has been left to the new regulator's chairman, David Norgrove, to make up his own mind. He formally takes up his powers today, and it is already apparent, to the dismay of financially insecure companies, that he intends to apply some uncompromising principles.

As a former head of the Marks & Spencer pension fund, Mr Norgrove's likely stance was perhaps wholly predictable. It was Mr Norgrove who helped scupper Philip Green's bid for M&S by refusing him access to the pension fund's inner secrets, the unspoken agenda being that the debt leverage involved in Mr Green's offer would undermine M&S's ability to support its pension liabilities.

Since then Mr Norgrove has gone further to suggest that pension fund deficits should be treated in exactly the same way as any other unsecured creditor of a company. Being forced to think of pensions as a debt, rather than a perk, or reward for long service, has come as a bit of a shock to some, more traditionally minded companies, which is one of the reasons why so many are closing their final-salary schemes. Thus has well intentioned regulation already begun to damage the very thing it was meant to protect.

Yet there is at least some purpose in the madness. When a pension is offered, it becomes a contractual obligation on the employer, and it seems reasonable to put in place mechanisms to ensure that the obligation is met. An industry-funded pensions protection fund, which also formally comes into existence today, has been set up to prevent these obligations bouncing back on the taxpayer. Mr Norgrove's job is to try to ensure that calls on the fund are restricted to a minimum.

Present indications are that despite the hardline attitude on deficits, he plans a relatively pragmatic approach to the task in hand. If he's as good as his word, he'll only interfere where there is a serious deficit in combination with sub-investment-grade debt, indicating a degree of solvency risk in the sponsoring company. This applies to only about one in ten companies with funded pension schemes, or about 560 in total. The only member of the FTSE 100 in this position is British Airways. The BPs and GlaxoSmithKlines of this world will be left well alone. What's not clear is how Mr Norgrove plans to deal with those on the hit list, or indeed how he intends to define the minimum funding requirement he may wish to impose.

None of this was properly thought through by the politicians. The regulator has been given considerable leeway in deciding quite how meddlesome and demanding he should be. Mr Norgrove is presumably as aware as any that too oppressive an approach risks killing the goose that laid the golden egg.

jeremy.warner@independent.co.uk

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