Jeremy Warner's Outlook: Green's alchemy makes M&S investors weep

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The Independent Online

How does he do it? Whatever the answer, Philip Green's apparent ability to turn base metal into gold continues to astonish. Last week he paid himself another £40m in dividends from Bhs, taking to £400m the amount he's been able to take out of the company since buying it for £200m four years ago.

How does he do it? Whatever the answer, Philip Green's apparent ability to turn base metal into gold continues to astonish. Last week he paid himself another £40m in dividends from Bhs, taking to £400m the amount he's been able to take out of the company since buying it for £200m four years ago. The alchemy he's performed with Arcadia is even more impressive. After just two years, he's largely paid off the £866m he borrowed to buy the company, and is now in a position to declare a £500m dividend in respect of the current year, £460m of which will go straight into his own family piggy bank.

Both Bhs and Arcadia are now privately owned companies, so Mr Green isn't obliged publicly to announce anything about how well or badly they are doing. The fact that he does is in itself instructive, for most of the super rich prefer to keep their affairs as private as possible. Why's Mr Green so happy to flaunt them? In part it is because there is so much interest in everything he does that it is better to stage manage the news than to allow the press covertly to discover it, with all the dangers of misinterpretation this entails. But there is a lot more to it than that.

It is a common characteristic of high achievers and accomplished money makers that underneath the bombast and apparent self confidence, they can also be deeply insecure, restless souls, never happy unless in the limelight, always longing for recognition. Mr Green is no exception. It's what drives him on to ever greater heights, long after most of us would have retired to the South of France to spend our ill-gotten gains. Mr Green already has more money than he or his family could possibly spend in their lifetimes, yet he wants more.

Given the chance, Mr Green would still dearly love to prove himself at the helm of Marks & Spencer, or failing that, maybe Sainsbury's. So here's the other motive for public disclosure. Look what I could have done for you, he was telling shareholders in Marks & Spencer yesterday, if only you had listened to me. Just look what you've missed out on (for he was offering them 30 per cent of the upside) and weep. Over the past three months, Mr Green has proved not only that he can perform in a manner legacy retailers seem quite incapable of in the publicly quoted sector, but that he can also raise billions of pounds in equity and bank debt to finance his acquisition making. My door's open, he is saying; bring on the deals.

So how does he do it? In part it is just financial engineering. For instance, at Arcadia, Mr Green took out a 10-year mortgage on his Oxford Street store, thereby paying off £220m of the bank debt he used to buy the company. It's also better cash management of the business - speed to market, stock control, supply chain reform, vigorous control of capital spending and more effective cost controls. In these circumstances it hardly seems to matter that Mr Green isn't in fact generating any overall growth in sales. The sales are just a lot more profitable.

Having fought off Mr Green, M&S and others are now desperately trying to do some of the same things. The property is being mortgaged to pay back capital to shareholders, the supply chain is being reformed, and capital spending is being subjected to much more demanding tests of value for money.

Yet it remains questionable whether M&S can achieve the same cash back returns to investors in the publicly quoted sector as Mr Green seems to manage as a private equity player. However hard Stuart Rose, chief executive of M&S, tries to get off the treadmill of like-for-like sales growth, he will continue to be judged by his ability to deliver it, and that may mean crimping on cash delivery and margin. He must also manage the business in a way that ensures it is still around in 50 years' time. It's a different set of priorities. Unfortunately for Mr Rose, they don't seem likely to produce the same instant results as Mr Green's particular brand of alchemy. Nor does it seem likely Mr Green will allow him to forget it.

Morrison bounce

Sir Ken Morrison would like us to think of June's shocker of a profits warning as no more than a blip in the ever onwards and upwards march of his eponymous supermarkets group. In fact he would much rather we forgot it entirely. The stock market seemed to do just that yesterday as it greeted half-year results with an astonishing 15 per cent leap in the share price. This may have been more to do with relief that the figures didn't amount to a second profits warning than anything else. Like buses, profit warnings tend to come along in threes.

Yet nor were the results unalloyed good news either. "A great amount has been achieved in the last few months which have illustrated what a good business Morrison's is and has convinced me what a good deal the purchase of the Safeway business will be", Sir Ken insisted. The reality is that the Safeway integration has so far been botched in a manner that has completely collapsed the profits. The conversion of a Safeway store to the Morrison format seems to produce an immediate uplift in sales, yet even on the accelerated plans announced yesterday, full conversionis taking an awfully long time to achieve. It won't finally be complete until the end of next year.

In the meantime, growth in the core Morrison stores seems to be slipping. Like-for-like sales growth in the last 10 weeks was less than half as strong as it was in the first half. Sir Ken is right to believe that ultimately the Safeway takeover ought to prove a brilliant deal. What's more, he's already defrayed nearly one-third of the equity costs of buying Safeway through store disposals. But the jury is still very much out on whether he's capable of managing the integration to best effect.

Russian dolls

To Warren Buffett, credit derivatives are financial weapons of mass destruction. Much bought but little understood, the purpose of derivative securities is to reduce financial risk. CDs seem for many buyers only to have greatly enhanced it. But if you thought credit derivatives were complicated, try getting your head around their near relation - collateralised debt obligations, or CDOs.

These are packaged portfolios of credit risk made up from an array of different loans and bonds, sliced and diced into a supposedly easily digestible form.

To make matters even more complicated, CDOs often contain investments in other CDOs, which is why they are sometimes known as Russian dolls. And to cap it all, the underlying assets contained in the CDO can be substituted at the whim of the asset manager, making it difficult for the rating agencies to track them and even harder for investors to know how well, or how poorly, they are performing.

Unless Barclays Capital and HSH Nordbank can settle their differences amicably, it will fall to a High Court judge to don the wet towel along with his robes early next year and decide whether the German landesbank was mis-sold $570m of CDOs by its City counterpart.

The dispute has all the ingredients of a classic courtroom thriller: a murky area of the capital markets rarely exposed to the spotlight of public scrutiny; an investment bank run by an aggressive American, Bob Diamond, pitted against the most staid and conservative of state-owned German banks. The icing on the cake is that the Barclays Capital team who marketed the CDOs in question were the very same who gave us a glimpse of investment banking excess by forking out £44,000 on a meal for six at Gordon Ramsay's Petrus restaurant.

The dispute has been rumbling on for the best part of three years and now there are only four months left before the case goes to trial. It is still possible that one side will blink and settle on the steps of the High Court. But those interested in high drama can only hope it goes all the way. According to Warren Buffett, you should never invest in something you don't fully understand. Naivety, rather than mis-selling, may have been the root cause of the Germans' misfortune. But the chief moral of the story is beware investment bankers bearing gifts.

jeremy.warner@independent.co.uk

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