City casts doubt over flotation valuing Ocado at up to £1.1bn

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The home delivery grocery service Ocado is to float on the stock market this month in a move that could value the company at up to £1.1bn and net its bankers and legal adviser fees of £15m.

The retailer, which sells groceries from Waitrose to internet customers, set an unusually wide price range of 200p to 275p a share for the initial public offering yesterday, which would value its equity at between £800m and £1.1bn.

The shares are set to start trading on 21 July but the offer will be open only to institutional investors, Ocado employees and customers who have spent more than £300 with the retailer in the first six months of this year.

Despite the attention the float has attracted, analysts were sceptical about the valuation and timing of the IPO. Ocado has not made a pre-tax profit since it was founded in 2000. Earlier this week, analysts at HSBC said Ocado would not make a pre-tax profit until 2014, although others in the City expect it to do so earlier. Meanwhile, Philip Dorgan, a retail analyst at Ambrian, said he considered a fair market valuation of the business to be "no more than £500m". Market volatility this year has prompted other companies, including the fashion chain New Look, to shelve planned flotations.

A key concern for industry experts is the amount of cash Ocado needs to spend to continue growing, in addition to the profitability of the warehouse model it uses. Mr Dorgan said yesterday: "It has burned through a lot of cash in the past 10 years and it looks like it will continue to do so."

Ocado is looking to sell up to 257.7 million shares, including as many as 102.5 million new shares to raise £200m to fund its expansion. Managers and existing shareholders, including the pension fund of the John Lewis Partnership, will sell up to 155.2 million shares, including 10 million options or warrants that could be exercised ahead of the IPO.

According to its prospectus, Ocado will use the bulk of the funds raised to build a second customer fulfilment centre (CFC), in addition to enhancing the existing automated distribution facility in Hatfield, Hertfordshire.

Ocado needs to build new centre, which is likely to be in the Midlands, to extend its coverage beyond 66 per cent of British households. However, directors said that even assuming it starts building the site in the first quarter of 2011, it will not begin operating until the end of 2012 "at the earliest".

According to the prospectus, Ocado plans to invest a whopping £210m in the second site. Of this, £155m will come from the proceeds of the IPO and about £120m from its undrawn debt facilities and credit lines, as well as cash flow generated from operations. It will also invest about £80m in Hatfield, to increase its capacity from 105,000 to 180,000 orders per week.

However, Ocado revealed that through its extra capacity and increased efficiencies in technology, systems and training, it has a "long term" target to grow its average drops per van per week – a key building block to profitability – to 175 from 121 at the end of 2009.

One City source said: "At each step along the way, the development of its own software and processes has been achieved at a high cost for the sales growth and lack of profitability it has delivered. It now down to Ocado to lower the average costs per drop and average costs per pick."

Another concern for potential investors is that Ocado's 10.6 per cent share of the online market trails a long way behind Tesco's 45.1 per cent. The gap is smaller between Sainsbury's 14.1 per cent and Asda's 13.7 per cent share. One source said it was "only a matter of time" before Morrisons launched an online grocery offer, and Marks & Spencer has said it could follow suit.

Despite this, a market source said that even if Ocado grabs a small additional slice of the fast-growing online food market, it could give its revenue a sizeable jolt. Online grocery is estimated to account for just £5.3bn of the total £146bn UK food retailing sector.

The eight banks and the legal advisers working on the float, including Goldman Sachs, UBS and JPMorgan, will make £15m in fees. For the 24 weeks to 16 May 2010, Ocado's underlying earnings rose 181 per cent to £8m, on total sales up by 29 per cent to £230m.

The men behind Ocado

Jason Gissing

Mr Gissing is one of the three former Goldman Sachs financiers who left the investment bank to set up Ocado in 2000. Formerly the company's finance chief, he is now the director of people, culture and communications at Ocado, which will come as no surprise to journalists because he engaged with them the most over the years. He and the other two founders, below, will net a combined paper windfall of £180m from their stakes if Ocado is floated. Mr Gissing took home a total pay packet of £486,616 in 2009.

Tim Steiner

Shy but determined, Mr Steiner can be prickly when criticism of his corporate baby is made. In fact, some in the industry joke that Ocado would have to be prised out of 40-year-old Mr Steiner's hands by a potential buyer. In addition to selling up to a tenth of his own stake of 9 per cent, Mr Steiner will be the biggest beneficiary of a scheme where 15 of Ocado's most senior managers are in line for a £30m payout if its share price doubles after the flotation. He took home total earnings of £651,356 in 2009.

Jonathan Faiman

The least is known about Jonathan Faiman, the third former banker who was a founding father of Ocado. He gave up his executive duties a couple of years ago and since then is thought to have tried his hand at setting up an agricultural business in Russia, supplying groceries on an industrial scale. He formally resigned from Ocado in March but still owns three million shares in the business and will make a small fortune if the company floats. His wife, Kira, holds 24.4 million shares in the company.

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