Q2 profits may be up 60%, but Royal Ahold remains under pressure from major shareholders Centaurus and Paulson to give returns a shot in the arm by selling off US operations. For now, Ahold is standing firm, but it needs to deliver tangible results to appease activist investors. Katy Humphries reports.

Centaurus Capital and Paulson & Co., which collectively hold a 6.4% stake in the Dutch retail giant, are pushing for management to be more proactive in releasing value within the group and increasing returns to investors. The hedge funds want to unlock capital in Ahold's disparate units and increase profitability by sharpening the company's focus on its European operations, including Dutch market leader Albert Heijn.

Centaurus and Paulson first publicly urged the company to divest its US businesses on 14 August, arguing that profit margins there have come under increased pressure and the units have no synergies with the retailer's European operations.

This would be no minor disposal as the units in question are valued at about EUR12bn (US$15.19bn), almost half of Ahold's enterprise value. However, "the company needs drastic action to deliver shareholder value," Centaurus and Paulson said in a statement. "We believe keeping Ahold's disparate retail and wholesale interests together diminishes shareholder value and limits the operating potential of the individual businesses.

"We further believe that one of the best strategic actions to take for the future prospects of the company and for enhancing shareholder value is to sell Ahold's US businesses and become a pure-play European retailer," the funds added.

The US accounts for about 70% of total Ahold sales, and includes the Stop & Shop, Giant Landover, Topps and Giant-Carlisle grocery chains along with a food distribution division. Sales growth at the US retail units has been sluggish, as the supermarkets have struggled to compete with Wal-Mart and Kroger in a competitive and constricting market place. Meanwhile consumer spending has dropped while escalating costs, notably energy outlay, have squeezed profit margins.

Difficult market conditions had caused Ahold to revisit its ambitious growth targets in March, when Ahold president and CEO Anders Moberg revealed that the company expects retail operating margins to fall between 4% and 4.5% in fiscal 2006. It had previously forecast operating margins of 5% for the full year. The company dropped its retail net sales growth forecast for FY2006 to between 2.5% and 3%. Moberg also said that the company would undertake a strategic review of its underperforming units.

As a persistently poor performance coupled with this downbeat forecast were thought to have sparked the spate of investor activism, when the company delivered a forecast-beating second quarter some analysts believed the results would help management ignore calls to break-up - especially given the improvement seen in US operations.

The retail giant posted second-quarter operating profits of EUR376m, up 55% from 2005 and ahead of analysts' forecasts. Net profit rose from EUR131m to EUR225m, also ahead of market estimates. However, Ahold cautioned that it did not expect such a strong performance for the rest of 2006, confirming its revised full-year guidance.

Delivering the results, Moberg said that the company's strategic review of underperforming assets was "well underway and will be completed in the fall". The company has since confirmed to just-food that the review is on schedule.

"These results should give management breathing space ahead of the strategic review," Dresdner Kleinwort analyst Joshua Galaun said.

Since going public with their plan, Paulson and Centaurus have sought a "constructive dialogue" with management. However, a spokesperson for Ahold told just-food: "We aren't in any dialogue with Paulson or Centaurus." Denying reports that its board of directors is split over the proposals, Ahold told just-food that it has refused to meet with the hedge funds because of the strict corporate governance standards implemented after the 2003 accounting scandal.

This notwithstanding, the hedge funds have begun drumming up shareholder support for their recommendation, holding meetings in the Netherlands and London. A source close to the situation told just-food that the activist investors hope to win enough shareholder support to force the company to take note. Under Dutch law, investors with a minimum 10% stake can force an extraordinary general meeting.

"Partly the management of Ahold are not talking to Centaurus or Paulson because they think that they are in a minority," the source said. The hope is that if significant support for the plan comes forward, management will come to the table.

Citing analysts at their advisor ING Corporate Finance, the hedge funds have told Ahold shareholders that the retailer could be worth more than EUR9 per share if US operations were sold, 22% higher than the share price before Centaurus and Paulson made their intentions public.

Despite the hedge funds' appeal for support, Shorecap analyst Clive Black told just-food that the activist investors remain in the minority: "A large segment of shareholders will be prepared to give management some time to complete its own strategic review. But the hedge funds feel they have waited long enough and want rapid results," Black said.

Rumours surfaced yesterday (Tuesday 19 September) that the retailer was planning to merge with Belgian supermarket group Delhaize. While analysts found this eventuality highly unlikely, Black told just-food that it could be a signal that pressure from the activist hedge funds had forced management to "think outside the box". Nevertheless, Black said, "A merger would come as a big surprise. Ahold carries a lot of debt and I'm not sure the company has the resources available. I'm also not convinced Delhaize investors would want Ahold shares."

The possibility that Ahold is considering drastic measures to increase profitability has sent stock soaring, with Ahold shares reaching their highest point in nearly three years. Since rumours of a break-up surfaced shares have increased from EUR7.33 on 14 August to EUR8.07 at midday today (20 September).

However, this does not necessarily mean that shareholders will rally behind Centaurus and Paulson, Black told just-food: "When you get this situation there will be a lot of investors who are happy to sit back and benefit from the rising share value. Whether this will be a long-term increase depends on the outcome of the review and whether Ahold's current activities deliver more value than investors were hoping for. If not, then management will have to answer to continued pressure to deliver value."

Even if Ahold manages to dodge demands for radical restructuring until it delivers its strategic review, the spotlight will remain on alternatives for value creation within the group. This need not mean an exit from the US market, but could include less radical measures such as the sale of smaller central European and Iberian operations or investment property. However, if Ahold fails to deliver increased returns investors look set to become increasingly vociferous in their calls for action.