With the takeover battle for the number two US supermarket, Albertsons, stepping up a gear, the rival factions should consider the fate of a recent food industry merger in the UK before committing their investors’ billions, says David Robertson.
The takeover of Safeway Supermarkets by Morrisons has destroyed a third of the merged company’s value and the whole process has raised questions about the viability of acquisitive growth in established retail markets.
Morrisons has been dogged by problems since the £3bn (US$5.2bn) deal and delivered a succession of profit warnings (six at last count) that have rattled investors.
According to research by Taylor Nelson Sofres, Morrisons has seen its market share fall to 11.3% from 13.9% last year and an effective share of 14.6% at the time of the takeover.
Tesco, the largest retailer, has gained the most during this period increasing its dominance to 30.4% from 28.1% last year.
Morrisons has also sold 228 stores in order to streamline the group, making the merged company smaller than the original Safeway – prompting some critics to wonder why they bothered with the deal.
Can such a merger ever work?
Morrisons’ patriarchal culture has been partly blamed for creating this situation but the real issue is whether two modern-day supermarket chains can merge without destroying value. Can food retailers in countries like the UK or USA still horizontally integrate?
This is particularly relevant to Albertsons as the Kroger supermarket group, the largest in the US, has now joined the list of potential bidders.
Albertsons, which has 2,500 stores, is no longer just a stalking horse for private equity groups wanting to turn around the struggling retailer.
A merger with Kroger would force the biggest rationalisation of the food-retail industry in the US for many years – and Kroger should consider what has happened to Morrisons before stumping up an estimated $10bn for Albertsons.
Sir Ken Morrison has run his family’s business for 34 years and by 2003 the company had 127 stores, making it the fifth-largest supermarket chain in the UK.
When the opportunity arose 18 months ago to buy fourth-placed Safeway (with 606 stores), Sir Ken jumped at the chance – realising it was the only way Morrisons could catch up with market leaders Tesco, Asda and Sainsbury’s.
But Morrisons has faced huge problems attempting to fashion one supermarket out of two very different chains.
In an attempt to take advantage of marketing economies of scale, Safeway stores are being rebranded as Morrisons – despite that name being unfamiliar in many parts of the country. This is believed to have led to customer defections and may help to explain Morrison’s slipping market share.
The Safeway stores are also being refitted and this is costing about £1m a site – an exceptional item that wiped £90m off the balance sheet in the first half of this year alone.
Safeway store managers must also be taught the Morrisons way of operating. This is being achieved through a mentoring programme where Safeway store managers join Morrisons people for a time, but this leaves Safeway stores without their top managers just when they are needed most.
Then there is the whole distribution network that needs to be rationalised. Morrisons has two sets of depots and delivery systems, which must be streamlined in the face of union anger. Strike action has already been threatened.
The company also had to decide how to integrate two completely different ordering systems. Morrisons has achieved this by simply forcing Safeway stores to adopt its own system, but this has inevitably led to problems as stores get used to the new process.
Another issue in this takeover has been the financial arrangements Safeway had with its suppliers, which have to be unravelled and renegotiated on Morrisons’ terms. This has become a bigger problem than expected as Safeway’s accounts contained a number of nasty surprises that only emerged months after the deal was concluded.
This array of problems has led to a string of profit warnings and the company is now forecasting year-end profits of between £50m and £150m with guidance indicating the lower number is more likely. This compares with a forecast profit figure of £350m published in March.
Some of these issues have been exacerbated by Morrisons’ unique culture – a strength when it was a medium-sized regional retailer but now seen by some investors as a liability.
Much of this stems from Sir Ken Morrison’s position in the company. He controls about 17% of its stock and was until recently both chairman and chief executive. Nearly all his senior managers have been long-term Morrisons men and the company’s board had just one non-executive on it.
Too many yes men?
Financial analysts are now questioning whether this yes-man culture led to Morrisons doing insufficient due diligence on Safeway. (Shareholders have been demanding changes and the company has just appointed a new finance director and is looking for a new chief executive. Four non-executives have also been added to the board.)
After a terrible 18 months there are now indications that Morrisons may be turning the corner. Like-for-like sales in the converted Safeway stores were up 12.9% in the 25 weeks to 24th July. Unfortunately core Morrison store sales were down 2.7% during the same period.
A Morrisons spokesman said the company was confident it would be able to concentrate on building sales in the near future: “We had to drive out the costs we were carrying because of the conversion and the need to maintain two sets of infrastructure. In the next two years we will move from a business conversion plan to one of optimisation.”
However, even if investors choose to believe the message that things are getting better at Morrisons they have witnessed significant erosion in shareholder value.
It is, therefore, reasonable to ask whether modern retailing enterprises like this can be merged with one another. These businesses have become such complex organisations with so many relationships and ties to suppliers that to achieve economies of scale the whole system must be ripped down and rebuilt.
This produces vast exceptional costs that, in the case of Morrisons, will outweigh any longer-term benefits for years to come, particularly if the upheaval continues to erode market share.
It is perhaps no wonder that so many recent retail deals have been done by private equity groups (Kmart/Krispy Kreme/Toys R Us). Indeed, at least two of the bidders for Albertsons are believed to be private equity groups. Private equity has the luxury of being able to focus on correcting management issues when a company loses direction and then selling out once the problem is fixed.
This is something Kroger will have to carefully consider before exposing its shareholders to the sort of mess Morrisons has got itself into.