Marks and Spencer Group (LSE: MKS) had to take drastic action earlier in the year after its group revenue declined by 3% to ÂŁ10.4bn. Mired by constant news of store closures, tough trading conditions and its clothing and home line unable to compete with the online players, the decision the board decided to make was for M&S to buy 50% of online grocer Ocado Groupâs UK retail business for ÂŁ750m and launch a new joint venture.
On the face of it, this was a good move for Marks and Spencer. From 2020, Ocado will replace Waitrose products with M&S goods on its website. M&S in the past has struggled to effectively distribute its products online. By distributing products on the Ocado platform, it will have access to an existing customer base.
The chief executive of Marks and Spencer, Steve Rowe, trumpeted the deal, saying: âThis is not about the short term. This is about the transformation of M&S [and] the transformation of online grocery shopping in the UK.â It is certainly an area where M&S is lagging behind its competitors.
A basket case
Food retailing is a highly competitive environment, and in recent times this is more evident than ever. With the town-centre locations and convenience store businesses, M&S is often not well suited for a big weekly shop: the average price of an Marks and Spencer shopping basket is ÂŁ20. Rather than a weekly shop, customers view M&S as a place to top up with premium goods. Partnering up with Ocado may help to open up this section of the market, without the outlay of opening new supermarkets.
However, the announcement left some investors concerned. The Marks & Spencer Group share price fell by 12% on receipt of the news surrounding the partnership. There was speculation in the market that M&S had overpaid to get into the online world, which left investors feeling nervous. To me, a value of ÂŁ1.5 billion does seem like a high price tag for a technology company with only a 1.3% share of Great Britainâs grocery market.
A worrying discount
M&S is hoping to raise ÂŁ600m for the venture through a rights issue. This was offered at a 20.9% discount to existing shareholders at 185p per share. This discount worries me, and signals the challenges that M&S face going forward. Marks and Spencer also announced that it is rebasing its dividend, and the 40% cut to its dividend is a red flag.
This could be an exciting time to be holding M&S shares. The promise of linking up with Ocado might get investors enthusiastic. But for me, buying is too big a risk and I would wait until the fruits of the partnership are seen.