Sainsburys – a missed opportunity?

For some time now Delta Two, the Qatari backed investment vehicle has been circling J. Sainsbury. Yesterday we learned they have entered into formal talks with the company’s pension trustees and its advisors. Is this icon of UK retailing one step nearer to falling into foreign ownership?

The “traditional analyst’s” point of view is that the return on the likely full value of the assets is low, even though Justin King’s recovery plan has improved performance and restored value to the share price. This argument continues that if the value of assets can be unlocked in some way to the benefit of shareholders then it has to be a powerful consideration. Additional persuasion suggests that shareholders, especially the Sainsbury family and trusts, would consider selling out at this time because they had a severe fright previously when market share, profits and shares plunged and there are no Sainsbury family members involved or likely to be involved in the business.

These arguments have been deployed by Delta with their “indicative” offer at 600p per share, against a current price of 574p, a premium of just 4.5% as things stand (though the share price is likely to still include some further potential takeover premium). The precise structure of Delta’s proposition is as yet not clear but it will be based on taking on significant debt with Sainsbury’s assets as the key collateral. In effect the purchaser will use the seller’s assets to finance their bid – in macro-economic terms, arguably, a reduction in the overall wealth of the UK.

All this is based on “traditional” thinking together with the business and financial analysis and the behaviour that results from this. We have looked at the different insights that come from using the Competitive Strength perspective. This gives a radically different and challenging alternative view and asks - Are the Sainsbury’s shareholders going to forego the longer term opportunity to see 800p or more for their shares for the sake of quick cash based on a real value diluting financial manipulation?

The Competitive Strength assessment suggests that, given the real potential value of the business, the Delta valuation is derisory. We must ask whether Sainsbury shareholders should even consider any offer at the current level. Or do they genuinely believe that their management cannot ever deliver the real potential value in the business? Delta appears not to think so (see below).

For some time after it became the market leader Sainsburys remained in a “Comfortable” competitive strength condition. Then market conditions changed, the competition hotted up and Sainsburys quickly fell back into a “Constrained” condition. Under Justin King they have climbed back to “Comfortable” with signs of the potential to move on to “Excellence”. This is why Justin King himself has stated that they are only about halfway through the recovery plan. But does even he appreciate the full potential value that the business could deliver?

We know from the research by Vinod Singhal that “Excellent” businesses can deliver double the profitability and financial returns of those in “Comfortable” competitive strength conditions. Suppose Sainsbury shareholders decided to ignore takeover approaches and instead charged their management with rapidly and effectively moving the business towards Excellence. The research tells us that you could see the share price achieving 800p in the short/medium term and up to £10 thereafter with greater Competitive Strength enabling more and more strategic choice for the business. In addition, they would still have the assets, unencumbered and available to serve the best interests of shareholders, employees and the pension funds.

The research is rock solid, if you don’t know about this then you should read this. The only question is can the management deliver? Delta seems to think so as by all accounts retaining Justin King is central to their plans. Are Sainsbury shareholders about to miss their big opportunity and hand over all their business’s accumulated wealth to Delta and is this what Delta are counting on?

How Competitive Strength creates Competitive Advantage

The Royal Crown Derby Porcelain Company manufacturers the highest quality English fine bone china tableware, giftware and collectables. It sells primarily through china and glass retailers in the UK and overseas.

Based in Derby for over 250 years in 2000 became an independent and privately owned business again via an MBO from its parent company Royal Doulton. In spite of its well established reputation it faced formidable challenges. The majority of its competitors have moved their manufacturing offshore, in the UK market there has been a major shift away from formal dining tableware, and the weak US dollar hit profit margins in their most important export markets. Their retail customers are reluctant to hold stocks and have reduced their order lead times significantly.

Crown Derby believes that their history is a key factor in what their customers buy. Royal Crown Derby china still “made in Derby” is a crucial part of this history. They have therefore resisted offshoring any manufacturing even though this put them at a significant cost disadvantage.

What they have done is to focus on Continuous Improvement, in particular the multi-skilling of their workforce. In an industry where traditionally the different “crafts” would never easily interchange their employees now are highly flexible. This has reduced lead times and they can now ship orders in 4/5 days from receipt. In the US, one of their biggest export markets, this enabled them to dispense with their warehousing facility, a significant cost saving coupled with improved customer service. Their competitors still have their warehouses and the costs these entail.

Businesses with high quality upmarket products can often believe that this is enough on its own, but it is not. From a Competitive Strength perspective Royal Crown Derby have moved themselves from a Constrained Condition to the beginnings of Excellence where more dimensions across the business are beginning to match the quality of their products. This has already produced significant competitive advantage.

By contrast their old parent company Royal Doulton in spite of moving all its manufacturing to low cost countries is a still a constrained and struggling business.

More Competitive Strength Contrast in the Retail Sector

From The Times - September 19, 2007

Gloom deepens in retail sector as Debenhams admits having to slash prices
by Sarah Butler

Debenhams increased the gloom about the prospects for the retail market yesterday when it revealed that it had been forced to discount heavily in the summer to clear stocks.
Shares in the company fell 3.8 per cent to 101½p as the retailer said that gross margins slid 0.9 percentage points in the six months to September 1, worse than expected, after poor summer weather and disappointing ranges forced it to discount heavily to clear stock.

Growing taste for luxury gives Harvey Nichols that expensive look
by Sarah Butler

Harvey Nichols recorded a 47 per cent jump in profits last year as the Knightsbridge department store benefited from strong demand for luxurious fashions and accessories…

Selfridges, Harvey Nichols’s rival, which also filed accounts at Companies House in the past fortnight, announced that it had doubled annual trading profits in the year to February 3.The chain, which has stores in London, Manchester and Birmingham, said that trading profits had risen from £10.1 million to £26.8 million as sales increased 13 per cent to £356 million.
One day, one journalist, three stories – two spectacular contrasts in performance.

Who has high Competitive Strength? Who is Constrained? How do these contenders compare with John Lewis (see other story)

The Retail sector is volatile and changes very rapidly. Competitive Strength can be seen in those that consistently stay in the lead, have freedom to invest, maintain growth.

Retail – picking winners from losers

Hardly a day goes by without a warning of tough times for retailers. Just last week Next, in spite of announcing half year profits up 10%, warned that life was getting tougher both on the high street and online. Morgan Stanley downgraded its recommendation on DSG Group, owners of Currys and PC World to "underweight" adding that that they were "much more sickly than most investors realise" and that the dividend "appears unsustainable and could be cut next summer". This week Debenhams report like for like sales down 5%. All cite interest rate rises, fuel and food price rises and now Northern Rock’s problems as factors affecting consumer confidence and their willingness to spend. A distinct nervousness about the prospects for Christmas is creeping in

In August we commented on how John Lewis’ superior Competitive Strength (read it here) had enabled them to buck the trend when it reported substantial increases in sales and a programme of stores openings, new concepts and investment in customer service.

Last week John Lewis announced a 50% increase in first half profits. Their Chairman Charlie Mayfield said that he was “quietly confident” about in the run up to Christmas. He claims that “We are confident our partners will continue to set us apart from the Competition”. A clue as to why his confidence is justified and why John Lewis’ superior competitive strength will continue to set them apart from their competition can be found in a report in September’s Which magazine.

In a guide to buying a computer the clear winner was John Lewis, the only retailer to get a 5 star rating with 61% of customers saying they’d be very likely to return when they needed a new computer. Which was curious about what makes John Lewis so good so they asked some survey participants for some more detail. The overwhelming impression was that “the staff knew what they were talking about”!

When times are tough it is a real advantage if you can hang on the customers you have got. John Lewis can clearly do this and when research shows that it costs 5 times a much to win a new customer than to keep an existing one this creates significant competitive advantage. What’s more they are investing a further £1.5m in staff training and increasing by 200 the number of trained specialist staff in stores.

So we say Charlie Mayfield’s “quiet confidence” is highly likely to be vindicated. As for the others well, PC World came bottom in the Which survey. Looks like Morgan Stanley have got it right with the downgrade. Go to the Competitive Strength Report website and see if you can spot why John Lewis is likely to win and DSG may well lose.

Carphone can…. and it has!

As a postscript to our posting on this company on 10th September (read it here) we read this week that Carphone Warehouse is expected to enter the FTSE 100 shortly. Charles Dunstone started the company in 1989 with just £6,000 of savings. Not many FTSE 100 companies have come from that little that fast!

We believe that this success is an inevitable outcome for a company that has achieved a high Competitive Strength condition, Excellence or above. How can we justify this in the case of Carphone Warehouse?

Well like any other really excellent company they are not immune from making mistakes. Carphone made a big one when it completely underestimated the level of the response it would get to its TalkTalk broadband package. Service levels were catastrophic and the potential damage to their brand was real and significant. Carphone faced up to their mistake, made the investment to rectify it and slowly worked its way out of the corner it had got itself in.

That’s the difference Competitive Strength makes. How do we know? Well do you really think Carphone Warehouse would be knocking on the door of the FTSE 100 less than two years after a disaster like that if it doesn’t?

Can the Poacher turn Gamekeeper?

Chrysler the US car maker now owned by private equity group Cerberus has announced a string of high profile appointments. First was Robert Nardelli late of Home Depot and famous for extracting a £103m severance package. His appointment is seen as a sign that Cerberus are intent on fast and radical restructuring as Nardelli has a reputation as a tough negotiator (just look at the severance package!) and decision maker.

Then last week Chrysler announce that James Press, President and CEO of Toyota North America and the first non-Japanese to sit on the company’s worldwide management board, is to join them to lead Chrysler’s sales and marketing team. This is the second top executive Chrysler has poached from Toyota. Last month they hired Deborah Wahl Meyer, previously vice-president of marketing for Toyota’s luxury car division Lexus. Then Chrysler announces that Jim Murtaugh, head of GM’s China business is to head up Chrysler’s Asian business.

Commentators see all this as signal of how serious Cerberus are about turning round Chrysler and doing it fast. The appointment of Press in particular who joined Toyota in 1970 and oversaw their dramatic growth in the US is seen as quite a coup. Jim Hall, an analyst at AutoPacific told the Bloomberg news agency “Press understands automotive sales better than 98% of people involved in the business. More significantly, he has real product savvy, something that Chrysler needs”.

Whilst both these recruits from Toyota bring in talent and expertise that Chrysler sorely need note that they are also both “front end” appointments. Toyota’s success is built on the whole organisation from front to back and back again operating to the highest standards of excellence and Chrysler haven’t been near that ever. The research on which our Competitive Strength Report is based demonstrates clearly that being excellent in just one or two dimensions is not enough to achieve more than marginal additional pay off. These ex-Toyota appointees will make a difference but on their own they are unlikely to make “all the difference”.

What is more Press and Wahl Meyer are used to the backing of a business that consistently delivers on the promises they make to customers and will soon grow frustrated with a business that does not. This will happen even quicker if they find they are unable to directly influence and implement change throughout the whole business.

Applying Exceeding Expectations principles our perspective on this is simple. If Nardelli carries out the restructuring and then bows out leaving a good foundation for Press and others to build Excellence as standard throughout Chrysler then this could work. If it does then the people who should really worry are Ford and GM. However if Nardelli hangs around then it won’t get much further than the restructuring.

Cerberus may decide to cash in all or part of their holding in Chrysler around the time the numbers look better following the restructuring (and they will for a while).

Guess which of the above scenarios would suggest to us that the shares would be worth buying and which suggests don’t touch!

Either way we suspect that the one company that won’t lose any sleep is Toyota.

The Doorway to The Abyss...

Exceeding Expectations? How to do the Absolute Opposite – and where will it take Virgin Media?

Virgin Media customer loss continues in Q2
Published: Wednesday 8 August 2007 ; TelecomPaper

“UK cable operator Virgin Media reported a continued loss of customers in the second quarter, reducing its total by 70,300 to 4.7 million. The company estimates it lost some 40,000 customers in the period due to Sky removing its channels from the Virgin platform in March. Average revenue per user also fell, to GBP 42.16 from GBP 42.75 in Q1, hurt by lower telephony use and more retention discounts. Growth in broadband subscribers slowed from the previous quarter to 45,800 net additions, while both the mobile and fixed telephony activities showed declines in customer numbers.”

And before that both its predecessors, NTL and NTL Telewest also reported massive customer losses – and even more spectacular financial losses, totalling billions eventually. They have had a lot of practice at losing customers (on one occasion the then Chief Executive reported that they “expected to lose lower value customers”).

“NTL, the cable group that merged with Sir Richard Branson’s Virgin Mobile to form Virgin Media, was twice targeted by private equity players. The merger was supposed to transform the group, which was plagued by a reputation for poor customer service, into a major media and communications player.” May 10, 2007; The Times.

Virgin Media now claim that they are losing customers because of their falling out with Sky. It is just another excuse – they are losing customers because they are treating them with arrogant contempt – because, and their history proves it, it is the only thing that they know how to do.

I have just switched from Virgin Media after 7 months of progressively deteriorating broadband performance and experiencing the same sorts of dispiriting, cynically money grubbing, contemptuous and economical-with-the-reality service transactions that you can find for yourself if you Google “ Virgin Media Service”. As a final inconvenience, I will now lose my personal email address for the last 10 years – “we don’t do that (let you remain on a different deal) anymore”.

What a “perfect result” for Virgin Media – they really have got rid of a “low value” customer - it is difficult to imagine what else in Customer Retention they could have done worse.

Now Sky have gained a high value customer – Virgin Media have scored a total own goal.

What we say from a Competitive Strength point of view is:-

This experience was full of illustrations that typify what happens when a business becomes CONSTRAINED.

• You make counting pennies more important than Customer Satisfaction.
• Your performance standards slide, and keep falling.
• You expect your customers to do your Quality Management for you
  and in this case, even to pay you through the nose to do so!
• You seek to evade accountability as your basic response.
• You stop being honest with your customers.
• You deny initiative and responsibility to your customer facing staff
• You isolate your Customer Complaints department from customers (of course, why doesn’t everybody else do that?)
• You “lose” key Directors with a proven track record in Good Customer Service
  and
• You play repeated claims about your Amazing Customer Service to your customers while they wait more than 20 minutes for you to reply to their call!!!!!!
  You could not make this last item up – it beggars belief – it happened!

Based on this experience, Virgin Media as a business appears to be in the CONSTRAINED condition of Competitive Strength and that means that it is approaching The Abyss – and there will lie failure, again.

• This means that its shareholders, employees, suppliers and customers all face the possibility of serious disappointment in the foreseeable future - again.
• This means that Sir Richard Branson’s promise that everything would be to the “Virgin” standard by the time it was in use has proved worthless – and that diminishes both him and the brand.

We say, please look at the Competitive Strength web site. Please see the frightening difference in both financial strength and business resilience there is between the Constrained and the Excellent. Please see just how deeply temporary and precarious is the position of the Constrained business.

Then, if you have any stake in Virgin Media, please do a serious risk assessment of the implications of that for you and your business now, before you have an unpleasant surprise - just like a series of stakeholders in NTL had in the past and sadly it now appears that nothing has changed..

Carphone can…. So Carphone does!

Carphone Warehouse has struck a deal to sell Virgin Media’s broadband, digital TV, home phone and mobile services in its stores. So it is actually offering a broadband fixed line package that is in direct competition with its own TalkTalk service. Does any sane business offer a leg up to its competition?

In fact Charles Dunstone, Carphone Chief Executive, said he hoped to strike more broadband deals and did not rule out offering to resell the services of fierce rival BT! The answer as to why he is doing this can be seen in the Carphone stores where they are setting aside room for The Broadband Shop. This is dedicated area gives a choice of mobile broadband services from T-Mobile, Orange, 3, fixed line through ADSL from TalkTalk and AOL Broadband (also owned by Carphone) and via Cable through Virgin Media.

The more fascinating question is how can they do it, how can they take the risk of offering products from direct competition? We think the answer lies in Carphone’s relative Competitive Strength compared to many of its rivals. To see what you think go to the Competitive Strength website and see how you think Carphone compares to Virgin Media and what conclusions you can draw.

Our only concern would be just how long Virgin Media will remain a viable player in this market (see our article “The Doorway to The Abyss” on this). However if they do not then Charles Dunstone is likely to have others queuing up to take their place. Carphone Warehouse can…. So it does. Many of their rivals can’t …. So they just can’t!

No Summer – No Sales

Magners Cider owned by Irish drinks group C&C has been described as a “triumph of marketing” and since its launch in 2003 has grown rapidly in popularity. C&C’s share value grew just as rapidly from €2 to nearly €14 earlier this year. They built their product distinction on the new idea of Cider Over Ice and sales grew strongly during three successive summers and this year’s early Spring heat wave.

Suddenly in July came two profit warnings in rapid succession. C&C said trading "deteriorated at an unexpected rate" and warned that first-half operating profits were likely to fall by 35pc compared with last year's €113.5m. They said there was "a degree of uncertainty" about the outlook for the second half. C&C blamed a collapse in sales on the wet weather and growing competition from rival Scottish & Newcastle's Bulmers who had launched their own over-ice cider brand last year and re-taken 20pc of the market.

The share price dropped to €6 so C&C's market value has more than halved over the past two months amid growing concern that Magners is just a craze. Liam Igoe, an analyst at Goodbody Stockbrokers in Dublin, said: "The question is whether sales are down because of the floods or because people are moving away from the concept." Paul Walsh, chief executive of drinks giant Diageo, said that the "boom" in cider was not a "sustainable proposition".

However Maurice Pratt, chief executive of C&C insists that Magners was not just a fad in the UK."I believe these are exceptional circumstances and don't believe our medium-term model in Britain will be compromised by these difficulties," he says.

These different opinions are not that helpful to anyone wanting to assess where C&C and its share price might go from here. They may not even be truly helpful to the board of C&C. However if we apply a “Competitive Strength Perspective” then further insights can be gained.

It is clear that C&C did a great job on both coming up with the Magners Cider product and in marketing it. However their strategy now is to redirect much of C&C's €40m annual marketing spend towards promoting cider over ice as an all-seasons drink – as a winter favorite no less - to reduce the apparent dependence of their sales on a warm summer. Although this response indicates that the marketing dimension of the business may be strong, the question must be asked whether that is all they really have to try to build a “sustainable proposition”? How often has “Sell It Louder” really changed a lost sales situation? C&C risk looking, and sounding, too much like a “one product, one idea” company.

The Competitive Strength Report, and the research from Vinod Singhal that it is based on, shows clearly why excellence in just one dimension is not sufficient to build a high level of Competitive Strength. In spite of C&C’s excellence in marketing and its importance in the sector in which it competes it still was not enough to overcome adverse weather conditions and a big competitor.

C&C enjoyed a new product “honeymoon” in which the markets, and possibly even they themselves, believed they had “Excellent” Competitive Strength – hence the inflated share price of €14. It was only when the lack of substance underwriting this perceived Competitive Strength became apparent that the markets recognised the reality. Actually C&C look much more as though they are in a “Comfortable” Competitive Strength condition and consequently the €6 share price was almost certainly about right all along. The sales and share price collapse, together or apart, was always going to happen; it was just a question of when and why.

If the markets could have applied the Competitive Strength perspective to an assessment of C&C’s performance perhaps they could have worked this out before the share price got chased up to unsustainable levels. If C&C truly understood their own Competitive Strength position, they may be addressing the competitive situation with a more fundamental shift – or possibly exploited the brief sales and profits bonanza more beneficially for the long term future of the business..

The other question this all raises is, what about Scottish & Newcastle? They appear to have been able to come from behind, bring out a new product and grab 20pc of the market. They were a bit slow off the mark, they let Magners have three years – 3 years! – but now they have hit the nail on the head utilizing their greater depth in distribution and business to business marketing. They have demonstrated a Competitive Strength well above “Comfortable” – possibly even heading towards “Excellence” – does this means that there is more to come? Maybe their shares are worth a look!