Satisfaction not always guaranteed

THE next time Co-op chief executive Peter Marks escapes the day job to rehearse with his Rolling Stones cover band, it's unlikely he'll sing "(I Can't Get No) Satisfaction".

The retailer and amateur musician, who once said the only job he'd rather do would be drummer for the Stones, received a large serving of satisfaction last week when, after months of speculation, he finally got his hands on rival Somerfield for £1.57bn.

The victory was particularly sweet for Marks, who has had to wait patiently until the Apax-led consortium that pipped him to the post for Somerfield in 2005 decided to cash in its investment, pocketing £470m in the process.

His delight was evident for all to see on Wednesday when he ebulliently told the City that the bosses of the big four supermarkets should start watching their backs.

With the deal giving the mutual company a new market share of almost 8% – just 4% behind Morrisons – Marks bullishly declared that the Co-op is on the cusp of a 'renaissance'.

"This is great for our business and in my view propels us back to the premiership of food retailing. I don't know if (Tesco boss] Sir Terry Leahy will be worried but I would say they have all got to start looking over their shoulders. The Co-op is coming back big style."

But as customer-members of the mutual, famous for its "divi card" loyalty scheme, treat themselves to a celebratory glass of fizz over the weekend, the City is asking if the likes of Morrisons' Marc Bolland and Justin King at Sainsbury's really do have anything to fear from Marks and his team. Will the Co-op be able to revive its glory days of the Sixties when it was Britain's largest grocery retailer with 13 million customer-members? And as supermarket stocks continue to battle against a consumer slowdown, analysts are questioning if Marks will pay the price for doing such a large deal in such difficult times.

The City's immediate reaction to the news last week was relief that the deal had actually gone through when the appetite for mergers and acquisitions is at a 15-year low. Somerfield was put up for sale at the beginning of the year but after initial interest from a number of parties including Asda, the Co-op was the only serious bidder. A disagreement over price is then understood to have led to a deadlock, and there were fears that the deal could come to nothing. Sources close to the consortium, which also included Barclays Capital, Kaupthing and Robert Tchenguiz, the property tycoon, say it had been seeking a price closer to the £2.5bn mark.

As a result, argues Sam Hart, analyst at Charles Stanley stockbrokers, Marks can justifiably pat himself on the back for the price he negotiated for Somerfield's 880 stores – almost a billion pounds less than the reported asking price.

Although some critics have questioned the wisdom of doing such a large deal when the markets are clearly depressed, Hart says now was as good a time as any for Marks to go after his target.

"From a buyers' point of view, it's definitely an extremely good time to be buying. Banks are being extremely cautious about who they are lending to and there were few competitors for Somerfield. Commercial property values are fairly depressed as well. I think the price is very reasonable. The deal will certainly strengthen its position significantly."

Stephen Pope, chief global strategist at Cantor Fitzgerald, agrees: "I would say it's a fair price given where the market is at."

But few in the City share Marks's enthusiastic forecast about his group's ability to cause sleepless nights among the management of the top four.

"The other retailers can look over their shoulders at the Co-op but they'll find the Co-op is actually quite a long way behind them," says Neil Saunders, director of consulting at Verdict Research. "It is a significant deal in terms of the size and scale that it brings to the business, but the market share differentials are just too great. It's a lot of marketing hype without the physical evidence to back it up."

According to the latest market share data from TNS, the new merged group is still about 24% off the market leader, Tesco; 9% off second place Asda; and 8% below Sainsbury.

Robert Clark, of the Retail Knowledge Bank, argues that even though on paper Morrisons, the UK's fourth-largest supermarket chain, now looks to be within the Co-op's sights, 4% is a lot to make up in the competitive grocery sector, which M&S boss Sir Stuart boss recently declared is undergoing the most aggressive price war for the past 20 years.

Although there is little doubt the deal is a significant one for the group, whose roots can be traced back to a collective of 28 weavers and artisans in Rochdale, Clark says Marks has close to no chance of bridging the gap between fourth and fifth place. "To be quite honest, I don't think it has got a chance of rivalling the big four," he says.

Instead, argues Hart, the Co-op should focus on what it does best: running smaller, high street convenience stores which shoppers dip in and out of, but where they don't necessarily do their full week's shop. "That is where their strength is," he says. Marks has admitted that the Office of Fair Trading is likely to force the Co-op to sell some of the 880 stores it acquired for competitive reasons. The expectation in the City is he is likely to pluck for the larger Somerfield supermarkets, and retain the smaller branches that fit with the mutual's existing stores. Analysts place the total number that are likely to be sold at 120, with Waitrose and Morrisons already being named among the likely bidders.

According to Clark, accepting that the 'big four' are too far out of the Co-op's reach and focusing on the smaller convenience end of the UK's £120bn grocery market would be a wise strategic move for Marks. The convenience market is estimated to be worth up to £31bn a year and, Clark argues, the Co-op is well positioned to claim the lion's share of that sum. "It can have a significant stake in that market," he says.

Many of the big retailers have awoken to the lucrative opportunities that the convenience market offers over the past few years, with the likes of Tesco opening Tesco Express and Sainsbury branching out into Sainsbury's Local.

But Clark says Somerfield has found a particularly successful formula, and the Co-op should use that to build on its own – not insignificant – expertise. He says Marks should use the Somerfield acquisition to improve standards at his existing stores, and needs to avoid the trap of imposing the Co-op model on Somerfield stores that are already working well.

"Somerfield has done a pretty good job of getting it fairly right recently after many years of under-performing. The Co-op stores are not of the same relatively high standard. The Co-op Group has probably got a lot to learn from Somerfield. The fear is that it may drag Somerfield down whereas the idea is to drag the Co-op up."

But making the takeover work in what are extremely difficult times for retailers is going to be no mean feat for Marks. Although he has plenty of experience on the acquisition trail – he acquired 600 Alldays stores in 2002 and last year merged with United Co-operatives – analysts suggest he has made a rod for his own back by setting such ambitious goals when across the market sales are taking a battering.

In April Marks announced that the group intends to double its profits over the next three years. But, say analysts, with the latest statistics from the British Retail Consortium showing a 0.4% fall in high street sales last month, that will be easier said than done.

Saunders of Verdict Research offers a reminder that when Morrisons bought Safeway in 2004, not everything went to plan and it was forced to issue several profit warnings. Bedding down an acquisition is difficult at the best of times, he asserts, let alone in a slowdown. "What tends to happen is there are difficulties when you try to integrate things. It's about being able to focus on the day-to-day running of the business as well as the integration."

Clark suggests in the long-term the takeover will be a success, but Marks and his customer-members should not expect a miracle. "You can't expect the new, merged business to suddenly act as if it's in a buoyant market place," he says.