Business Analysis: Sir Ken stumbles in Safeway's aisles

Crisis of confidence looms for autocratic Yorkshireman as acquisition goes awry

Sir Ken Morrison is 12 months into the biggest adventure of his illustrious retailing career. Yet when the 73-year-old executive chairman of Wm Morrison unveils the supermarket group's full-year results this morning he is likely to be feeling anything but triumphant.

Sir Ken Morrison is 12 months into the biggest adventure of his illustrious retailing career. Yet when the 73-year-old executive chairman of Wm Morrison unveils the supermarket group's full-year results this morning he is likely to be feeling anything but triumphant.

For starters, the Bradford-based group painstakingly built up by Sir Ken's father will reveal that it made less profit last year than it would have done had it not spent £3bn buying Safeway.

Two profits warnings in the space of nine months have tarnished the group's reputation. Shares in the group have plunged 20 per cent since Sir Ken sealed the transforming deal, destroying shareholder value by anyone's metric.

Sir Ken is under pressure to fire his long-standing finance director, Martin Ackroyd, and there are big question marks over how long he can remain as the sole authoritative voice at the country's fourth-biggest supermarket chain.

Yet when Morrisons announced it was buying Safeway, investors clamoured to get a piece of the action in what everyone was agreed would be the sector's last big deal. As the Yorkshire-based retailer took control of its southern brethren, its shares hit an all-time high of more than 250p. Yesterday they closed at 201.75p.

So what has gone wrong?

"Have they bitten off more than they can chew?" one food retail analyst asked yesterday. "Everything is telling you 'yes' ... We keep rolling back the date at which the rehabilitation of the company will be complete. But the truth is, we don't know when the three-year integration story will have a happy ending." He added: "Last week's profit warning showed integration issues are ever present and that is trying the City's patience." Morrisons has spent more than 12 months as the supposed master of Safeway's destiny, yet when it warned there would be a £40m hole in last year's numbers it still chose to heap the blame on Safeway. It was tight-lipped as to the cause for the provision, saying the shortfall became clear after a "review of Safeway supplier balances". In the absence of any explanation, speculation as to the cause of the profits warning ranged from the theory that suppliers were being unsupportive to the belief that this was a one-off timing issue and Morrisons would recoup the shortfall.

Yesterday's scapegoating of Safeway by the Office of Fair Trading only served to muddy the issue further, prompting some analysts to link the cessation of demands for upfront rebates directly to Morrisons' profits warning.

That Sir Ken's attempts to integrate Safeway have come unstuck surprises no one who witnessed his display of triumphalism on day one of the enlarged company's new life. More than 300 Safeway staff, who had crammed into the main auditorium at its Hayes headquarters, were shocked to hear Sir Ken describe the deal as a "takeover, not a merger" and then deride the group's profit and sales track record. "The morale of that meeting sunk right through the floor," one attendee recalls.

Sir Ken's attitude back on 8 March last year is illustrative of the pitfalls he has charged into during his group's attempt to integrate a business two-and-a-half times its size. "He has shown a blind insensitivity to the step change required to integrate a much more complex organisation and a cavalier disregard for anything that Safeway staff might have contributed," one industry insider said.

That Morrisons was the only FTSE 100 company not to have any non-executive directors until investor pressure forced Sir Ken to appoint two last May, is telling. Richard Singleton, the director of corporate governance at Isis, a Morrisons' shareholder, said: "Somebody with any knowledge of integration, not necessarily in retail, would have been able to add a lot to pre-bid discussions." Instead, Morrisons - whose biggest acquisition pre-Safeway had been a mere handful of stores - was forced to rely on an M&A team from Deloitte & Touche, who stayed for just six months.

In any case, just weeks in to buying Safeway, Morrisons abandoned its pre-merger blueprint for integrating its target. Rather than run the Safeway estate alongside the core Morrisons one until it was ready to proceed with the store conversions, it introduced a national pricing policy overnight, confusing existing Safeway shoppers by flooding the aisles with its own brands and crucifying its margins. In fact, it had little choice but to switch immediately to its own operating model because it failed to persuade the two men key to its former plans - Lawrence Christensen, the operations director, and Jack Sinclair, the trading director - to stay.

Of the 600 Safeway old-timers that Morrisons had hoped to persuade to move up to Bradford, just 50 are thought to have gone, evidence of just how extreme was the culture clash between the two businesses.

The lack of guidance from Hayes may help to explain why, one year on, Morrisons chose to highlight the "issues" it encountered with Safeway's accounting systems when it issued last week's warning. One analyst said: "There is only so much they can blame on Safeway. If they have still got problems with systems one year on that is serious." Underlying sales growth has dried up across its "core" estate. Like-for-like sales growth of 9 per cent, excluding petrol, last year fizzled out over Christmas. Underlying sales at unconverted Safeway stores were running 8.4 per cent lower.

Even at the much-vaunted converted stores all has not been well: Morrisons is still well off achieving the sales densities it needs to make its numbers stack up. The internal target is to hit sales of £19.72 per square foot in converted stores over 25,000 by 2007. Yet over Christmas, itself a distorted figure, it was achieving an average of £18 per square foot. Unless Sir Ken manages to boost sales he will not hit his 7.5 per cent return on capital target. Matthias Reschke, at JP Morgan, warned that 2005 would be the "toughest" year of the integration battle as Morrisons converts 180 Safeway stores at a pace of four per week. It is also building or converting five distribution centres and moving into a new corporate HQ.

Meanwhile shareholders are adamant that Sir Ken must shake up his board, even if that means firing himself. David Jones, the Next chairman, and Duncan Davidson, the chairman of Persimmon, the two independent directors on a board of nine, clearly have their work cut out. Mr Jones, who heads the audit committee, has shown his mettle by persuading Sir Ken to issue last week's profits warning, but investors have questioned Mr Davidson's appetite for a fight with Sir Ken.

Mr Singleton says: "It looks as though the problems associated with the difficulties of growing from a large business to a much larger business are to do with the level of controls that are in place."