By Kate Holton
LONDON (Reuters) - British high street chain Marks & Spencer (M&S) is in talks with Ocado (LON:OCDO) to form a joint venture that would give M&S a full online food delivery service for the first time, sending shares in both companies surging on Tuesday.
Britain's best known store group and the online supermarket pioneer released short statements confirming discussions after London's Evening Standard newspaper said M&S was set to pay ˜£800-£900 million for a 50 percent stake in a combined online retail business.
One source with knowledge of the situation indicated the cost to M&S would be lower. It is unclear how M&S, which in November reported net debt of £1.78 billion, would finance any deal.
The 135-year-old M&S is a mainstay of Britain's shopping streets, but has been struggling to cope in recent years with the rise of fast fashion, discounters and online shopping.
The firm currently sells wine, flowers and clothes online, but does not offer a full delivery service for its upmarket foods, putting it at a disadvantage to rivals such as John Lewis-owned Waitrose and Britain's biggest supermarket Tesco (LON:TSCO).
"We believe the food of M&S (ready meals, quality food) is perfectly suited for this more upmarket convenience shopping," said Bernstein analysts in a research note.
M&S shares jumped as much as 4.3 percent to a three month high on the news, while Ocado's shares leapt as much as 12.5 percent to a three week high. At 1555 GMT, Ocado's shares were up 10 percent at 975.4 pence, while M&S's were up 3.3 percent at 303.5 pence.
However, some analysts questioned whether M&S might be in danger of paying a large amount of money to join a highly competitive market too late.
"We would be wary of the ability for the M&S brand to support a basket size of the magnitude required to make the online economics work (given its natural bias to convenience and events)," Jefferies analysts said in a research note.
Only last month M&S Chief Executive Steve Rowe said the firm's basket size was not appropriate for a full online grocery service, noting 41 percent of M&S customers shop for "today/tonight".
'EXPECTING BIG THINGS'
For Ocado, however, analysts said news of the talks was a relief following a devastating fire this month at its flagship robotic distribution centre that hit its shares.
"Ocado's current share price is still lofty, and that means investors are expecting big things, considering the group is yet to make a meaningful profit," said Hargreaves Lansdown (LON:HRGV) equity analyst Sophie Lund-Yates.
Ocado has a 1.3 percent share of Britain's grocery market, according to Kantar Worldpanel data, while M&S has 3.6 percent according to Nielsen data.
Ocado, founded by three Goldman Sachs (NYSE:GS) bankers 18 years ago, has been transformed in the last year after it struck major deals to sell its technology to international retailers such as U.S. group Kroger (NYSE:KR) Co and France's Casino.
While the focus on technology has boosted its share price, the deal as mooted with M&S would enable Ocado to keep a stake in its British retail business rather than selling it completely to focus on tech deals.
The cash from M&S would also enable it to invest further in the online distribution centres it is building.
"In our view a 50/50 JV makes a lot of sense for Ocado today," Bernstein analysts said. "It is too early to lose their retail business as it is an essential and unbeatable part of the sales pitch to global customers (i.e. they are not just selling you some hardware/software, they operate it very successfully in the most competitive grocery ecommerce market in the world)."
The Evening Standard report suggested Ocado would use M&S as a supply partner for its British customers. Many of the products that Ocado currently sells are supplied by Waitrose, and it was not clear what the M&S talks would mean for that arrangement.
Ocado's deal with Waitrose ends in September 2020. Ocado is required to give 18 months notice if it does not intend to extend the contract.
Waitrose, which has built up an online food business in parallel with its partnership with Ocado, declined to comment.