By James Davey
LONDON (Reuters) - British supermarket chain Wm Morrison is investing more than 200 million pounds in a 25-year deal with online grocer Ocado, seeking to catch up with rivals in home delivery and sending Ocado shares to a record high.
Morrison, which trails Tesco, Wal-Mart's Asda and J Sainsbury in annual sales, has suffered falling profits and market share, partly due to its late entry into online grocery which is growing about 16 percent a year.
Morrison and Ocado said their deal would not affect Ocado's arrangement with upmarket grocer Waitrose, due to run to 2020. Yet Waitrose, which provides many of Ocado's products, said it had instructed lawyers to advise on whether there had been any breach of contract.
Waitrose, part of the John Lewis group, said it had asked to see details of the agreement between the two companies. "Once we've done that, we'll decide what appropriate action to take," a spokesman said.
Morrison, which already sells non-food items online, had held back from selling food because of doubts over the profitability of delivering groceries to customers' homes. Ocado has yet to make a pretax profit in a decade of business.
"We think that the deal is easily a better one for Ocado than it is for Morrison," said analyst Philip Dorgan at brokerage Panmure Gordon. "The agreement lasts for 25 years which seems unnecessary to us, given the pace of change online."
Ocado shares have had a rollercoaster ride since the company listed at 180 pence in 2010. Heavily "shorted" before Friday's announcement by market participants speculating they would decline, they jumped as much as 47 percent to a record 296.8 pence, valuing the company at 1.72 billion pounds.
Shares accounting for 10 percent of Ocado's share capital were out on loan as of Thursday's close, corresponding to nearly 70 percent of those available to be borrowed, Markit data showed - an indication of the level of short-selling in the stock.
Morrison shares rose up to 2 percent.
POLARISED OPINION
Ocado has polarised opinion. Fans point to rapid growth in online grocery, with the UK market expected to double in value over the next five years to 11 billion pounds, its state-of-the-art distribution centres and high customer service ratings.
Sceptics, however, note it has not made a profit since it was founded by three Goldman Sachs bankers in 2000, and doubt its model of filling orders from central depots will ever be as profitable as online operations at grocers like Tesco and Sainsbury, which mostly pick orders in stores.
Ocado, which made a pretax loss of 0.6 million pounds in 2012, forecast the Morrison deal would deliver an annual profit contribution in the "mid-teens millions of pounds", while Morrisons' upfront payment of 170 million pounds would enable it to pay down its debt of 85 million pounds.
It said the deal was a vindication of its business model and could lead to overseas sales of its technology. "This validation should support the internationalisation of our model as well as the growth of our UK business," said CEO Tim Steiner.
Ocado entered a small supply partnership deal with French supermarket firm Carrefour in 2011.
Morrison CEO Dalton Philips said the Ocado deal would help achieve the company's home shopping aims, though it was not expected to make money until the 2016-17 year.
"This is a Morrisons website, it's Morrisons food, in a Morrisons van, with a Morrisons driver, it's Morrisons the whole way through," he said. "It's a very different arrangement from the sourcing arrangement Ocado has where they source Waitrose food," he told reporters.
Morrison's online offer will be met from Ocado's recently opened distribution centre in Dordon, central England.
It will make an initial payment of 170 million pounds to Ocado to acquire Dordon and associated equipment, as well as a licence and integration fee.
Morrison said a further 46 million pounds will be invested to expand Dordon to accommodate its range, integrate with its systems and establish a delivery network. It expected to incur a further 25 million pounds of development costs this year.
"The deal gives Morrison access to, we estimate, around 500 million pounds of online sales for an initial outlay of 200 million pounds," said analysts at Credit Suisse.
Morrisons will also pay Ocado annual service costs and a contribution to R&D expenditure, as well as at least 25 percent of Morrisons.com's earnings before interest and tax for 15 years.
(Additional reporting by Franceso Canepa; Editing by Rosalba O'Brien and David Holmes)
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