Structured investment vehicles losing millions of pounds to the sub-prime crisis, landmark acquisitions, OFT consultations, lucrative joint ventures in China, doubling shareholder dividends the Co-operative Group is no less corporate than anyone in the City. But perception being nine-tenths of reality, the company’s mutual model comes over a tad too cuddly for many in the business world; unlisted, owned and governed by millions of ordinary people united by a common aim of doing good, where possible, by doing well.
From the 12th floor of Manchester’s New Century House, Co-op’s chief financial officer Martyn Wates can glance across a patch of prime city real estate that houses the group’s central offices, its financial services HQ in the 25-storey CIS Tower over the way, clad top to bottom in solar panelling. Against forbidding views of the Pennines, the ageing cluster of buildings serving as the Co-op nucleus looks a little worn. But the group plans to flatten the whole area and build a new office complex. “We’ll do it sympathetically, though,” says Wates surveying from a great height.
The Co-operative Group is nothing if not sympathetic by nature, being wed to a core of social goals harking to its beginnings as a movement for the welfare of the poor more than a century ago. If you know anything about Co-op, you’ll know it for those little local supermarkets whose owner is some sort of socialist organisation though you’re sketchy on the details or as the owner of that internet bank, smile. Those little supermarkets constitute the country’s fifth-largest supermarket business and smile is regularly outdoing its high-street rivals in customer satisfaction surveys.
Co-op’s financial services business posted a slight increase in profit for the first half of 2008, reporting ‘shareholder profit’ before tax, significant items and short-term investment fluctuations of £73.4m, up from £35.4m at the same time in 2007. The group reported 2007 operating profit “before significant items and changes in valuations of investment properties” of almost £323m, a 35.2% year-on-year increase. Co-op members enjoyed dividends (Co-op calls it “total share of profit payment”) of £38.1m in 2007, compared to £19.6m in 2006.
Getting the message
Where Co-op has been a poorer performer is in pushing its brand as a group and among its business units. As Wates concedes, there has long been a lack of any cohesive message, but this has merely reflected how much change there has been as today’s group has emerged as a mothership to countless minnow mutuals across the UK, and the world’s largest consumer co-operative society.
“Co-op has been very fragmented over the years, with a lot of small independent societies each running their own businesses in their own way and the consumer hasn’t been able to get a grasp of what it stands for because it has not been uniform,” says Wates. “We haven’t been able to project ourselves in the way that, say, Tesco has.”
Indeed, Tesco doesn’t own 311 separate business subsidiaries or societies, as Co-op does. It’s almost as complex as a Korean chaebol group, except that Co-op subsidiaries are mostly 100% owned. The strategy has been fruitful: the company’s purchase of convenience store chains Alldays, in 2002, then Balfour in 2003 helped it quietly grow its estate to become the UK’s number five food retailer. On top of this, the group is also the UK’s biggest farmer with an estate of 700,000 acres of farmland across England and Scotland, and operates a £250m car dealership. Between absorbing smaller co-operatives and buying up portfolio-boosters like Alldays, the group has been one of the most acquisitive in the UK’s business landscape. So clarity has been difficult.
This has been changing since the group enlarged following the merger with another mutual, United Co-operatives, in May last year, the owner of United Norwest Co-operative where Wates had been CFO since 2002 (he was made CFO-designate to succeed Co-op’s retiring CFO Brian Portman at the same time).
A year later, this May, came the pivotal £1.5bn Somerfield acquisition, bumping Co-op’s 5% share of the UK supermarket business up to 8%. By the time you read this, Wates will have the Office of Fair Trading’s decree on if and how many of Somerfield’s 3,000 stores it must dispose of to satisfy competition criteria; he will then add to his £1.5bn budget to revamp Co-op’s existing network of 4,300 stores (as well as its other retail-based businesses, such as its 90 banking sites and 374 travel agency operations) to include those it retains.
“We’ve been waiting for critical mass within the business before we got out the big guns and now we’ve got it,” says Wates. “In the past, people probably viewed us as a bit quaint, old-fashioned, safe, solid and trustworthy, but not as exciting or modern as our rivals. We’re doing a lot of work to overhaul our offering now. Our shares would be significantly up if we were a listed business, because I know the Somerfield purchase is a value-enhancing transaction.”
With additional responsibility for group-level strategy planning and risk management, he’s not only the best placed person in the group to maximise the chance to steal market share from the top four supermarkets.
As CFO of an organisation that can never unpick its financial targets from its ethical policies, he is one of the most genuinely engaged CFOs around. Speaking with him is more akin to speaking with a CEO who can talk about why his baked beans are the best, then switch to the forensics of discounted cash flow. A good man to have around.
“I’ve met a few FDs, blue-sky men, who consider themselves above the nitty-gritty. But what makes this business great is the detail; the customer going into our shop and buying something, leading to profit and we never forget that. And I like to think I can argue with anyone strategically. But if you don’t know what’s going on, you’re just throwing the dice. You’re gambling.” Not a strategy that would sit well with an ethics-based model.
Ah, the subject of Co-op’s ethical policies. You might imagine these would be divorced from Wates’ 600-strong finance function, but this is no ordinary company. Accusations that Co-op isn’t under the same economic pressure as other companies disappoint Wates, who cites some figures doubled dividends in 2007 and the intention to double profit in 2008-09 and his dual responsibility to make the business as profitable as possible while handing out millions each year to the long list of social, ethical or charitable groups it funds.
“We’ve looked at distribution strategies among our competitors, asked ourselves what returns our shareholders expect and what we can afford to pay, and we’ve benchmarked our distribution policies along with the best of them,” he says. “Instead of paying dividends to some faceless institutional shareholders, our dividends go to our members, the people who shop with us, our employees, various charities and the local communities we trade in.
“Some people can use ethics as an easy excuse to hide behind [for lack of profits or dividends]. If you’re ethical, you can’t shy away from being efficient, challenging and driving hard. We approach investment and shareholder return on capital the same way anyone else does. Being a one-person, one-vote organisation we’re certainly different. But we’re a part of the corporate world. “
Active engagement in companies and regions where the group believes money and positive change can be made is underpinned by Wates who backs the group operating, for example, local supermarkets in areas its rivals shun because it is too deprived, too dangerous, and deemed not worth the time. Co-op, Wates says, will stick with these often loss-making operations because they make real the group’s social policies.
The group made a £20m investment in July 2007 in a joint venture with Chinese pharmaceutical generics manufacturer Tasly Group, to build and staff a production plant in the country. Co-op’s pharmaceutical wholesale subsidiary Sants will supply the generics to Co-op’s 600 pharmacy outlets and eventually exploit the growing cost of prescription drugs by marketing them across Europe.
Of course, Co-op stresses that Tasly is “highly regarded as a major source of charitable support for the community”. But few will read that and not wonder how Co-op’s strict ethical policies will be effected in a country also noted for its relationship with sweatshop labour.
Wates argues that engagement is better than avoidance. “A lot of plcs are not venturing there yet and I suppose it does raise ethical issues: why should Co-op trade with China? Because we will work with this company, which already has high standards, to raise standards in that country. We are commercially focused and we can make the ethics in that deal work, having done a lot of social auditing on employee conditions and manufacturing practices over there.” Co-op will build the factory from scratch so that it can develop it according to its responsible trading standards.
One area in which Wates seems uncomfortable is talking about the group’s use of structured investment vehicles (SIVs), on which it lost £31.8m in 2007 as the sub-prime crisis took hold. The group’s last Responsible Business report said Co-op was founded on working for ordinary people who were fed up of “profiteering shopkeepers selling adulterated food”.
Are SIVs highly-geared, risky investments amounting to little more than gambling and, moreover, securitised by debt products derived from mortgage defaults by families or individuals who could not afford to keep their homes socially responsible? And if so, are those investing in SIVs not party to profiteering from adulterated loans, as we now know they frequently are?
In his defence, Wates wasn’t yet CFO of Co-op when these investments were made. “But there were so many layers to these products, weren’t there? Someone sold a standard mortgage and then built a mortgage book and an income stream from that, which was sold to another institution. This was then aggregated with others and bounced on again; but by then they’re just traded assets, aren’t they?
What we were picking up was a financial asset. That income stream I am paying £35m for will give me £3m a year for the next 20 years. Had that asset been traceable to arms manufacturing or something like that, you’re right, we would not have been there. But it was divorced from that.”
This seems no less profit-minded than any regular corporate’s attitude to investment. Which illustrates the rather unique position that Wates, as CFO of a company that sells products on the back of ethics, is in. There is no doubt he is personally invested in the belief system behind it. Aside from a brief stint among the Big Four, followed by three years at Woolworths, Wates’s career is built on mutuals and managing constant change as the bigger ones eat the smaller ones.
On joining United Norwest Co-operative in 1995, he was tasked with assisting a major turnaround, introducing new financial controls and reporting mechanisms, making disposals rolling up his sleeves and going through the books, cheque number by cheque number.
Buying and selling businesses is something that has been a part of Wates’s daily life since joining the mutuals world and integrating these to ensure they produce impressive numbers, while ensuring ethics are adhered to, is something else he knows about. “These mergers, acquisitions and driving the business forward in profit terms can’t just happen; systems, controls and processes need to be integrated in a controlled fashion and people need to be treated fairly and properly,” he says.
“Our ethics are always paramount. But without profit, there is no money for all the good work we do in local communities. So we must be commercial in everything we do we’re just responsible at the same time.”