Ocado's £1bn price tag is unreasonable

Ocado is to float because it needs fresh capital and there has not been a trade buyer.

The economics of delivering groceries to people's homes as a pure-play operator, using a warehouse picking model, are difficult, as is shown by its record.

This leaves it with a structural problem and £1 billion looks an unreasonable valuation. We consider a fair market valuation to be no more than £500 million.

Ocado has state-of-the-art technology, good customer service and a strong sales-growth record.

Sales grew 25% in 2009 and by 29% in the first half of 2010.

It looks well-placed to benefit from the growing demand for ordering groceries online. However, over 10 years, Ocado has never made a pre-tax profit.

We think this is because the economics of a pure-play, sub-scale food retailer, with no brand equity, operating a warehouse-picking model, delivering groceries to customers' homes, do not stack up.

Capital expenditure over the next five years will be five times that spent over the last five.

Shareholders want to cash in as well, so this all adds up to a placing of about £400 million, hence the racy valuation.

The obvious question is — why has there not been a trade buyer? One obvious answer is that the economics don't stack up.