Shopping for a turnaround

Food retailing can be a pretty unappetizing business in the best of times. Supermarkets operate on razor-thin margins, squeezed by the consumer product giants whose big brand names dominate their shelves, earning the lion's share of profits in the business. Competition, always fierce, is intensifying, thanks to the relentless expansion of giants like the U.S.'s Wal-Mart Stores, the world's largest retailer of food and seemingly everything else, and France's Carrefour, the No. 2 global player, which pioneered the hypermarket model of selling food alongside clothing and household goods.

For Royal Ahold, the Dutch supermarket operator, these are anything but the best of times. The company expanded rapidly during the 1990s with a string of more than 30 acquisitions in Europe, the U.S., Latin America and Asia to become the world's third-largest food retailer, but its decentralized model failed to generate any economies of scale. Then it stunned investors last year when it disclosed massive accounting fraud that used fictitious rebates from suppliers to boost earnings by E900 million ($990 million) and improperly consolidated roughly E33 billion in revenues from joint ventures that it did not control. The company fired its chief executive and chief financial officer and saw its stock price plunge by 63 percent in a single day. Ahold, whose name had been synonymous with food retailing in the Netherlands for more than a century, suddenly acquired a new reputation as Europe's Enron.

In September, Ahold agreed to pay E8 million to settle a criminal investigation by the Dutch public prosecutor, an amount equal to the maximum fine the courts could have imposed. As part of the settlement, the company admitted "without reserve the improper use of side letters," or secret agreements, which hid the fact that it shared control of several joint ventures with its partners. Shared control should have prevented Ahold from consolidating revenues from the ventures in its results. Last month the U.S. Securities and Exchange Commission charged Ahold with fraud. But citing management's "extensive cooperation with the commission" and "remedial actions, including revising its internal controls" the SEC

settled its investigation without levying a fine and without obliging the company to admit guilt. The company still faces a daunting series of legal challenges, though. The SEC and the U.S. Department of Justice have brought civil and criminal charges against four former executives of Ahold's U.S. Foodservice catering subsidiary, which used the fictitious rebates. Additionally, the Dutch public prosecutor's office charged former chief executive Cees van der Hoeven and former CFO Michiel Meurs, as well as two former board members, with fraud and forgery last month and may bring charges against other current or former Ahold executives. Shareholders have filed class-action lawsuits in the U.S. and are likely to claim they suffered billions of dollars in damages, according to lawyers involved in the case. They are also petitioning Dutch courts for investigations that could result in yet more claims.

In a bid to turn around its fortunes, Ahold turned to Anders Moberg, the former Ikea chief executive who spearheaded the privately held furniture retailer's rapid growth in the 1980s and '90s. Since joining Ahold as CEO in May 2003, Moberg has struggled to regain the confidence of the markets. He drafted a plan to sell off unprofitable subsidiaries around the globe and concentrate on Ahold's core supermarket chains in the Netherlands, Scandinavia and the U.S., but progress in carrying out that plan has been slow. Meantime, the Swede has alienated some of the company's long-suffering investors with his unwillingness to openly communicate company plans and a combative style illustrated by a controversial attempt to quash some of the court investigations demanded by shareholders.

"The dearth of information coming from Moberg, combined with behavior that often doesn't seem to take account of shareholder concerns, makes it tough to have full confidence in Moberg's ability to turn the company around," says Dana Deusing, who oversees E300 million in assets at AMB Generali Asset Managers in Munich. She complains that Moberg has given shareholders few clues about how he intends to raise profit margins at a time when many Ahold operations are facing severe pressure from competitors. Deusing, who holds 1 million Ahold shares, bought an undisclosed number in January at E7 apiece, only to see their value fall more than 23 percent, to E5.36, by late October. By contrast, the Dow Jones Euro Stoxx retailing index rose 6.2 percent during that period. "I thought Ahold represented good value, yet worries about its operational competitiveness have only grown," she says.

For all of his problems, however, there are growing signs that Moberg may just succeed in turning around the troubled supermarket group. The adoption of a new low-price strategy at its core Dutch store chain, Albert Heijn, has stemmed market share losses to Europe's cut-price leaders, Aldi and Lidl, German groups that have expanded aggressively in the Netherlands and elsewhere. Ahold also is stepping up the pace of asset disposals, which are essential to cut the company's crippling

E7 billion of debt. Last month Moberg sold the group's 600-store Spanish supermarket network to London-based private equity group Permira for E685 million.

"You don't need a guy who can smooth the feathers of investors and analysts to turn Ahold around," says Jón Scheving Thorsteinsson, chief executive of London-based private equity fund BG Capital and former chief investment officer at acquisitive Icelandic retailer Baugur Group. "What you need is a real retailer, which Moberg is in spades."

Adds Burt Flickinger III, founder and chief executive of Strategic Resource Group, a New York­based retailing consulting firm, "Moberg is really one of the three or four seminal geniuses of retail over the past 30 years who is still working, even if people following public companies don't know it."

Moberg acknowledges mistakes in adopting a confrontational stance toward shareholders, but he is unapologetic about his tight-lipped approach to communications. He wants to be measured by the bottom line and insists that Ahold is making progress in divesting poorly performing subsidiaries and using its buying power to wring lower prices from suppliers.

"I know that there is still disbelief out there, and that there are investors who would like us to say more about what we intend to do to reach our goals, but we have decided to be cautious," the 54-year-old executive says in an interview at Ahold's gray granite headquarters in Zaandam, a suburb of Amsterdam. Moberg insists that although he knows what Ahold will look like when it completes its restructuring at the end of 2005, key variables such as the exact mix of high- and low-margin products that the group's supermarkets will sell remain uncertain. "If I can't be precise, I prefer to say nothing," he says. "We certainly have a lot on our plate, but I'm sure we can deal with our problems."

Moberg plans to boost the group's retail operating profit margin by one fourth, from 4 percent to 5 percent, by the end of next year. To achieve that, he needs to sell more than E800 million worth of underperforming store chains in addition to already completed disposals, cut costs sharply in remaining operations and generate fresh top-line sales growth. Those are ambitious goals for any company. Given Ahold's troubled history and the unrelenting competition from cut-price retailers, many investors are skeptical Moberg can succeed.

AHOLD STARTED OUT MODESTLY ENOUGH AS Albert Heijn Holding. The eponymous founder and his wife opened their first shop in 1887 in Oostzan, a small canal-side town just north of Amsterdam, selling food, dredging nets and tar. The family-run company expanded steadily over the next 102 years under Heijn's son and grandson -- both also named Albert -- until it became the country's largest supermarket group. The grandson, who retired at the age of 62 in 1989 and now lives in Hertfordshire in southeast England, launched the company's first overseas expansion by buying South Carolina­based supermarket chain BI-LO in 1977. In 1981 he bought Pennsylvania's Giant Food Stores and seven years later added Ohio's First National Supermarkets, another midsize food retailer.

A four-year hiatus in expansion followed under CEO Pierre Everaert, a career Ahold employee, before he was succeeded in 1993 by van der Hoeven. For the first time in its proud history, the supermarket chain was in the hands of a man with no retailing experience. The then-45-year-old van der Hoeven had earned a master's in economics at the University of Groningen and risen through the ranks of the finance departments at the British arm of Royal Dutch/Shell Group and at the Petroleum Development Corp. in Oman before joining Ahold as chief financial officer in 1987.

Van der Hoeven used his financial skills to embark on a bold expansion strategy, scooping up Massachusetts-based Stop & Shop Supermarket Cos., today the company's crown jewel, for $2.9 billion in 1996 and spending more than $14 billion to buy up more than 30 other food chains around the world in an effort to generate double-digit earnings growth. The strategy appeared brilliant in the gung-ho, globalizing '90s: Sales and net income quintupled (even after results were revised downward for 2000 through 2002 last year to account for overstated earnings and improperly consolidated sales), to E54.2 billion and E750 million, respectively, by 2001. Ahold shares reached a lofty E37.39 that June, up fourfold in just seven years, giving it a market capitalization of almost E35 billion. The breakneck growth, however, masked serious operational weaknesses.

The acquisitions saddled Ahold with more than E11.6 billion in debt and left it struggling with inefficiencies. The company had ten different store formats, ranging from candy stores to hypermarkets, and 30 different brands, most run by local management. For all of its worldwide spread, the company purchased only 5 percent of its goods on a global basis. By contrast, rivals like Wal-Mart and Carrefour, as well as cut-price chains like Aldi, generate massive economies of scale by keeping store formats and branding as uniform as possible and using their purchasing power to wrangle discounts from suppliers.

"Van der Hoeven's biggest priority was meeting aggressive 15 percent-a-year earnings-per-share growth targets," says consultant Flickinger. "Trying to achieve that at all costs is what got the company in trouble."

Ahold's share price fell by more than 50 percent from its June 2001 peak as earnings fell sharply that year. The February 2003 announcement of the accounting scandal was the coup de grâce for van der Hoeven, prompting the search that led the board to Moberg.

The son of a farmer and a housewife of modest means, Moberg was born in Almhult, the small town in the forests of southern Sweden where teenage entrepreneur Ingvar Kamprad founded Ikea in 1943. Originally a mail-order outfit that sold everything from ashtrays to soap for washing cow udders, Ikea had become a warehouse-style retailer of furniture and housewares by the time Moberg graduated from high school in 1970.

Instead of going to university, Moberg stayed in Almhult to take care of his younger brother while his divorced mother studied for

a nursing certificate. He spent

six months working in Ikea's

mail-order customer service department and then enrolled in the company's 18-month executive training program, where he thrived. Over a three-year period, he gained experience in each of Ikea's departments. His "uncanny ability to assimilate experience and learn from it," as one former colleague put it, brought him to the notice of founder Kamprad, who in 1974 offered Moberg, then just 24, a high-profile assignment in Zurich opening the group's second store outside of Scandinavia.

"I was always trying to learn from others, and I found I was just as capable as colleagues who had finished university," says Moberg, who completed two years of a four-year business program through a local branch of Lund University.

Moberg spent the next five years opening stores in Austria, Germany and Switzerland and eventually rose to become president of Ikea in Austria, France, Germany and Switzerland. In each of those countries, he aggressively expanded the company's footprint and revenues. Kamprad, still chairman of Ikea, appointed Moberg to succeed him as CEO in 1986.

Over the next 13 years, Ikea grew from 66 stores in 17 mostly Western European countries to 150 stores in 29 countries in Europe, North America, Asia and the Middle East. Sales expanded fivefold, from 11 billion Swedish kronor ($1.5 billion) to almost Skr56 billion, making Ikea the world's largest furniture retailer. (The privately owned company does not disclose profits.)

Moberg's biggest accomplishment, and the one of greatest relevance for Ahold, was turning around Ikea's U.S. business when it ran into trouble. The company opened its first U.S. outlet, a 169,000-square-foot warehouse store, outside Philadelphia in 1985 and added a further three stores by 1990. But unlike in Europe, where Ikea usually succeeded in turning a profit within two years of entering a market, the company was still losing money in 1990. The problem? The Scandinavian-sourced goods that sold so well in Europe literally didn't fit the U.S. market. Swedish beds were too narrow for American tastes, kitchen cabinets were too shallow to accommodate big American plates, and the appreciating Swedish krona undermined Ikea's low-price formula.

Moberg, who spent months in the U.S. in 1989 and 1990 visiting stores and talking with customers -- often incognito, wearing a blue Ikea jumpsuit with the name "Anders" on it -- convinced Kamprad that Ikea needed to change. Over the next few years, the company began replacing Swedish-sourced furniture and housewares with U.S.-designed and produced goods. By 1994, 45 percent of the furniture sold in the U.S. outlets was produced domestically, up from 15 percent in 1990. Moberg also added more checkout clerks to shorten lines and introduced a more-generous policy on returns to appeal to American consumers. The changes helped sales to triple between 1990 and 1994, to $480 million, and Ikea's U.S. operations became profitable in 1992. The experience persuaded Kamprad to let Moberg make similar changes in Ikea's sourcing throughout the world, generating strong sales growth through the latter half of the 1990s.

Moberg soon became restless, though. His hopes of succeeding the founder as chairman faded as Kamprad stayed on and groomed his two sons as potential successors at Ikea. Moberg left in 1999 for Home Depot where, as president of international operations, he was to lead what was expected to be an aggressive overseas expansion by the U.S. do-it-yourself home improvement chain. He had barely begun, however, when a sudden decline in U.S. sales prompted the company to replace CEO and co-founder Arthur Blank, who had hired Moberg, and sharply curtail its international plans. Moberg resigned in January 2002 and spent the next 16 months traveling with Ragnhild, his Norwegian wife, and playing golf and tennis with his three grown children. He also served on eight boards and advised a private equity fund.

When he arrived at Ahold last year, the situation was bleak, to say the least. The company had 9,028 stores -- mostly supermarkets -- in 27 countries in Asia, Europe, North America and South America in addition to a catering business, U.S. Foodservice. The accounting scandal had forced the company to delay the publication of its 2002 results for six months. When they finally came out in October 2003, they made for grim reading. By illegally consolidating the results of several supermarket joint ventures and padding the accounts of U.S. Foodservice with fictitious cash rebates, Ahold had overstated consolidated sales by E33 billion over the previous three years and net profit by E900 million.

After revising its accounts the company posted a loss of E1.2 billion in 2002 on sales of E62.7 billion, after writing down goodwill by E3.2 billion to reflect the drastically reduced value of U.S. Foodservice, which Ahold had acquired for $3.6 billion in 2000. The damage didn't stop there: With the company's future uncertain, suppliers of U.S. Foodservice and many of Ahold's supermarket chains demanded contract renegotiations and won higher prices, eating into the company's already-thin margins.

In the Netherlands the Vereniging van Effectenbezitters, or VEB, the Dutch shareholders' association, has asked the Enterprise Chamber of the Amsterdam Court of Appeals to authorize a general investigation into mismanagement at Ahold. The VEB argues that Ahold's previous earnings restatements were not sufficient to reveal the full extent of the accounting fraud, or who was responsible for it. The VEB is still considering whether it will also ask the Enterprise Chamber to order a costly revision of Ahold's annual reports going back to 1998. The two U.S. class-action suits filed by current and former shareholders are just getting under way in the Federal District Court of Maryland and are not likely to conclude until 2006. Under a worst-case scenario, the legal challenges could force Ahold to pay investors billions of euros in damages, say analysts.

"As a policy we don't speculate on how costly litigation could be," says Moberg. "I will say that after looking at the various cases and investigations, we assume that we can handle most likely scenarios without facing severe financial difficulty." Ahold estimates it will take about two years for the various investigations and litigation to come to an end.

AS DAUNTING AS THE COMPANY'S LEGAL PROBLEMS are, Moberg's appointment seemed to promise a fresh start. Ahold's share price jumped by 27 percent, to E5.20, when he was named CEO on May 3, 2003. The honeymoon proved remarkably short, however.

Moberg declined to speak to investors for four months, explaining through spokesmen that the company had to go through an extensive forensic accounting exercise and publish its 2002 results before he could discuss strategy. Matters only got worse when he met shareholders at the annual general meeting on September 4, 2003, at the Dutch coastal resort of Scheveningen. About a half hour into the meeting, a slide flashed onto the screen revealing that Moberg's annual compensation could amount to as much as E5.25 million, including a guaranteed bonus of E1.5 million, and that his potential severance could be four times as much as the bonus.

After a moment of stunned silence, angry shareholders rushed the microphones. A finger-wagging, elderly woman summed up the feelings of most of those present. "How can you pay Mr. Moberg so much when things are going so badly right now?" she demanded, to deafening applause. "This is scandalous."

Moberg's blunt response did little to win over shareholders. "Take it or leave it," he said. "The company needs leadership now."

One month later Moberg bowed to pressure and agreed to cut his pay package in half and tie his bonus to results, but the concession did little to repair the damage to shareholder relations. "Right or wrong, there is still a lingering impression, especially among many smaller shareholders, that Moberg isn't much better than a carpetbagger," says Peter Paul de Vries, chief executive of the VEB.

"I think that after spending most of his career in a private company, Moberg needs to learn how to communicate a lot better, especially since investors must make a leap of faith when investing in Ahold," says Maren Hernando, a portfolio manager and retailing specialist at Gesbeta Meespierson in Madrid, who oversees E50 million in assets. She has held Ahold in the past but is steering clear of the stock for now.

Moberg further upset shareholders after the VEB announced its plan in January to petition the courts. The executive tried to block the shareholders' association with a combative open letter, published in Dutch newspapers and on the Internet, pressing it to submit its plan to a vote by Ahold shareholders. He tells Institutional Investor that the VEB's legal actions were "value-destroying overkill" because of the pending class-action suits against the company in Maryland and the government investigations in the U.S. and the Netherlands.

Moberg abandoned his demand for a vote after receiving vehement objections from many investors, including the two biggest Dutch pension funds, ABP and PGGM, which together own 2 percent of Ahold. "We definitely think the open letter was the wrong way to deal with the issue," says a spokesman for PGGM. "Management must try to clarify what happened at the company, not antagonize shareholders." In a rare concession Moberg acknowledges that his hardball tactics were a mistake. "We have not always done a good job communicating. I take the blame for that," he says. "But I learn every day."

Moberg is making a better impression on Ahold's operations. Albert Heijn, which has 705 supermarkets in the Netherlands and accounts for almost half of the group's E12.9 billion in European revenues, had been losing market share to rivals since 2002. Moberg decided to fight back in October 2003 by abandoning the chain's traditional marketing, based on periodic sales and product promotions, and adopting a new strategy of everyday low prices. Ahold slashed prices on 2,500 of its 15,000 items -- everything from Kellogg's Special K cereal to bananas -- by as much as one sixth. The response? Market share increased 10 basis points in the first half of this year, to 26.7 percent. Equally encouraging, sales rose 1.4 percent in the second quarter, even as they fell 7.7 percent at Laurus, the Netherlands' second-largest food retail chain.

Moberg insists that despite the price cuts, earnings at Albert Heijn are growing and that there has been minimal deterioration from the 3.6 percent operating margin the unit achieved last year. "We got more customers, we got our suppliers to lower their costs, and we did it in a weak economy," says a clearly elated Moberg. "We will not pass price increases on to consumers, but we will pressure our suppliers to lower their prices a lot more than Ahold did in the past."

Over the next year Moberg hopes to roll out similar repricing programs in Ahold's other operations. Key to the effort is a E600 million cost-cutting program launched last spring and a new 15-person business control unit created by Moberg and chief financial officer Hannu Ryöppönen, who was also Moberg's CFO at Ikea and joined Ahold late last year. This unit closely tracks all the main metrics, from sales per square meter and profit margins to weekly hours worked and inventory levels, at each store in the group. "Before, we had a central corporate control function that was focused exclusively on understanding the rationale of consolidated numbers and meeting earnings-per-share targets for Wall Street," says Ryöppönen. Now, under the new setup, he says, "we are finally getting a clear picture of the dynamics behind the numbers, which will allow us to negotiate effectively with our suppliers, restructure and offer competitive pricing to all our customers."

In the U.S., which accounts for 70 percent of group sales, Moberg is concentrating on spreading the practices of Stop & Shop, the New England­based supermarket chain. Stop & Shop generated E8.9 billion in sales last year and boasted an operating profit margin of 8.6 percent, well above the U.S. industry average of about 3.5 percent and more than twice the margin at Albert Heijn.

In May, Moberg put Stop & Shop managers in charge of Ahold's second-biggest U.S. chain, Maryland-based Giant-Landover, which had sales of E4.7 billion last year and an operating profit margin of 5.7 percent. The managers aim to lift those margins by adopting Stop & Shop's information technology system, procurement chains and promotional efforts. In similar fashion Moberg is integrating two other U.S. operations, Pennsylvania-based Giant-Carlisle, which had sales of E2.6 billion last year, and upstate New York­based Tops Markets, which had sales of E2.8 billion. Ahold doesn't disclose profits for these smaller chains, but analysts estimate that they generate operating margins of between 1.2 and 1.4 percent. "We will be in a position to significantly increase growth and profit at all our core U.S. operations when we finish the current integration processes sometime in the fourth quarter," says Moberg.

Although willing to talk about cost-cutting, the CEO so far has been mum on his plans to boost sales. "We will reveal them when we are finished with the current integration processes," he says.

Observers are betting that Moberg will seek to spread other Stop & Shop concepts. "I think we will see Stop & Shop's formula of branded retail partnerships with the likes of Dunkin' Donuts, Toys "R" Us and Office Depot generalized to Ahold's other chains," says Strategic Resource Group's Flickinger. "Selling distinctive brand-name goods, plus plenty of prepared foods, is the group's best bet when it comes to staving off competitors."

The stakes are huge. "Stop & Shop's profitability will have to remain high if Ahold wants to both pay off its debt over the next two years and invest in its businesses," warns Ingrid Azoulay, a food industry analyst at Deutsche Bank Securities in London. The chain's future profitability, she adds, "is in the hands of discounters like Wal-Mart, Save-a-Lot, Aldi and Trader Joe's. If these groups decide to penetrate the Northeast, as they have in virtually every other region, and develop quickly, it is unlikely Stop & Shop could maintain its profit margins."

Still, Ahold is showing tentative signs of recovery. Net income in the first half of 2004 amounted to E32 million on sales of E27.7 billion. By comparison, the group posted a loss of E1 million for all of 2003 on sales of E56.1 billion as pressure from suppliers slashed margins.

Elsewhere, Ahold has raised about E1.6 billion of a targeted E2.5 billion by selling money-losing supermarket chains in Chile, Indonesia, Malaysia, Paraguay, Peru and Spain as well as its Golden Gallon fuel and convenience stores in the southern U.S. and two hypermarkets in Poland.

Roughly half of the funds raised through asset sales, along with E3 billion from a two-for-three rights offering last December, have gone to reducing Ahold's debt from E10.9 billion a year ago to E7.1 billion today. The rest of the E2.5 billion Moberg wants to raise will be crucial for meeting roughly E1.4 billion in debt payments that Ahold must make by next June to its bondholders.

In addition to accelerated asset sales, there has been other good news lately for Ahold on the debt front. The company dodged a potentially dangerous bullet last month when Canica, one of its two joint venture partners in Scandinavia's ICA supermarket group, exercised a put option that forced Ahold to pay it

E811 million for 20 percent of the retailer. As part of the complicated transaction, Ahold immediately got back E682 million by selling half the stake to its other joint venture partner, ICA Förbundet, and by getting almost two thirds of a special E607 million dividend paid out by the supermarket chain to its two remaining shareholders. The deal cost Ahold only E129 million out of pocket and left it with 60 percent of the solidly profitable ICA.

Still on the block are Ahold's barely profitable BI-LO and Bruno's Supermarkets in the southern U.S., which have a total of 334 stores; 204 Tops convenience stores, mostly in Ohio; smaller supermarket interests in Portugal and Thailand; and Deli XL, the largest food caterer in the Netherlands and Belgium. Ahold agreed in March to sell its 236-store Disco supermarket chain in Argentina for E258 million to Chilean retail group Cencosud, but that deal has been frozen by an Argentinean antitrust investigation and lawsuits in Uruguay against a former minority investor in Disco.

All of those businesses suffer declining profit margins, raising doubts about whether Moberg can achieve his disposal target of E2.5 billion. The CEO also aims to boost margins at U.S. Foodservice over the next 15 months by renegotiating contracts with suppliers before deciding whether or not to sell the operation. "If we do have trouble reaching the target, there are other divestments that we can't specify but which we are planning anyway that will get us there," Moberg says cryptically. Such vagueness disconcerts investors, but the company says it is necessary to preserve the values of the businesses.

By 2006, as Moberg sees it, Ahold will consist mainly of Albert Heijn in the Netherlands; ICA, Scandinavia's second-largest supermarket group; and Giant-Carlisle, Giant-Landover, Stop & Shop and Tops supermarkets in the U.S. The slimmed-down group is expected to have annual sales of between E31 billion and E47 billion, depending on whether Moberg keeps U.S. Foodservice. The U.S. will provide anywhere from two thirds to almost three fourths of revenues, and the balance will come from Europe, where Moberg also intends to keep some small but regionally important chains in Central Europe and the Baltics. "Once we've restructured operationally and finished selling assets, we should have significant growth opportunities in all our markets," declares the optimistic executive.

Strategic Resource Group's Flickinger gives Moberg a 75 percent chance of success. "Those odds are better than I'd give to anyone else," he says. "Being a good retailer and understanding the supply chain is what will be key to Moberg's success at Ahold, not whether or not his experience was in the food sector or the furniture sector."

Moberg insists that a leaner Ahold can hold its own against tough competition from giants like Wal-Mart and the fast-growing discount chains. "I believe that being a successful retailer, whether it's food or something else, comes down to having the right choice for the customer," he says. "Given that, I think I know how to defend this company's market position successfully and make it grow. I feel very confident in my ability to do that."

That's a confidence shareholders would love to share.