COMPASS GROUP PLC. (CPG.L)
CEO Interview - published 08/27/2001

DOCUMENT # MAY612

MICHAEL J BAILEY was appointed Group Chief Executive in July 1999. He joined Compass Group in 1992 as Group Development Director and was responsible for establishing New Famous Foods, the Group’s branded food service subsidiary. He was a key member of the Compass Group team that led the buyout of Canteen Corporation from Flagstar. From 1994 to 1999, Mr. Bailey was Chief Executive of the North American Division during which time the division almost trebled its sales and profits. From 1964 to 1991, he was with Gardner Merchant progressing from Food Service Manager to Managing Director of its $750 million contract feeding business in the UK. In 1985, he was appointed President of Gardner Merchant’s US subsidiary and over the next six years grew the business from $40 million to $225 million through a series of acquisitions and organic growth. Mr. Bailey then joined Nutrition Management Food Services Company in 1991 as Executive Vice President returning to the U.S.A. He has been in the contract food business since 1964 and is a graduate of Westminster College London. He has also attended a number of business classes at both Oxford and Manchester Universities and is a Fellow of the Hotel and Catering International Management Association.

Sector: Food

TWST: Could we begin with a brief history and overview of Compass Group?

Mr. Michael Bailey: The companies that founded Compass Group were first established in 1941 although many of the companies now part of the Group are much older. Compass group was formed asa management buyout in 1987 from Grand Metropolitan (which is now Diageo). It public on the London Stock Exchange in late 1988 and, like all MBOs, went through its first years in the conserve cash, pay interest mode. The company did quite well at that up until about 1991 when Francis Mackay, our current chairman, took over as chief executive. At that stage, the UK was also going into a recession. It was really then that Compass grew up fairly quickly. We were a reasonably small company with revenues around 250-300 million pounds with 90% business in industry and 99% UK-based. The 1% was a remote site in Alaska. When you are in country like England with a small, focused business you learn pretty quickly that you need to go further a-field. That really culminated in the Compass acquisition and overseas expansion trail, which kicked off in 1993 when we acquired our first overseas business, Scandinavian Service Partner, promptly followed by Letheby & Christopher, a UK-based sports and events foodservice provider. Since that time we have done a series of acquisitions, including some fairly big ones: Canteen Corporation in America in June, 1994; Eurest International about a year later; and SHRM, which was a French-based remote site and business and industry contractor that came on board in 1997. There were a series of other US and UK-based transactions leading up to the Compass/Granada merger in May of 2000. We had at that stage a set plan to be married for a short period and then get divorced. It was a prearranged situation for all sorts of reasons, none the least of which was a huge tax bill if we had for example just bought the MSAs and Sutcliffe businesses. That occurred and having de-listed to do the merger, we then re-listed on the London Stock Exchange as Compass Group (in February this year). Here we are today at over 8 billion pounds or $13 billion.

TWST: Is this growth predominantly attributable to the acquisition strategy?

Mr. Michael Bailey: No, it is been a combination of organic growth and acquisition. We have been steadily year-on-year growing for the last ten years at about 8% annually in organic terms. The balance has come from acquisitions.

TWST: Could you provide a specific breakdown of the markets you operate in?

Mr. Michael Bailey: We are the world's largest foodservice and vending company and we are the market leader in vending in the States, Europe and now England after the acquisition of Vendepac a couple weeks ago. The companies that we run are in business and industry, military, healthcare and education foodservice and vending. We have a large concession business that covers particularly the travel market in the form of airports, rail stations and motorway stations. We have a business that covers performing art centers, museums, some public restaurants and one or two brands that we own such as Au bon pain in America. That generally covers most of our business lines.

TWST: I recall when we last spoke you were not operating in the healthcare sector.

Mr. Michael Bailey: We had a gap in the US - where we were in healthcare but in a very small way. Since we last spoke we have acquired Morrison's and this month Crothall, who are an American healthcare management services company. They provide complementary services such as, housekeeping, linen, laundry, maintenance and so forth. For the healthcare and remote site and defence markets, our clients often seek to 'bundle' foodservice with other support services so we now have the capability with Morrison and Crothall in the US to meet that specific client need.

TWST: Are there any areas that are of particular interest that you are not involved in now but potentially will be in a year or two?

Mr. Michael Bailey: This past week saw the investment in services management for healthcare and we do see that as an opportunity in healthcare. I say healthcare very specifically. Over the past few years, we have seen the number of bids in healthcare that ask for bundled services go from about 5% of all bids to about 30% in the last three years. So, we have said we need to be able to provide that service if we are going to be successful in healthcare. There are areas around the world geographically and certainly sectors territorially that we are not in. There is no area where we say, "Wow, we have to be in this" because for the most part we are in it somewhere and to some degree. However, if you go to somewhere like Germany we are a market leader but do not have a concession business, which is certainly out of character. If you go to Japan, the second largest market in the world, we have a very small joint venture there. We need a bigger business in that part of the world. So, as you rightly said, six months ago it was healthcare in the States. There are different requirements for different geographies and different sectors within the Group.

TWST: If we break it down and look at the individual businesses, could you provide either a summary or specific figures on market growth potential?

Mr. Michael Bailey: If you look at it on a macro scale, the worldwide market is about 200 billion pounds a year, i.e. $300 billion. We, as the world leader, have about 4% to 4-1/2% of the market. I think the economics of outsourcing have been well proven throughout the world for the most part - professional contractors can do it cheaper and better. If you think that the lion's share of the market globally is still in the hands of self-operators, then I look at our market share and say, "Why can we not be three or four times the size that we are now?" I believe that we can; it might take five-ten years, but that is okay. Even if we were a 30 billion pound company instead of an 8 billion pound company, we would still only have 15% market share. When you look at the likes of General Motors and the worldwide motorcar market then that gets dwarfed fairly quickly.

TWST: Who are the other big players you are competing against?

Mr. Michael Bailey: Sodexho, of course which is the second largest company in the World after Compass Group. ARAMARK in the States are also a very good competitor. They are the main two and the reality is that the consolidation that has gone on in the industry has raised the barriers to entry quite significantly in the market. If it is an international contract that somebody wants us to pitch, there are probably only two players that could do it. That is Sodexho and ourselves. Obviously, consolidation on our part and theirs has played a part in that and we would like to keep it that way if we can.

TWST: So, globalization is the key in many respects?

Mr. Michael Bailey: Yes, it is. We are now bidding many more national, international, multinational and global accounts with different customers. People are looking for one point of contact - no hassle, do the job, work within our parameters and just fix it.

TWST: What are the particular advantages and skill sets that differentiate the company from the other two competitors?

Mr. Michael Bailey: If you take ARAMARK, we are in over 90 countries; they are in about a dozen. Clearly that makes a significant difference. In the case of Sodexho, we are focused on foodservice. They are broader than that with their service voucher business and FM. They are still a good competitor, that is for sure. But, we have worked hard at looking for the international benefits of our size probably more so than most and that gives us a little bit of a USP in terms of best practicing and benchmarking. It goes on regardless because the people know each other so well.

TWST: Are there any significant changes that you foresee on the horizon, any particular trends that may impact the business?

Mr. Michael Bailey: The one thing we have seen of late is quite a change in the military market. The American military and the German military have always been staunch self-operators; that is changing and military markets are opening up quite significantly. We are being asked to bid a lot more of those accounts than we ever have in the past. In fact, today we announced that we have just picked up the Pentagon. So, that is an illustration of that. That came as a result of our relationship with NEXCOM, the Naval Exchange contract, which we secured in January 2000 in the States and who up until then had been self-operated. So, that was particularly gratifying. The other thing that has been a change in the market per se is the way that contracts are financially structured. We have seen the States' practices are migrating at speed to Europe.

TWST: How do you incorporate technology and e-commerce into your business model?

Mr. Michael Bailey: E-commerce has made quite a difference in recent years, particularly on the purchasing side of life. Here we are with 30,000 restaurants throughout the world; trying to get people to coincide with our views on authorized suppliers is not always the easiest thing. It is far more important now with safety issues surrounding food. We do not just say you must deal with Fred because he is the best price. Sure, that plays a part in it, but we want to have inspected people's premises. From that, we want to know if there is a foot-and-mouth or a mad cow food scare. We are also in a position to backtrack, audit, and know what we have had, what we have got and where it is with our suppliers. You cannot do that unless people are computer literate, know their product, where it has come from, and so forth. So, we have seen those sorts of practices on purchasing come in. On the accounting side, we are online in many of our units now so you do not have to send in weekly trading returns. You put it in the computer and push the button and it downloads to the mainframe at the end of the week. You can get the P&L back much quicker and you can manage the business better as a result of that information flow; you are not waiting three weeks for somebody to come back and suddenly tell you there was a problem. You can actually do something about it on next week's menu. There are other things such as reverse auctions where we have gone onto the Internet and said, "We want to buy 58 tons of baked beans next month. Who has got the best price?" That style of doing business has not been the way that we have done it hitherto, but many of our suppliers like it because they have an ability to take advantage of certain specific situations. That has made a great deal of difference to the way that we have managed the business.

TWST: If we look forward to the next 24 months, what targets have you set? What will make that time period a success?

Mr. Michael Bailey: From a target point of view, there are a number of things that are out there. Certainly, we want to grow organically in the high single-digit percentages worldwide. We want to grow mid-teen earnings per share and that will be through a combination of acquisitive and organic growth. We do believe in the next three to five years we can essentially double the size of the company. We will do that by in-fill acquisitions, not going away from the core. We are a contract foodservice business. We do not see ourselves running a main street restaurant company. We see ourselves having things like facilities management in healthcare markets where it makes sense. But, we do not see ourselves going that far away from the core guts of the business. We do not see ourselves with a one size fits all answer. In Japan, we need to buy a big business and in Germany we need to find a concession business. Up until a month ago, we did not have a vending business in the UK. We now do with the acquisition of Vendepac. Up until six months ago, we did not have healthcare of any substance in the States. Now we do with Morrisons and are number 2 in the US healthcare marketplace. We are really continuing that kind of approach, identifying the good companies that could fit with Compass to achieve these financial goals and at the same time continuing in the organic growth side of the business to improve what we do.

TWST: Do you see any substantial opportunities to increase profit margins?

Mr. Michael Bailey: We are not a high margin business; we trade at 5, 6, and 7%. So, clearly there are opportunities to improve that. We have steadily improved that by 20 or 30 basis points a year over the last four or five years. I do not see why we cannot continue to do that going forward as we refine our procedures and programs. Do I think we are going to double the margin overnight? Absolutely not; it is a very competitive environment, but I do believe that we can organically grow in our target 6-9% We can steadily increase margins over time through efficiency, purchasing, better labor utilization and with the market going more P&L oriented. Sure there are some risks in that the more P&L it goes, the more risky it is. But, as I said earlier, we would rather have those risks than not. So, I can see steady, solid improvement around those rates progressively over the next three to five years.

TWST: Moving on to the management team, could you outline the structure, experience and strengths behind the team that you have in place?

Mr. Michael Bailey: We have an executive board that essentially manages the day to day running of the business. Practically, that is five geographical operators: the States, the UK, northern Europe, western Europe, and what we call 'southern Europe and rest of the world', which covers Latin America, Australasia, Asia, etc. We have a global business manager who manages airports and remote sites - businesses where we see the decisions taken in one or two places around the world as distinct from many places. Then, we have a fairly classical backup structure of finance, HR, purchasing, branding, etc. One of the best qualities about our management team is the cosmopolitan makeup of the Compass board. There are 11 people on the Compass board including myself. That consists of three Frenchmen, a Dutchman, a Spaniard, a Belgian, two quasi-Americans, and three Brits. Now, for a British PLC traded on the London Stock Exchange, I do not know any other board that is more cosmopolitan. To be honest, that is exactly what we need. We are in over 90 countries, so you do not need to run the business in the classic Anglo-Saxon way. Some of the conversations that we have around the Compass Board table are very different; the Frenchman's view, the Belgian's, and the Spaniard's can often be extremely different from the Americans or Brits. That is a good thing not a bad thing in a service business of our breadth and magnitude. So, we have stability and in my book are probably one of the strongest teams in the world. The average age is mid to late 40s and certainly they will be around for some time to come. We have good bench strength and work very hard on succession planning to make sure that we have capable individuals ready to step into situations as we move forward. So, we feel pretty comfortable about the team.

TWST: How do you feel the investment community is responding to Compass? Do you think they understand the company and has this been reflected in the stock price?

Mr. Michael Bailey: They understand the company. There are still investors out there that looked at the Granada merger, did not like it and therefore the jury is still out. We have made some progress on that this year by convincing people that, yes, we did the Granada deal because we thought it was long-term in the interests of our investors and we still vehemently believe that. The fact that the bottom dropped out of the media market at the time we dispatched the media business has not helped - lousy advertising revenues for example. So, in many instances, by doing what we did, our shareholders had both Compass stock and Granada stock. Some have taken the view that if they wanted to get into media they would have bought it - they did not need us to put them there. I understand that point of view, but our stock is moving forward quite steadily. In this current market we are quite a good recession resilient stock because being in over 90 countries our biggest customer is less than 1% of the business. We are in some defensive markets as well as opposite markets. We would like to see our rating come back a little more. We had a PE of close to 40 when we went into the Granada merger that is about 26 today. We do see good shareholder value to be secured by our shareholders with an old Compass type strategy and we will concentrate on the core business in international growth terms. In terms of acquisitions that we do, we will look for a decent return on capital- we target to beat the WACC rate by the third year. We also focus on cash flow and the other thing that will help our stock is when people see that we are getting some quality growth out of the motorway business where, again, I think with many of the shareholders the jury is still out on that particular sector. We feel good about it, but we need to show through a couple of sets of quality results that we know how to manage it. If we do that, then I believe we will steadily climb back to a better rating; more where I believe we should be than necessarily where we are.

TWST: One would imagine that that synergies are all in place in the motorway business. So, what are the specific concerns being expressed by shareholders?

Mr. Michael Bailey: Granada previously had pushed pricing to the limit for customers. Quality perhaps was not all that it should be either. So you have the fairly expensive product that arguably was not as good as it should be. As a result of that, people's perception of the business was not particularly brilliant. Also, in the UK the way the business works is different to the rest of Europe. In Europe if you manage a motorway service station it is just like an airport or a railway concession. You pay a concession fee for the privilege of being there. In the UK that is not the case, you own the real estate and the land. So we have a huge asset on the books and that is something that clearly we are looking at. Whether we will have that asset there in 12 months' time or securitize the property is entirely another question. But, we believe that we can reposition the business by changing its name, which we have already done. We have converted away from the Granada name to the Moto name. We had to change the name as it was part of the deal with Granada anyway, but to be honest, we wanted to change it because there was a bit of baggage with it. We are putting in Compass brands like Upper Crust and Caffé Ritazza to capture more customers. Currently, we have 120 million people a year visiting our Motorway service stations in the UK alone. Fifty million of them do not buy anything and that arguably comes back to this pricing argument of when a family of four stop for a quick bite to eat on the motorway service station they cannot all afford 30 pounds. By putting in products like Upper Crust and Ritazza, we can get somebody away with a grab-and-go sandwich for 2 to 2.50 pounds. So we are trying to broaden the appeal of the product to get more of those 50 million non-spenders spending, albeit on a slightly different product range. We think with that approach, and a new name and image, we can change people's perception and show that we can get good growth out of that business by charging more modest prices and getting better customer satisfaction.

TWST: Is interaction and communication with the investment community an important personal role for you?

Mr. Michael Bailey: Probably at least 20, 25% of my time is spent on investor, city and financial situations. A large part of it is spent seeing the management groups in our different geographies in the world. So, I travel extensively as a result of that. Obviously, I tend to be involved in any major negotiations by way of acquisitions. We meet as a group very regularly; the executive board of Compass meets at least ten times a year. Again, when you think about the logistics and geography involved, that is ten times face-to-face and not including video conferences and all the other wonderful IT things that we do to improve communications. We do like to meet pretty well monthly and can keep a good handle on where the business is and how it is going if we adhere to that schedule.

TWST: What are the main reasons why a long-term investor should be interested in the stock?

Mr. Michael Bailey: It is undervalued at this moment in time. We still have 8 to 9% organic growth and mid-teens earnings growth. I believe that now we have divested the hotel portfolio and put 3 billion in the bank, which we can sensibly spend on quality in-fill acquisitions over the next few years, you will see good growth coming through income as a result of that. It is really those qualities - a good management team, good strategy, hotels gone and a focus on the food - that will drive the Compass share price back to previous levels.

TWST: Thank You.

MICHAEL J. BAILEY
Group Chief Executive
Compass Group Plc
Cowley House
Guilford Street
Chertsey
Surrey KT16 9BA
United Kingdom
44-1932-573-000
44-1932-569-956 – FAX
www.compass-group.com