The move by Waterford Wedgwood (WW) to buy a 14.9 per cent interest in rival china manufacturer, Royal Doulton, was tactically correct; provided it is not forced to make a bid for the whole company which would be very painful financially.

Its strategy has a number of obvious advantages. First, it does not have to consolidate Royal Doulton's results thereby minimising its exposure to a heavy loss maker. Second, it makes it more difficult for an outside party to make a bid. Third, it gives WW time to work out a meaningful relationship with Royal Doulton.

Waterford Wedgwood paid 90p sterling per share, a 15 per cent premium on the market price of 78p, at a cost of £11.1 million sterling (€17.4 million), to get the 14.9 per cent shareholding. This was not expensive for a strategic buy. The shares were above 140p last May but that was before its recent problems were announced. The five institutional shareholders who sold part of their holdings, endorsed the deal by keeping their remaining shares. And by rising to 88p, following the announcement, the market showed its approval. The 14.9 per cent stake was the highest WW could buy at one go. It can increase this stake seven days after the initial purchase. It will not be surprising if it goes down this road but it is almost certain to avoid a position whereby it would be forced to consolidate Royal Doulton's losses. Equally it will avoid going above the 29.9 per cent mark which would trigger a mandatory takeover bid (WW has said it has no intention of making a bid for the whole company but reserved the right to do so if a rival bid were made). In the meantime it has shelled out funds which will have a negative return over the immediate future. The u £11.1 million will increase its borrowings and increase interest payment. However, the impact on earnings will be negligible. WW has now made it more difficult for rivals such as Lennox, and Villeroy and Boch, to make a counter bid for Royal Doulton. However, a stake as small as 14.9 per cent is hardly sufficient to thwart a serious bidder. A holding of more than 20 per cent would provide greater protection.

So what has WW bought into? It is generally accepted by a number of British analysts that Royal Doulton is a disaster zone. So much so that some have stopped writing reviews about the company. Royal Doulton is approximately the same size as WW's subsidiary Wedgwood, but it is about three years behind Wedgwood's rationalisation programme. Royal Doulton has not been idle - it announced the laying off of 1,200 employees, a fifth of its workforce last year and has discontinued shipments to discount retailers - but it has been too slow and still needs substantial rationalisation.

Royal Doulton incurred a loss of u £14.6 million in the six months to June 30th 1999 compared with profits of u £1.8 million a year earlier. And it shocked the market with the disclosure that it had lost u £10 million to u £12 million in sales, representing some 5 per cent of sales, due to software problems. Royal Doulton's latest results contrasted with Wedgwood's profitability but even this company is not getting a sufficient return. The operating margin is reckoned to be around 8 per cent which is way below what is needed. Wedgwood, of course, in common with other British ceramic groups, has had to face weak domestic demand which has been compounded by the weakness of sterling. The smaller British ceramic companies such as Portmeiron and Churchill China have traditionally got fatter margins and that has to be the goal of both Royal Doulton and Wedgwood. Royal Doulton, however, still has a long way to go as losses this year are expected to exceed analysts forecasts of £16 million. Indeed, the most optimistic scenario is that profits will not come through before 2001.

That is all the more reason for Wedgwood and Royal Doulton to sit down and explore ways of co-operating in the much needed rationalisation of the industry. While the Royal Doulton board has not endorsed WW's investment, neither has it rejected it. However, institutional shareholders have a controlling shareholding in Royal Doulton and they are likely to support a closer arrangement between Wedgwood and Royal Doulton, And that can only be good for the industry that boasts so many fine brand names; Royal Crown Derby dates back to 1748.