Woolworths faces a showdown with its biggest shareholders after the ailing retailer rejected a takeover approach for its 815 stores yesterday from Malcolm Walker, the founder of the Iceland frozen-food chain.

Hours after Mr Walker's move emerged, Woolworths said that the highly conditional approach was unacceptable. Richard North, its chairman, insisted that the group had the right strategy in place to turn the business around.

The rejection sparked an angry reaction from investors in Woolworths, who have seen its shares plunge by more than 80 per cent since the start of last year to as low as 5.4p last month. The shares closed on Friday at 6.65p.

A source close to Baugur, the Icelandic investor that owns 10 per cent of Woolworths and which had backed Mr Walker's approach, said: “The performance of the Woolworths retail chain has been a concern for some time. It's important from a shareholder perspective that anyone who is willing to take on the stores and comes up with a solution is listened to.”

Mr Walker is thought to have offered less than £50 million for the Woolworths stores in a formal letter three weeks ago. He was willing to proceed only if the retailer retained most of the store division's debt and wiped out its pension deficit.

Across Woolworths as a whole, the pension deficit is £48.2 million. The entrepreneur was not interested in E.UK, Woolworths's CD wholesale business, or 2entertain, its video-publishing joint venture with the BBC.

Mr Walker has resurrected the fortunes of the Iceland supermarket chain, now owned by Baugur, since returning to the business in 2005. He approached Baugur about his plans for Woolworths last year.

These are believed to include selling Iceland food in some of the stores and closing the worst-performing sites.

The Woolworths stores division generates £1.7 billion of revenue but fell £15 million into the red in 2007-08 before one-off property gains.

It was unclear last night whether Mr Walker and Baugur would return with an improved offer. Mr Walker, who began his career with Woolworths but was dismissed by the retailer 37 years ago for moonlighting, is on holiday in the Caribbean.

Analysts said that his approach could spark a long bid battle. Ardeshir Naghshineh, the property tycoon, has built a 10.2 per cent stake in Woolworths in recent weeks and had been rumoured to be assembling a consortium of his own to bid for the stores.

Woolworths announced the appointment of Steve Johnson, the former head of Focus DIY, last week as its new chief executive. Mr North's revival plan is based on making Woolworths the high street's best discount operator.

Woolworths said that its board had confirmed that it had rejected an indicative proposal that involved “a complex restructuring which in practical terms is not achievable ... It undervalued the assets of the company and potentially would have adversely impacted the group's existing funding arrangements, after meeting any resultant obligations to the pension fund.

"And it required the company to retain all the pension liabilities for current and former employees of the retail business. This is unacceptable.

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