Wal-Mart tries to set up shop in Africa and why this is huge

A few weeks back it was HSBC announcing news of its talks for South Africa’s Nedbank. Now it is the world’s biggest retailer, Wal-Mart, seeking a foothold on the continent with a plan to buy South Africa’s Massmart for more than $4 billion.

Wal-Mart Stores Inc. made an aggressive but expensive bid to expand in Africa ahead of its international competitors, offering to buy South African retailer Massmart Holdings Inc. for 32 billion rand ($4.6 billion).

Wal-Mart’s proposed offer—the company’s biggest acquisition in more than a decade—would represent a relatively high premium for Massmart, a 290-store chain operating in 13 African nations.

Yet a deal would give the Bentonville, Ark., giant a critical foothold to expand in Africa and allow Wal-Mart to beat European multinational rivals Carrefour SA, Tesco PLC and Metro AG into the potentially lucrative sub-Saharan market.

Massmart would serve as “a fantastic entry point to a broader part of the continent,” said Andy Bond, a former chief executive of Wal-Mart’s U.K. subsidiary Asda, who is spearheading the purchase. Massmart already is expanding beyond its South Africa base, Mr. Bond said in an interview Monday.

Wal-Mart has learned the hard way that a first-mover advantage can be important in international retailing.

Carrefour, Wal-Mart’s global archrival, beat Wal-Mart to South America, opening stores in Brazil in 1975, nearly two decades before Wal-Mart. The France-based company also was the first major international chain to establish a presence in Asia, through a joint venture in Taiwan in 1989.

Despite investing billions of dollars building and buying stores, Wal-Mart still trails Carrefour in Brazil today. And Carrefour remains the largest international retailer in China, the most coveted retail market in the developing world. While Carrefour doesn’t have sub-Saharan operations, the chain has stores in northern Africa.

Wal-Mart’s African foray is risky, however. The offer is roughly 13 times Massmart’s pretax earnings and would place Wal-Mart into a politically combustible region.

South Africa is emerging slowly from the recession, is plagued by high crime and unemployment and marked with a heavily unionized work force known for long, sometimes violent, strikes. Other sub-Saharan nations carry even more political risks.

“Massmart is well positioned as a springboard for sub-Saharan Africa, but we believe that it will take a much longer time period for the company to earn its cost of capital in Africa,” said Janney Montgomery Scott analyst David Strasser. “For every relatively stable country like Botswana, there is a Zimbabwe.”

Nevertheless, Wal-Mart appears prepared to face those risks as it looks to extend its reach in emerging markets and expand its international business, which makes up a fourth of the company’s roughly $405 billion in annual revenue.

The international division clearly is Wal-Mart’s growth engine, now that sales at U.S. stores open at least a year have fallen for five consecutive quarters. The company is examining entering other emerging markets as well, including Russia and the Middle East. “Wal-Mart is a company that wants to aggressively expand world-wide,” Mr. Bond said.

But Wal-Mart hasn’t always managed to get its formula right abroad, in part because the retailer sometimes has failed to cater to local habits and markets. Wal-Mart in 2006 abandoned its Germany operation after spending eight years trying to crack the market, one of Europe’s most competitive discount-retailing environments. Wal-Mart pulled out of South Korea last decade.

South Africa, particularly Johannesburg and Cape Town, is an attractive prospect, drawing shoppers from Nigeria, Kenya and elsewhere on the continent because of its well developed roads and wide range of retailers, from discount stores to high-end, international brands.

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Like Wal-Mart, Massmart operates low-cost, high-volume stores with a strong general retail business and an emerging food operation. Founded in 1990, Massmart operates several chains, including Game general-merchandise stores, Makro warehouse-club stores and Builders Warehouse for construction and home improvement.

Massmart is one of several large chains, including Shoprite Holdings Ltd. and Woolworths Holdings Ltd., that dominate South Africa and have expanded into neighboring countries. Massmart reported sales of 47.55 billion rand in the fiscal year through June, up 10% from a year earlier.

Wal-Mart made a nonbinding proposal that could lead to a cash offer of 148 rand ($21.08) a share for Massmart. The companies said Monday that they are in exclusive negotiations to try to hammer out a deal, which would be subject to regulatory approval.

The idea of Wal-Mart bidding for one of South Africa’s retailers had been around for a while as it focuses on international growth.  South Africa presents a compelling growth opportunity for Wal-Mart and offers a platform for growth and expansion in other African countries.

The expansion in the rest of Africa is key. Massmart doesn’t only have a presence in South Africa, it also has stores in 13 other countries in sub-Saharan Africa.  It could be a hugely significant deal from an African perspective.

Why this signals a big change.

This is a significant move is for investors. This acquisition, if completed, will be the biggest acquisition undertaken by Wal-Mart in 10 years – and of all places, it’s in Africa. For markets, this could be a game changer, and I venture there are many computer screens in trading floors around the world tracking this transaction very closely.

For quite some time, I have felt that corporate America was missing the Africa story. Like tourists frightened off by rumors of lions prowling the city streets of Nairobi or Lagos, America’s corporate sector has been bamboozled and bogged down in an old African landscape where the only opportunities are to be found in digging up raw materials, and the greatest challenges are with intractable or corrupt government bureaucrats. To be sure, that African landscape still exists, both in mind and in reality.

Last year, India, Inc. completed its second biggest acquisition anywhere, via the purchase by Bharti Airtel of Zain’s mobile phone network. The deal added up to a staggering $10.5 billion. That was quite a statement. China is simply everywhere on the continent, buying up oil reserves and copper mines, and building dams, bridges and roads. But despite all the news of America’s growing military footprint, through the newly established Africa Command, there was not a sniff of America, Inc. It was as if America understood the security and resource games, but that those were the only games in town.

This has changed with Wal-Mart now wanting to put Massmart in its shopping cart. The African continent remains the last frontier of the 21st century. Africa’s resources are vast and still not properly quantified, but the far greater value may be in Africa’s human capital: its consumers.

There are 1 billion souls in Africa, 40 percent of whom live in urban areas, and according to a McKinsey report on Africa’s booming opportunities, Africa already has more middle-class households than India. It’s fitting that a company like Wal-Mart that has always understood the economies of scale is leading the way for America. Africa’s consumer market has scale, and plenty of it.

This will prove a valuable acquisition for Wal-Mart. The company is set to reap an advantage as an early mover. The critics say that it won’t be easy since South Africa is a quirky market; its labor force is unionized and combative when compared with the rest of the world. However, when viewed as a “Gateway to Africa,” South Africa is a winner.

When Wal-Mart first announced its intentions to launch a presence in India back in 2006, many onlookers said they were crazy. Yes, India has an estimated $250 billion retail market and is the second largest country by population, but the government is very protective of its domestic businesses and Wal-Mart at the time was fresh from humiliating defeats in both Germany and South Korea.

What the critics and pundits failed to understand about the India initiative was that Wal-Mart is one of the most gangsta companies in the history of the world. They are as ruthless as their customers are fat. Fine, some of them are fat but you get the idea. They will go to any lengths and twist themselves into whatever contortions they need to in order to build the beachhead. And once they get a foot in the door, everything changes and the takeover begins.

In the 1990’s when Wal-Mart began establishing their beachheads in China and Brazil, there was similar talk of how the company didn’t understand the lay of the land or the culture or whatever. Meanwhile, they’ve since opened hundreds of stores throughout both countries – there is a Wal-Mart directly facing the massive statue of Chairman Mao in the middle of Beijing, talk about a juxtaposition!

Their foray in India has not been quite as successful yet, and the qualifier “yet” is important when you consider the hoops the company is jumping through just to be there. For starters, there is a law that says foreign retailers are not allowed to sell goods directly to the public, so Wal-Mart built a wholesale distribution center instead of their typical retail outlet. They launched a joint venture with the big Indian wireless company Bharti and it is Bharti that owns and operates the retail stores with Wal-Mart acting as supplier and “consultant”. See what I mean about the ruthlessness?

Indian opponents of Wal-Mart are calling it “backdoor retailing” in violation of the country’s laws. And they are right of course, but again, Wal-Mart is straight gangster. Besides, they’ve bought the local farmers’ loyalty as they not only pay 7% more for wholesale crops, they actually arrange for trucks to pick up the goods right from the farms themselves. No one else in India has the scale or the logistical know-how to compete with that. Wal-Mart still has just one distribution center in India, but having laid the groundwork over the past 2 years and established themselves favorably with the farmers, you can bet that their expansion plan throughout the massive nation is about to accelerate.

And if the foreign retailer restriction ever gets eased or lifted? Forgetaboutit. I wouldn’t bet against Wal-Mart in Africa and I wouldn’t ignore the peripheral investment opportunities that may arise because of it.

With a good deal of its supply coming from China, Wal-Mart will surely be able to take a knife to Massmart’s costs by bringing its scale to bear.

I think this acquisition will be viewed as transformative. And, when the competition sees Wal-Mart’s success, they’ll wish they had been early movers too.

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