Walmart may sell stake in Massmart

Massmart may have escaped a sell-off this year by a whisker, but pressure is mounting and Walmart may in future alter its view that the South African retailer is a strategic asset worth holding onto.

A top analyst has warned that US retail giant Walmart could lose its patience and sell its 51% controlling stake in Africa’s second largest retailer, Massmart, if the Johannesburg-based general merchandiser fails to turn around its lukewarm performance by 2018.

Shamil Ismail, an analyst at Primaresearch, has suggested that Walmart, which paid $2.5 billion to acquire Massmart in 2011, has a history of pulling the plug on its offshore investments that misfire and that Massmart was in danger of being dumped by the US retailer if it does not turn the corner in the next two years.

Ismail’s ominous prediction is not baseless. In January this year Walmart announced the closure of 269 stores, of which 115 were in Latin America.

This massive scale-back sent shockwaves through the markets and triggered speculation that Africa could be the next target of Walmart’s pull-back – not an unlikely scenario in light of the recent announcement by British lender Barclays Plc that it was intending to sell down its stake in its African business significantly.

“The closure of these stores follows a review that took into account a number of factors, including financial performance and strategic alignment with long-term plans,” wrote Ismail in a research note.

Ismail believes Massmart, which currently operates 38 stores in 13 countries outside South Africa, would not have passed the financial performance muster as the retailer’s earnings have largely been flat over the past nine years.

“We have noted Walmart has failed in and exited two countries – South Korea (1999-2006) and Germany (1998-2006) – and the tenure of these holdings was seven to eight years. With the 2011 entry into South Africa, applying the same time frame would suggest that Massmart may have until probably 2018 to turn around its performance, in our view,” he wrote.

Walmart failed to crack the Russian market after spending eight years trying to find a suitable local acquisition target. It also has not managed to get into the Indian market. In Japan, it is scaling back by closing 30 of its 373 outlets in that country.

“We have noted Walmart has failed in and exited two countries – South Korea (1999-2006) and Germany (1998-2006) – and the tenure of these holdings was seven to eight years. With the 2011 entry into South Africa, applying the same time frame would suggest that Massmart may have until probably 2018 to turn around its performance, in our view”
Massmart may have escaped a sell-off this year by a whisker, but pressure is mounting and Walmart may in future alter its view that the South African retailer is a strategic asset worth holding onto for a very long time.

“In light of recent developments, with the substantial weakening of the rand and the announcement that Barclays Plc will sell off its stake in its African business, we believe there is a heightened risk that Massmart’s anchor shareholder Walmart may consider a similar move,” notes Ismail.

A fall in Massmart’s share price and a sharp depreciation in the value of the rand against the US dollar have conspired to eat a big chunk of the value of Walmart’s stake in Massmart. The US retailer acquired the 51% stake in Massmart in October 2011 at a share price of R148 and at an exchange rate of R6.76 to the US dollar, costing the US company $2.5 billion to consummate the transaction.

According to Ismail, Walmart’s investment in Massmart has faltered. On January 21 this year Walmart’s stake in Massmart hits its lowest value (peak diminution) in US dollar terms when it was reduced to $545 million, a whopping 78.2% reduction from the original price it paid to buy into the South African retailer. This means the “peak diminution” or the stake’s rock-bottom value was reached at a share price of R83.20 and rand/dollar exchange rate of R16.55.

Since January 21 both Massmart’s share price and the rand have recovered, helping to boost the value of Walmart’s shareholding in Massmart.

At the time of going to press, Massmart’s share was trading at R124.50 while the rand was quoted at R14.42 against the US dollar, implying the two key ingredients that drive its valuation had lifted the stake’s value to $964 million. Still, the value of the stake is 60% lower than Walmart’s initial investment of $2.5 billion.

As Walmart was concluding its acquisition of Massmart in 2011, established South African retailers were lying in wait to give the foreign invader of their home turf a proper baptism of fire.

From the word go, the likes of Shoprite and Pick n Pay – both powerful merchants of fresh meat, fruit and vegetables – played rough with Walmart after the American giant signalled its intention to get into fresh food retailing through Massmart-owned Game stores, a specialist general merchandiser known for selling household goods ranging from soap to electronics.

“In South Africa Massmart is known to achieve the highest retail trading densities (sales per square metre), indicating we generate higher sales out of fewer stores. For example, the ratio of Game stores to specialist grocery competitors is about one to 33, which is consistent with the ratio of stores outside of SA”
They have prevented Game from adding fresh food in shopping malls, where they have a presence, citing clauses in leases they signed with mall owners that give them exclusive rights to sell food.

Pick n Pay and Shoprite have used the courts to have the exclusivity leases enforced.

Massmart has sought the help of competition authorities to ban the “anti-competitive” exclusivity leases. Walmart never saw this counter punch coming. Game is selling fresh produce in about half of its 110 stores.

The feud over food, plus slow growth in the South African economy, has pegged back Massmart’s performance. The retailer’s first-half earnings to December 2015 dropped by 26% to R364 million while main rival Shoprite lifted its half-year earnings 12% to R2.2 billion.

Brian Leroni, Massmart corporate affairs executive, said the general merchandiser is planning to open five stores outside South Africa, where Massmart stores are known to generate three times the turnover of a South African store.

“In South Africa Massmart is known to achieve the highest retail trading densities (sales per square metre), indicating we generate higher sales out of fewer stores. For example, the ratio of Game stores to specialist grocery competitors is about one to 33, which is consistent with the ratio of stores outside of SA,” said Leroni.

Shoprite wants to increase the number of its supermarkets in oil-rich countries like Angola and Nigeria, where it has noted the sharp drop in oil prices has not led to a slump in consumer spending. Shoprite plans to open 168 stores between now and June 2017, of which 58 will be outside South Africa.

By Andile Ntingi for www.getbiz.co.za

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