Wal-Mart's Cheap Doubling in China (WMT)

Wal-Mart (WMT-NYSE) just snuck further into China with an investment that will either to lead to further control or an outright acquisition of locally operated Trust-Mart.  As of December 2006 Wal-Mart already had 73 units in 36 cities throughout China, and 68 of these are the supercenter units.  The company has acquired a 35% interest in Bounteous Company Ltd., which operates hypermarkets in China under the Trust-Mart name.  Trust-Mart has 101 Trust-Mart retail stores in 34 cities across China. 

This is in reality much more than just an investment in the press release: Subject to certain conditions, Wal-Mart will acquire ownership control in the future.  Various reports from the past value the entire takeover transition at roughly $1 Billion and will allow Wal-Mart to better compete against Carrefour throughout the country, as Carrefour has more than 200 stores in China.  The current stake being acquired is 35% and this is essentially coming with an embedded call option for a controlling stake.  Wal-Mart will buy controlling interest if certain conditions are met by 2010.  The exact financial terms are not disclosed in the press release, but it sounds like Wal-Mart is getting a very generous deal here.

It is very difficult to be in praise of big deals that are often seen as acquisition for the sake of acquisition.  But this deal makes sense and on the surface seems a rather cheap way to grab a stronger position in the fastest way possible.  China is challenging on the lower and middle-tier retail fronts but this would allow Wal-Mart to instantly catapult from 73 units to 174 units without even considering future units under contruction or in the planning stages, and for what is said to be $1 Billion it seems like a cheap way to do it.  The company could opt to do it on its own organic growth model, but could you imagine being able to instantly buy this many stores with the land acquisitions and built-up infrastructure for roughly $10 million per store?  Even with development costs in China being much lower than in the US this seems like a cheap instant assimilation.  This sounds a bit like getting to put up hotels on Boardwalk and Parkplace before the other Monopoly players even get to have their second roll of the dice.  I didn’t realize that "Always Low Prices" pertained to acquisition prices of Chinese stores as well.  The company has a mixed international history, but China is one market it can’t afford to not expand in.

There were Chinese media reports speculating on this last year.  If there are no deal blockages by the Chinese government or attempts by other retailers to block this, then it seems like a genius move on Wal-Mart’s part.  This is one of those situations where you would hate to be an independent grocer or big box retailer in a competing market there, but one that investors would cheer.

It is a bit odd that Lee Scott is not mentioned once throughout the entire press release, and may lead one to believe the company is trying to keep him at bay.  We noted him as one of the 10 CEO’s where the stock would likely rise if he would leave the company.  CEO’s that have fallen from grace and lost any popularity can always save themselves and can always stage a miraculous comeback, but signing a deal of this magnitude is one where you would expect to see his name all over it. Instead, Wal-Mart’s Vice Chairman Michael Duke got to make the public comments in the press release.  Is there something brewing in this?      

Jon C. Ogg
February 27, 2007

Jon Ogg is a partner in 24/7 Wall St., LLC and he can be reached at [email protected]; he does not own securities in the companies he covers.