Wal-Mart's $4.2 billion bet on Africa

Wal-Mart Stores, Inc. the world's biggest retailer has made a preliminary, non-binding cash offer to acquire Massmart Holdings Limited, South Africa's third-largest store operator by value for South African Rand 148 per share. Massmart, headquartered in Johannesburg, is one of the largest retailers in Africa. The company runs 232 stores in South Africa which account for 92% of its total sales.

Location of Massmart's stores in South Africa (Source: Company Website)

The company operates 24 additional stores in other sub-Saharan African countries. In most countries it has just 1 or 2 stores. The largest presence outside Africa is in Botswana where it has 9 stores. However, sales outside South Africa account for only 8% of its sales.

Location of Massmart's stores outside South Africa (Source: Company Website)

Massmart was founded in 1990 and has grown rapidly through acquisitions - 20 Dion stores in 1993, 14 CCW stores and 26 Game stores in 1998. By the time the company listed on the Johannesburg Stock Exchange in July 2000, it had grown 10 times in 10 years.

Rapid Growth in Earnings (Source: Author analysis, Company Data)

Massmart reported sales of US$ 6.8 billion in its fiscal year, ended in June 2010, up 10 percent from the previous year. While that's a large figure, it will just about move the needle for Wal-Mart which reported sales of US$405 billion in its most recent financial year.

What are the strategic reasons for the deal?

• Wal-Mart is struggling in its home market U.S. where revenues have declined for five straight quarters because of the weak U.S. economy.
• Wal-Mart's overseas business is performing better with sales of US$100 billion accounting for 25 per cent of its total revenue. 
• The company has a strong presence in China, Brazil and Mexico
• The Indian market remains largely closed due to the Government's restrictions on Foreign Direct Investment (FDI) in retail. 
• The deal gives Wal-Mart's a strong position in South Africa a fast-growing market and a foothold in Africa for growth and expansion in other African countries.

What are the risks?

• While South Africa has a fast-growing economy the crime level is high 
• The country has a 24% unemployment rate and high inflation
• Massmart has a heavily unionized work force
• Massmart's same stores sales growth is less than South Africa's rate of inflation. Thus there is pressure of volume growth
• The boost provided by the Soccer World Cup is over.
• The PE multiple for the deal is nearly 26 times. Compared to this, Shoprite, South Africa's biggest listed retailer trades at 21 times. So, this is an expensive deal. There is also the potential of a counter offer which could drive the price even higher.

However, Wal-Mart seems to betting not on the short-term impact of the deal, but on the long-term potential of Africa. The IMF estimates that growth in Sub-Saharan Africa will reach 5% in 2010 and 5.9% in 2011. While that's less than the 9% growth in China and India, it compares well with the average 2% growth expected in advanced economies. After the stunning rise of China and India investors are betting on Africa as the next and possibly last untapped market.

However hype and hoopla aside, returns will take time. South Africa, which is the best economy in Africa has good penetration of modern retail, so Wal-Mart would need to grow business in the other countries. This might be easier said than done because for every relatively stable country like Botswana, there is a disaster like Zimbabwe.