Talking shop: Wal-Mart hit by shock-waves from Mexican scandal
Wal-Mart's operations in Mexico include the Superama chain
Shares in Wal-Mart de Mexico y Centroamerica plummeted this week as allegations the company bribed officials to speed up store openings prompted many shareholders to offload the stock at a rate of knots. Meanwhile, concern that US regulators will pursue action against parent company Wal-Mart Stores for violations of the Foreign Corrupt Practices Act could have some far-reaching consequences for the world's largest retailer. Katy Askew reports.
When a New York Times article unearthed allegations that Wal-Mart de Mexico employees had greased the palms of local officials to speed up approval of store openings this weekend (21 April), shockwaves were felt throughout the market.
The stock price of Walmex, which is 69% owned by US giant Wal-Mart, lost almost US$7bn in market value, dropping 12% on Monday alone. And the descent has continued with shares falling around 4% on Tuesday to settle at $36.43 in early trade today.
This dramatic drop in valuation reflects just how gravely the investment community views the severity of the charges.
The report contained allegations that illegal payments were made to local and regional Mexican officials to facilitate the granting of various licenses and permits until 2005.
In Mexico, the government has indicated it does not intend to examine the charges as they fall under local jurisdiction. However, the front-running presidential candidate, Enrique Pena Nieto, and national regulators have called on local bodies to investigate Walmex's dealings: a process that could prove both time-consuming and costly.
Further concerns over the outlook for Walmex surround the possibility that space expansion will slow in response to any potential investigations.
Space expansion has been one of the primary revenue drivers for Walmex. Between 2005 and 2012, Walmex has doubled its selling space in Mexico and in February of this year the company committed to a target of a 12% increase in square footage for 2012.
Indeed, when the company booked its first-quarter results after the markets closed on Monday, Walmex reported a 13.6% increase in sales. Significantly, only 5.6% of this was the result of increased same-store sales and the lion's share of growth was the consequence of new store openings.
Increased scrutiny of Walmex's planning applications could, at the very least, result in a more protracted development process, costing the company both time and money. At worst, analysts at US advisory firm William Blair suggest the company could be facing tougher hurdles to get approval for store openings.
"Our concern is that if payments to ease expansion were perceived to be necessary when the company was less than half its current size, the challenges to sustaining the high expansion rate must be even more acute today," they write.
While Walmex has said it cannot estimate the potential liability, if any, related to these matters, the group emphasised that, based on the facts currently known, it does not believe the corruption investigation will have an adverse impact on its business.
In an investor note, Credit Suisse analyst Antonio Gonzalez concurs that - at the present time - there is no reason to assume the scandal will impact Walmex's earnings.
"While we see no reason to change our earnings estimates at this point, we also think a resolution to the potential bribery case might be a cumbersome and long process," Gonzalez suggests.
However, he adds: "We see limited catalysts for the shares to recover the lost ground soon, until a resolution on this matter is reached."
If the allegations are found to be accurate, it is likely that much of the fall-out will rest on the shoulders of US parent Wal-Mart.
In this circumstance, Wal-Mart may have violated the US Foreign Corrupt Practices Act (FCPA) forbidding bribes to foreign government officials. The world's largest retailer could also have broken Sarbanes-Oxley rules that require companies to report material violations of securities laws.
According to the report, Wal-Mart's subsidiary in Mexico "had taken steps to conceal [the payments] from Wal-Mart's headquarters in Bentonville". With the exception of now vice president of Wal-Mart and then Wal-Mart Mexico CEO Eduardo Castro-Wright, it seems there is little to suggest that the retail giant's top-brass knew of or authorised the problematic payments at the time they were made.
However, as FCPA expert Professor Mike Koehler writes in his analysis of the situation, when Wal-Mart executives allegedly learnt of the wrongdoing, they failed to address the issue adequately.
"The remarkable aspects of the Times investigation include the conduct (or lack thereof) of Wal-Mart and its top executives upon learning of problematic conduct in its Mexican subsidiary," Koehler says.
In 2003, the New York Times claims, Wal-Mart was first alerted to issues at its Mexican subsidiary when it engaged risk consultancy Kroll to investigate an unrelated issue.
Kroll concluded Wal-Mex "executives had failed to enforce their own anticorruption policies, [and] ignored certain internal audits that raised red flags". According to the article, a further investigation from Kroll into Walmex's internal audit and anti-fraud units concluded that they were "ineffective".
In 2005 Wal-Mart conducted an internal probe into possible corruption in Mexico. The investigation was closed in 2006 and it is unclear what - if any - action was taken.
In addition to this, Wal-Mart indicated that it was examining whether it was in compliance with the FCPA in a December 2011 SEC filing. The retailer did not, however, indicate what time frame or region was being looked into.
"Most business leaders, audit committees, and boards tend to overreact to FCPA issues and often reflexibly launch broad internal investigations. However, the payment issues at Wal-Mart Mexico apparently resulted in exactly the opposite at Wal-Mart's corporate headquarters. Wal-Mart's conduct will not be viewed favourably by the enforcement agencies," Koehler predicts.
Enforcement agencies that are now likely to investigate Wal-Mart's dealings in Mexico include the US Department of Justice and the Securities and Exchange Commission. Meanwhile, two Congressmen, Elijah Cummings and Henry Waxman, have also said they are launching an investigation.
The Times report "raises significant questions about the actions of top company officials in the United States who reportedly tried to disregard substantial evidence of abuse," Cummings and Waxman said in a statement.
Fears that the allegations, if substantiated, could reach beyond Castro-Wright and include Wal-Mart executives as high-ranking as CEO Mike Duke and former CEO Lee Scott will certainly cause investors to pause for thought.
The DOJ and SEC will not be the only bodies examining the conduct of Wal-Mart executives: so too will legal firms representing shareholders who could potentially bring derivative claims against the group alleging breach of fiduciary duty and claims based on material omissions concerning Walmex.
Investigations into the allegations being raised against Wal-Mart and its executives are therefore likely to be a long and costly exercise for the company.
The group has already indicated it is conducting a world-wide review of its operations - opening the possibility that such corrupt practices were not limited to Wal-Mart's dealings in a single market.
The firm also said that it is creating the new post of global FCPA compliance officer to oversee its operations in 26 global markets and ensure compliance with US anti-corruption legislation. The officer will oversee five FCPA compliance directors based in the international markets, Wal-Mart said.
The company added that it has also taken actions such as training and "enhanced auditing" to "establish stronger" FCPA compliance in Mexico. It will also put a dedicated FCPA director in Mexico reporting directly to its global FCPA compliance officer.
However, in some respects this could be seen as too little too late.
According to Consumer Edge Research analyst Faye Lande, the scandal could also have a significant strategic impact as it could hamper Wal-Mart's ability to expand into new markets.
"Entering additional countries is a cornerstone of Wal-Mart's growth strategy," Landes writes in a research note. "We can foresee the authorities in some key countries, notably India, becoming dramatically less welcoming to Wal-Mart following the release of the allegations."
Shares in Wal-Mart dropped from $62.45 before the scandal broke to $58.20 at time of press. However, the allegations could have more far reaching consequences than the dip in share price seen over the past three days as they speak of the heart of Wal-Mart's corporate culture and reach up to encompass the group's highest ranking officials.
With India - and the prospect of wide-ranging economic reforms in the country - in the international business headlines, there are few other more opportune times to meet Rakesh Biyani, joint managing ...
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