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October 11, 2013

BRICs and beyond: Wal-Mart, Bharti both stand to benefit from split

They were partners but Wal-Mart Stores and Indian conglomerate Bharti Enterprises appear better able to take advantage of the potential opportunities in the country's high-growth food retail sector alone. Raghavendra Verma reports.

They were partners but Wal-Mart Stores and Indian conglomerate Bharti Enterprises appear better able to take advantage of the potential opportunities in the country’s high-growth food retail sector alone. Raghavendra Verma reports.

Wal-Mart’s decision to terminate its Indian joint venture with the Bharti Enterprises was not unexpected.

“The joint venture was like trying to run a three-legged race with one leg of each partner tied together,” Arvind Singhal, chairman at Technopak Advisors, tells just-food.

The two companies operated stores in India under the Best Price Modern Wholesale and Easyday banners. Wal-Mart will now take full ownership of the wholesale business, the US retail giant announced on Wednesday (9 October). For its part, Bharti will operate the consumer-facing Easyday retail stores across all formats.

According to Singhal, many of the difficulties faced by the partnership were rooted in India’s foreign direct investment regulations, which were updated last year. “Not much progress has been made – if any – by Wal-Mart…because investments are needed in both the areas but Wal-Mart cannot invest into the front end,” he tells just-food.

India’s restrictions on FDI had been hindering growth for both Wal-Mart and Bharti, Singhal argues.

New Indian FDI regulations require foreign investment to be channelled into creating fresh capacity rather than purchasing or investing in existing front-end and back-end operations.

Devangshu Dutta, chief executive of retail consulting firm Third Eyesight, says this contributed to mounting tensions regarding strategy and operations. In particular, Dutta highlights that FDI regulations meant that “Bharti would not have achieved any sort of cashing out of its investment in favour of Wal-Mart in the future.”

The split paves the way for Wal-Mart to step up the expansion of the Best Price wholesale business in India, pundits suggest.

“Wal-Mart can now go ahead without having to worry too much about the compliance with Indian foreign direct investment rules like local sourcing and any restrictions on back-end and front-end investments as none of those conditions apply on the cash-and-carry business,” Singhal notes.

The wholesale business stands to benefit from “the fragmented retail market and the myriad of small businesses in India” that “potentially provide a large customer base for the cash-and-carry business,” Dutta adds.

However, Dutta also warns growth might be hard to deliver. “The business has been coasting for over a year without new openings that [had previously been] planned.”

Dividing the business should prove beneficial for Bharti, because it will no longer face any restrictions on operating its supermarkets in states ruled by India’s opposition, where governments had been fighting foreign investment in organised retail. Singhal suggests Bharti might tap private-equity financing to fund an expansion of its retail chain, arguing the break-up might help the Indian food retail sector grow.

Dutta says the supermarket chain stands to benefit from increasing branded food consumption in India, as well as moves by state and federal government to improve the tax environment and infrastructure. He says supermarkets should see the positive impact of “issues related to the operating environment being tackled, such as the simplification of transaction taxes across states through the introduction of a common goods and services tax, and continued investment in transport infrastructure”.

That said, the break-up could dampen investment sentiment in India.

Deep N Mukherjee, India-based director of corporate ratings firm Fitch Ratings, observes foreign investors are already wary because of recent cases involving breaches of the US’s Foreign Corrupt Practices Act that have involved Indian businesses.

Furthermore, India’s retail sector might contract in the two quarters to March 2014. “Higher consumer inflation and marginal nominal wage growth are expected to act as major deterrents for consumer spending,” Mukherjee says. “Lower operating profitability will continue”, along with “higher funding costs and working-capital requirements, which are exerting pressure on operating cash flows of Indian retailers.”

However, for some, the longer-term prospects for India’s retail sector are brighter. “In the short term, modern retail businesses certainly need to become smarter and leaner to sustain themselves,” Third Eyesight’s Dutta says. “But in the long term, the trend is positive.

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