Wal-Mart sounds pricy vuvuzela on African growth

By Rob Cox
September 28, 2010

Wal-Mart <WMT.N> has finally sounded the vuvuzela on African expansion. After months of speculation about how it would try to capitalize on the continent’s growth, the U.S. retailer is offering $4.2 billion to acquire South Africa’s Massmart Holdings <MSMJ.J>. The price could grate on shareholders’ ears. But the deal gives Wal-Mart a local vehicle — and local knowledge — to help it gain access to a market with a profile that should suit it well.

If the deal is accepted by Massmart, Wal-Mart will be paying close to 13 times the Johannesburg-based retailer’s EBITDA. For a company that trades at closer to 7 times, that’s a big premium, albeit a drop in the bucket against Wal-Mart’s nearly $200 billion market capitalization.

But Wal-Mart will get a foothold in what should be a bright spot in the world’s growth map. South Africa, where Massmart operates 232 stores from Limpopo in the northeast to the Western Cape, is one of the CIVETS economies (Colombia, Indonesia, Vietnam, Egypt, Turkey and South Africa) widely hailed as the next sizable emerging markets.

The International Monetary Fund estimates sub-Saharan output will grow nearly 6 percent per annum from 2011. Capitalizing on this would be a stretch for Wal-Mart from its Bentonville, Arkansas headquarters. Sure, the retailer has become a smart international operator and broadly understands poorer shoppers, something Africa has in unfortunate abundance. But Wal-Mart would lack local knowledge in a new market.

Piggybacking on Massmart’s business makes African expansion a much less risky proposition for the U.S. giant. From its home market where it operates a variety of retail formats, the South African group has been rolling out its Game mass-discount stores in Botswana, Ghana, Malawi, Mozambique, Namibia, Zambia and elsewhere.

Moreover, buying Massmart should boost margins in Wal-Mart’s international business, which accounts for around a quarter of its revenue. While Wal-Mart International’s operating margins were around 3.8 percent in the first half of this year, Massmart’s stood at closer to 5 percent. Apply Wal-Mart’s massive purchasing power, and profitability could increase further.

This entry ticket to a CIVETS lair doesn’t come cheap. But with growth elusive at home, it should be a price Wal-Mart shareholders are happy to pay.

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