Wal-Mart expanding into Africa

By Jeanine Poggi, TheStreet

Wal-Mart (WMT) is looking to expand into South Africa, offering to purchase Massmart Holdings for $4.25 billion.

The discount behemoth said Monday it will pay $21.11 a share for Massmart, which operates 290 discount stores in 13 countries in sub-Saharan Africa, with most of its business taking place in South Africa. But that bid could go above $5 billion if Massmart's CEO has his way, Wall Street Strategies analyst Brian Sozzi predicts.

Last year, Massmart reported sales of $6.8 billion, up 10% from the year prior. But Sozzi says, "We believe no such certainty for Wal-Mart shareholders is obtained by adding Massmart to an already extensive international portfolio of assets."

Wal-Mart will have significant work to do when it comes to rebuilding Massmart's gross margins. The company generated a gross margin of 18.1% and operating margin of 3.92% last year, well below Wal-Mart's gross margin of 24% and 6% operating margin.

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South Africa is also a nation just emerging from a recession, with 20% unemployment and high-single-digit inflation in 2009, making it questionable how much benefit the country will have on business, at least in the near-term.

"Wal-Mart would likely leave Massmart's management intact (if they are inclined to stay aboard), but still, integrating such a diverse platform into Wal-Mart's operations will divert the attention of the international team," Sozzi wrote in a note. "This is unfortunate as Wal-Mart has been operating rather well in the U.K., for example, and has finally gained traction in the difficult Japan marketplace."

Wal-Mart has been looking into expansion opportunities in developing markets to offset U.S. sales declines. The company in recent years has made acquisitions in China, Chile and Brazil, with international sales contributing more than $100 billion in annual sales.

But in the U.S, the company is coming off five consecutive quarters of sales declines and will most likely report another drop in its third quarter. On top of a crippled economy, which severely weakened the spending power of its core customers, Wal-Mart has also struggled with some internal issues.

The recent management shakeup has done little to sooth investors' fears. Bill Simon became Wal-Mart's new CEO of U.S. operations in June, and following the announcement that former head of merchandising, John Fleming, would step down Aug. 1. Instead of filling the chief merchandising officer spot, Simon decided to name four new heads of product to adopt these responsibilities.

Wal-Mart has been struggling with some of its discretionary categories, namely apparel and home furnishings. Its product assortment has also been criticized after Wal-Mart removed some items from its shelves through its "Project Impact" initiative. This, no doubt, hurt sales, and Wal-Mart is currently in the process of restocking some of those items.

Wal-Mart attempted to woo back shoppers in its second quarter with aggressive price rollbacks, but that proved unsuccessful, and the company returned to its strategy of everyday low prices.

Now it looks like Wal-Mart will be focusing its attention on smaller-format stores to buoy U.S. operations. Reports surfaced last week that the retail giant is eying smaller urban real estate, as tiny as 20,000 square feet. This expansion plan is expected to be further spelled out next month when Wal-Mart hosts its analyst day.

"Our opinion is that Wal-Mart should be allocating its capital first and foremost to developing U.S. urban stores and then returning cash to shareholders through share repurchases and dividend increases," Sozzi wrote. "Moreover, the company should be articulating its strategy to investors for turning around the U.S., which is being attacked by Target (TGT), grocery stores and dollar stores, as well as bringing aboard new talent to the U.S division."

Last week Target announced during its media day that it plans on opening smaller-format urban stores with a square footage of between 60,000 and 100,000. The typical Target store is between 125,000 and 180,000 square feet.

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