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Wal-Mart's Plot: Divert Attention With Massmart Bid

Wal-Mart offers $4.25 billion for Massmart, but is it a ploy to distract investors from U.S. operations?

(Wal-Mart article updated with additional expert commentary.)



) --


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is looking to expand into South Africa, offering to purchase

Massmart Holdings

for $4.25 billion. But is this just a ploy to divert attention from weakened U.S. operations?

Investors, it seems, have some concerns about Wal-Mart's announcement, with shares of trading lower on the news, down 0.8% to $53.65.

The discount behemoth said on Monday it would pay $21.11 a share for Massmart, which operates 290 discount stores in 13 countries in sub-Saharan Africa, with most of business taking place in South Africa. But that bid could go over $5 billion if Massmart 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 also 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.

Cramer: Wal-Mart Green Lights Africa

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

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"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 decline, 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 customer, Wal-Mart has also struggled with some internal issues.

The recent management shakeup, for one, has done little to sooth investors' fears. New CEO of U.S. operations, Bill Simon took over in June, and following the announcement the former head of merchandising, John Fleming, stepped down on Aug. 1. Instead of filling the chief merchandising officer spot,

Simon decided to name four new heads of product to adopt these responsibilities


It's no secret Wal-Mart has been struggling with some of its discretionary categories, namely apparel and home furnishings, which made Wal-Mart's move not to fill the CMO position questionable.

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


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, 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.

But the African bid potentially should not garner as much criticism as it is receiving. It is yet another move in Wal-Mart's plan to target emerging consumers, says Craig Johnson, president at Customer Growth Partners.

While this segment of the world market won't immediately move the needle when it comes to earnings and top line, 10 years down the road it will be a big idea that Wal-Mart capitalized first.

Wal-Mart is already King of U.S. shoppers, and Johnson predicts emerging markets like Africa will position the company for decades of growth.

Wal-Mart is also a large enough operation that the move into Africa shouldn't be a distraction to Simon and his team in the U.S., Johnson notes.

-- Written by Jeanine Poggi in New York.

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