How Did Wal-Mart Crack Open China?

By Peter Cohan

Wal-Mart Stores (WMT) entered China in 1996 and has billions of sales there. But how did it crack China? One big answer is a 65%-Wal-Mart-owned joint venture with a company run by the son of a former Chinese vice president who was tossed in 2009 out by Beijing after investigations into a multi-billion foreign exchange trading scandal.

Wal-Mart has operated in China for 16 years. According to its web site, Wal-Mart "opened its first Supercenter and Sam's Club in Shenzhen in 1996." By March 2012, it ran Supercenters, Sam's Clubs, and Neighborhood Markets in China. Its footprint then included "370 units in 140 cities in 21 provinces and four municipalities." And Bloomberg reported that as of October 2011, Wal-Mart's China sales totaled $7.5 billion.

That was when Wal-Mart got into some hot water with regulators. The Chongqing government fined Wal-Mart $423,000 â¿¿ accusing it of selling "63,547 kilograms of falsely labeled pork over the past two years." And Bloomberg reported that Wal-Mart claimed that it was "cooperating with the investigation,  sorry for inconveniencing customers,  set up a hotline to address customers' questions."

But that would be a small fine compared to what Wal-Mart would face if evidence emerged that it made payments to Chinese officials in order to gain access to its market. After all, Wal-Mart has allegedly demonstrated its willingness to make such payments to grow rapidly in Mexico.

That was when the New York Times reported on an estimated $24 million in bribes that Wal-Mart allegedly paid to Mexican officials through a "perfect" scheme.  Thursday, Wal-Mart announced along with its earnings that its audit committee was investigating possible violations of the "Foreign Corrupt Practices Act and other alleged crimes or misconduct in connection with foreign subsidiaries, including Wal-Mart de México."

Could these Wal-Mart foreign subsidiaries include those in China? There are certainly reports of large companies forming joint ventures with the families of powerful Chinese officials. In fact, there seem to be so many of these, that it would appear impossible for a company the size of Wal-Mart to gain access to the market without following this practice.

How so? The New York Times describes several such "princeling" arrangements, including the following:

Animation. DreamWorks' $330 animation studio joint venture with "Jiang Mianheng, the 61-year-old son of Jiang Zemin, the former Communist Party leader,"
Satellites. Asia's potentially "largest satellite communications operator" is run by Wen Yunsong, the son of Prime Minister Wen Jiabao,"
Security Scanners. A "state-controlled monopoly on security scanners used in China's airports, shipping ports and subway stations," was once managed by Hu Haifeng, son of President Hu Jintao,"
Power Generation.  The chairwoman and chief executive of China Power International, a "big five power generating" company in China, is Li Xiaolin, daughter of former prime minister, Li Peng."

It's no secret that a major Wal-Mart expansion announced in 2005, sprang from a joint venture with a company known to have close ties to Chinese officials. And in 2009, the head of the company was forced to resign after a trading scandal.

Back in January 2005, Reuters reported that Wal-Mart had established a joint venture with Citic Pacific, a Hong Kong-based holding company with interests in "toll roads, power plants and stakes in Cathay Pacific Airways and rival Dragonair."

Wal-Mart would be able to avoid spending money on real estate while opening "hundreds of stores" by 2012. Wal-Mart held 65% of the venture involving at least $250 million. Managing director, Henry Fan told Reuters, "We have a lot of property projects in China and we will welcome Wal-Mart as our anchor tenant." 

Citic Pacific's history reveals that it's just another princeling arrangement. Founded in 1990, Citic Pacific "presided over the property-to-steel conglomerate from a gleaming office tower overlooking Hong Kong's Victoria Harbour," according to Reuters.

The Shanghai-born, Larry Yung, took control of the firm founded by his father, Rong Yiren, a vice president of China, between 1993 and 1998. As Reuters noted, Yung was "dubbed the red capitalist like his father the family enjoyed deep-rooted ties to China's Communist leaders fostered over half a century."

But Yung got tossed out of Citic Pacific in April 2009. The previous October, Citic had been caught up in a $1.9 billion loss "from unauthorized foreign exchange trading," according to Reuters.

And after Hong Kong's Commercial Crime Bureau sent investigators to find fraud, Yung's "powerful benefactors in Beijing with no choice but to let him go." And that week, Fan "resigned from the firm."

What did Wal-Mart have to do with Citic's problems? Did Wal-Mart engage in any practices that might be in violation of FCPA in order to build its presence in China? Did Wal-Mart pay Chinese officials to gain access to the Chinese market? Do any of the proceeds from this joint venture go to Chinese officials?

Kevin Gardner, Wal-Mart's Senior Director, International Corporate Affairs, commented, "Regarding your query on our China strategy, in light of your questions we won't have anything more to share in that regard beyond what was discussed in our earnings announcement yesterday."

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