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Japan: Wal-Mart's Looking for a Partner—Again

Having already sold off loss-making operations in South Korea and Germany this year, it's only natural that Wal-Mart's (WMT) ambitions in Japan are under scrutiny. Since taking a stake in Seiyu in 2002, the chain's struggling Japanese operations have lost well over $1 billion. Just as worrying, sluggish sales suggest that Japanese shoppers, like their Korean and German counterparts, haven't warmed up to the Wal-Mart way (see, 2/28/05, "Japan Isn't Buying The Wal-Mart Idea").

Yet for all the backtracking elsewhere, Wal-Mart doesn't appear ready to give up on Japan just yet. On Sept. 4, Kyodo News, a Japanese wire service, reported that Wal-Mart and market leader Aeon have submitted proposals to acquire a stake in Daiei from trading house Marubeni (MARUY), the largest shareholder in the once mighty retailer.

Wal-Mart declines to comment on the report, but the impact of a deal with Daiei shouldn't be underestimated. Its outcome could well determine the success or failure of Wal-Mart's experiment in Japan, the world's second largest retail market after the U.S.

BIG FOOTPRINT. "From a strategic point of view, Daiei is very important as to whether Wal-Mart stays and invests or gets out of the Japanese market altogether," says Masafumi Shoda, an analyst at Nomura Securities in Japan. "They still have the ambitions in Japan but they also have the requirement to make a profit." Marubeni, which is expected to sell a stake worth 10% to15% in Daiei, will make a decision on which rival it wants to become a partner with as early as next month.

There is little doubt a hook-up with Daiei makes plenty of sense for Wal-Mart. In a market with few willing sellers, bagging Daiei would give Wal-Mart a huge footprint in Japanese retailing. Combined, the two would have over 10% of Japan's $150 billion supermarket sector. In terms of floor space, the figure would be 12.7%—more than No. 2 player Ito Yokado, which has 10.3%, and only a few percentage points behind market leader Aeon's 15.6%, notes J.P. Morgan Securities Japan.

Economies of scale from the deal would also enable Wal-Mart to get closer to achieving its "everyday low pricing" model. Analysts note that synergies from the deal would be highly likely because Daiei and Seiyu stores have relatively little overlap, while even a small stake could allow cooperation on purchasing. That would be a big boost in a country where labyrinthine supplier networks and consumers' love of freshly prepared local foods make cost savings hard to find

BIG REGRETS. A deal with Daiei would also make up for a missed opportunity. Last year, Daiei was under the control of Industrial Revitalization Corp. of Japan (IRCJ), a government-backed body charged with acquiring, turning around, and selling distressed companies.

Wal-Mart made a bid for Daiei, but the IRCJ eventually sold it to Marubeni and Advantage Partners, a private equity investor. Market watchers say Wal-Mart bosses and their advisers misjudged the mood of IRCJ by submitting an overly aggressive bid and have rued missing out ever since.

Still, a deal with Daiei the second time around is far from certain. Wal-Mart will likely have to fend off Aeon, which is understood to be keen to partner with Marubeni because of its interest in Daiei affiliate Maruetsu. That retailer has a strong presence in Tokyo, where Aeon is keen to expand. "We will submit a written application to Marubeni if necessary," Aeon Chief Executive Officer Motoya Okada noted on Aug. 30.

FEDERATION OR EMPIRE? From an industry perspective, an Aeon-Daiei linkage may also make more sense. Kenji Tsukazawa, an analyst at J.P. Morgan in Tokyo, notes that 25% of Seiyu stores compete directly with Daiei stores which, while less than most rivals, is still higher than Aeon's 18%. "We think an Aeon-Daiei combination makes the most sense if Daiei were to merge with another major supermarket chain," Tsukazawa noted in a research report.

Nomura's Shoda says Aeon's decentralized management approach may appeal more to Marubeni. "Aeon's philosophy is to create a federation rather than an empire," he says. That may be preferable to dealing with Wal-Mart bigwigs in Bentonville.

However, Shoda also says Advantage Partners, which has a 23.5% stake in Daiei, has an important role to play. Unlike Marubeni, which is looking for a partner and only plans to sell part of its stake in Daiei, the private equity firm may be more willing to sell to any bidder if the price is right. "Advantage Partners can be key to the reorganization," Shoda adds.

SOME IMPROVEMENTS. But if Wal-Mart fails again to get its hands on Daiei, some fear it will bolt from Japan as it has from other countries. In Germany, Wal-Mart said in July it was selling 85 stores to rival Metro, taking a $1 billion hit in the process (see, 5/28/06, "Wal-Mart's German Retreat"). In South Korea, Wal-Mart sold out two months earlier.

Not that it has been all bad at Seiyu. Under Wal-Mart's ownership, which has grown steadily from an initial 6.1% investment in May, 2002, to 53% last December, investment in IT systems has helped boost purchasing efficiency. And many of Seiyu's older stores have been or are being refurbished.

What's more, since Ed Kolodzieski, formerly Chief Operating Officer of Wal-Mart International, took over as CEO in December, there's been a turnaround of sorts (see, 12/21/05, "Wal-Mart's Waiting Game in Japan"). During the first half of 2006, same-store sales improved by 1.4% to $4.02 billion, although overall sales fell. Yet red ink is still a problem. Having lost $105 million in 2004 and $152 million in 2005, Seiyu expects losses of $468 million during 2006.

FEW ALTERNATIVES. Another concern is that the market for all big retailers in Japan remains tough. Aeon, for instance, saw its same-store sales edge down 0.3% in the May to June quarter despite investing heavily in IT infrastructure in recent years.

But perhaps the biggest problem for Wal-Mart is a lack of alternatives if it can't snare Daiei. A daring bid for Aeon, for instance, would almost certainly be resisted, while buying up smaller regional chains would take time. Moreover, new regulations to be introduced next year will make it harder to build new stores.

So does that mean Wal-Mart should cut and run if Daiei slips its grasp? Not necessarily, says Yoshihiro Tamehiro, director of the Distribution Economics Institute of Japan in Tokyo. "Wal-Mart is desperately looking for M&A opportunities in Japan. If they don't get Daiei, they should have other plans in place." If they don't, the Seiyu gambit could turn out to be another messy and expensive overseas quagmire for the king of U.S. retailing.

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