Li & Fung Drops as Wal-Mart Option to Buy Unit Terminated

Li & Fung Ltd. (494), the largest supplier of clothes and toys to retailers, fell the most in two weeks in Hong Kong trading after an agreement giving Wal-Mart Stores Inc. (WMT) the option to purchase a unit was terminated.

Li & Fung dropped 2.6 percent, the most since Sept. 4, to HK$12.20 after announcing a new arrangement with the world’s biggest retailer that supersedes one made in January 2010. The new agreement also allows for Li & Fung to provide design and replenishment services to Wal-Mart.

The outsourcer set up Direct Sourcing Group Pte in 2010 to supply goods to Wal-Mart, now the world’s second-biggest company by sales. The deal would allow Hong Kong-based Li & Fung to act as a buying agent for $2 billion of goods in the first year, it said then. Yesterday’s agreement will last for five years with an option for a two-year extension, it said.

“The termination of the call option indicates that Wal- Mart itself is not giving enough orders to DSG to make it very profitable,” Gabriel Chan, a Hong Kong-based analyst at Credit Suisse, said in a phone interview today. “The only reason why someone would give up a call option without any compensation is that the call option is deeply out of the money and not expected to be in the money any time soon.”

‘Technical’ Changes

Today’s share-price decline extended the stock’s slide this year to 15 percent, compared with a 12 percent climb for the benchmark Hang Seng Index. (HSI)

Wal-Mart canceled “much of a deal” for Li & Fung to supply its international stores and will move to buy more goods directly from factories, the Wall Street Journal reported today, citing people close the company it didn’t name.

“There are no substantive changes to the buying agency agreement,” Li & Fung said in an e-mailed reply to questions today. “Most of the changes are technical” and allow its unit “to focus its efforts and on specific departments and categories and become much more efficient,” the company said.

Wal-Mart has said it “never anticipated exercising the call option” on Direct Sourcing Group and no payment was made to terminate it, Li & Fung said.

Ebru Sener Kurumlu, an analyst at JPMorgan, said the deal “removes the uncertainty around ownership” of Li & Fung unit Direct Sourcing. The new deal allows Direct Sourcing to focus on categories where “Wal-Mart really needs Li & Fung’s expertise,” said Sener, who has a neutral rating on the Hong Kong-based company’s shares.

Li & Fung will continue to be a primary supplier for Sam’s Club in the U.S. through its Direct Sourcing Group Pte. unit and provide buying-agency services to Wal-Mart’s U.S. operations and in some of its international markets, it said.

“This is positive not only for revenue streams but also for margins as distribution is traditionally a higher-margin business,” Vineet Sharma, an analyst at Barclays Plc in Hong Kong, said in a note to clients yesterday.

Li & Fung reported in August first-half core operating profit fell 22 percent to $221 million as U.S. consumers curb spending amid a slower economy.

To contact the reporters on this story: Eleni Himaras in Hong Kong at ehimaras@bloomberg.net; Michelle Yun in Hong Kong at myun11@bloomberg.net

To contact the editor responsible for this story: Stephanie Wong at swong139@bloomberg.net

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