A Comeback Plan for Gome, 'China's Best Buy'

One might think Gome executives would be patting themselves on the back these days. Since the Beijing-based electronics retailer, which aspires to be China's equivalent of Best Buy (BBY) in the fast-growing China market, announced late last month that it had won at least $417 million in investment from private equity firm Bain Capital, its Hong Kong-listed stock has soared more than 55%. The new financing should help Gome, which has more than 850 stores in almost 300 cities across China, tap strong Chinese consumer demand, up 15% in the first five months of this year. "Consumer-related businesses in China have a lot of potential going forward, and the company clearly has a tremendous platform," says Bain managing director Jonathan Zhu. "They have the footprint, they have the brand, and they have the vendor relationships. All of these are critical factors to succeed."

Thanks to the Bain investment, Gome looks well set to put the bad days behind it. In November, the company's founder and former chairman, Huang Guangyu, resigned following news he was under investigation for alleged economic crimes. That led to a seven-month suspension in the trading of Gome's stock and a severe drop in consumer confidence in the company. With the Chinese economy weakening because of the global financial crisis, first-quarter revenues were down 20%, to $1.4 billion, while profits of $47 million were off 37%. In response to the slowdown, Gome shuttered 43 stores and revamped product offerings in others.

Focus on "More Careful Management"

The Bain investment and comments from Chinese officials suggest Beijing is confident the company is not involved in any malfeasance, says Chen Xiao, Gome's new chairman and president. The investigation of the company's former chairman is "a personal matter of Huang Guangyu's," says Chen, 50, with "no connection to the company."

But Chen is hardly sounding smug. With China's economy suffering from recessions in the U.S. and among other major trading partners, Gome still has plenty of challenges. "We have never before faced such a serious crisis as the global financial storm," frets the chain-smoking Chen, a 20-year industry veteran who assumed the chairmanship from Huang in January. With sweeping plans to boost competitiveness by revamping stores, rejiggering product lines, and expanding into new parts of China, the "future Gome [must] be different from today's," he says.

First on the docket: boosting profitability at Gome's stores. Chen says Gome over-emphasized a rapid rollout of new outlets in recent years. That helped the company win leading market share, but sometimes came at the expense of profitability. (Executives will not reveal single-store average profit levels.) Chen has set up a new comprehensive evaluation system run by 20 top staff that is rating performance of stores, products, and Gome's more than 200,000 employees, as well as training top managers nationwide. The company plans to shut some 100 more stores, reorganize others, and open new ones, with a target of zero growth overall in outlets this year and single-digit growth in new stores in 2010. "We have become too accustomed to a rapid growth pattern in the past and have neglected management," says Chen. "Gome's future success depends on more careful management," he says, adding that Gome aims to reach $36.8 billion in sales by 2014.

Also, a key new strategy is adjusting Gome's product lines. The company plans to reduce its reliance on durable, long-lasting TVs, refrigerators, and washing machines, instead selling more higher-end and more regularly replaced products like digital cameras, PCs, and cell phones. Also attractive: newly popular kitchen appliances like toasters and coffee makers, which have average margins of more than 13%, vs. margins of only 10% for traditional white goods. "These products have good profitability, and price competition is not as fierce," says Wang Junzhou, a senior executive vice-president at Gome.

Expanding to Faster-Growing Provinces

Gome also aims to expand beyond its traditional markets in China's biggest urban areas into second- and third-tier cities, as well as away from the coast into China's interior. That goal is particularly important as economic growth in China's hinterlands begins to outpace that in coastal areas. While Shanghai's gross domestic product rose only 3.1% and neighboring Zhejiang province grew 3.4% in the first quarter, interior provinces including Anhui, Sichuan, and Guizhou all saw double-digit growth. "Urbanization in central and western China is developing very fast," says Chen. "We will continue opening stores in these markets."

But Gome is hardly alone in its pursuit of new markets in China. Best Buy, for example, is focusing on Chinese consumers. The U.S. retailer has a relatively small presence in China, with just seven of its own branded stores, but it has 170 shops nationwide under the brand of its wholly owned local subsidiary, Five Star. Best Buy purchased a 75% stake in Five Star in 2006, and in February bought the remaining 25%.

Moreover, local rivals like Suning Appliance are expanding fast. The Nanjing (Jiangsu)-based company saw flat growth, with revenues of $1.9 billion, while profits grew 10%, to $70 million, in the first quarter—both exceeding Gome's performance—and says it will add at least 200 more stores this year for a total of more than 1,000, exceeding the 850 stores held by Gome's listed company. "Now we are the largest home appliances retailer in China; our revenues and net profits are both higher than our competitor," says Min Juanqing, manager of brand planning at Suning Appliance, whose Shenzhen-listed stock is up 36% this year.

Founder's Fate a Mystery

Meanwhile, uncertainty remains about the fate of Gome's founder, Huang, who, with one-third of Gome's Hong Kong-listed shares, is still the company's largest shareholder. (Bain will become the second-largest with as much as a 23.5% stake after its investment is finalized.) According to Chinese media reports, the former chairman is being held while authorities continue to examine possible financial improprieties. "Since last November, I haven't been able to contact Mr. Huang and I don't think Bain has been able to reach him either," says Chen, responding to rumors that the former chairman weighed in on the deal from his jail cell. "So I don't think Huang was able to voice his views on this deal."

Delays in settling Huang's case are likely to slow plans to transfer to the listed enterprise an additional 450-plus Gome-branded stores still owned by the founder and his wife, says Huang Zhigang, a retail analyst at Everbright Securities in Shanghai. "Suning wishes to overcome Gome in the shortest time possible. The Huang incident gives them this opportunity."

Gome's Chen, though, points to a company-commissioned audit by Ernst & Young that has given Gome a clean bill of health. He says the retailer still plans to meet its goal of expanding the company's assets with the Huang-owned stores by 2011. "We are pleased and proud that even with the economic downturn and our company's incident, we have successfully faced the difficulties and coped with the crisis," says Chen. "Gome is like a long-distance runner. We see ourselves continually developing for another century."

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