Wal-Mart Starts Seeking Acquisition Partners on the Post-Soviet Union Market - Research Paper Example

December 5, 2010 Business Project Memorandum Executive Summary Wal-Mart is a global retail giant, operating on the two major international markets: the U.S. and China. However, an American based company is searching for an opportunity to enter new emerging markets and thus to increase its market share of global retail operations. Russia is recognized to be one of the most perspective markets which has a huge potential for the retail industry development mainly due to its huge population and gradual economic growth. While War-Mart’s executives have focused their ideas on the development of the retail stores in Russia, still there were no clear strategies developed. Consulting Group Company advised Wal-Mart to penetrate Russian market through the international merger or acquisition. However, before taking any strategic decision, Wal-Mart was recommended to evaluate current economic and financial position of the country, and to analyze the legal, political, socio-cultural and competitive forces. Providing consulting services to the Wal-Mart, Consulting Group Company has drawn a conclusion that despite all potential risks and regulations, an American company has to start seeking Russian based partners for international acquisition. Wal-Mart needs to focus continuously on legal and political forces with a primary purpose to avoid taxation, political and other related risks. Also, Wal-Mart executives have to be ready for high level of corruption in the country and thus expect additional costs incurred by this socio-cultural aspect. In June 2010, Wal-Mart International’s President and CEO, Doug McMillion entrusted our Consulting Group Company, located in Russia to give a professional advice whether or not to make acquisition/merger of one of the Russian retailers. The role of the Consulting Group Company is comprised of few main tasks that need to be performed before drawing a final decision whether Wal-Mart needs to enter Russian market through acquisition of the Russian based retailer or not. These tasks include: evaluation of the Russian retail industry and analysis of the potential Russian-based partners for merger or acquisition with Wal-Mart Inc.; selection of few potential Russian partners that are the most reliable and formidable for the future company’s success on the new market; providing an analysis of the main elements that influence the international mergers and acquisitions in the Russian Federation, including: corporate governance, company acts, the capacity of average workers, expectation of the consumers, political features of the Russia, tradition and culture of a country (Economy Watch, n.p.); foreseeing of the main potential difficulties, problems and hardships that may occur during acquisition/merger of Wal-Mart of the Russian based retail company; and finally, providing a risk/benefit analysis of potential acquisition/merger of Russian based company. Wal-Mart Inc. is an American based global giant of retail business, the main strategy of which is to save customer’s money by selling goods at “always low prices” (Wal-Mart Inc., n.d.). When American market was saturated with the Wal-Mart’s retail stores, the company’s management set a strategic objective to expand its business globally. After efficient expansion of business in China, Wal-Mart’s management has taken a decision to target a new emerging market with a huge potential – the Russian Federation. Doug McMillon, Walmart International's president and chief executive explained that “Russia is an attractive market for retailers, with a population of around 140 million and low retail penetration” (Dorfman and Baertlein, 2010, p.1). Thus, the type of Wal-Mart’s transaction is clear – to enter Russian market. Undoubtedly, Russian market introduces significant opportunities for Wal-Mart. However, for entering this new and specific market, Wal-Mart needs to find the most appropriate and efficient solution for entering the post-soviet market. International acquisition or merger is considered to be the best solution for the entry mode decision, because it might help “Wal-Mart to start off with a large enough presence to save costs through scale, letting it stick with its model of low prices for shoppers” (McMillon, cited by Dorfman and Baertlein, 2010, p.1). An objective of the company is to advise Wal-Mart Inc. whether acquisition/merger of the Russian retail company is a good alternative for entering retail industry in Russia. For giving an objective, adequate, and professional advice, it is necessary to: provide a professional research on the Russian retail industry, to analyze the main legal and political forces, and to evaluate the major benefits and risks of the potential acquisition of one of the Russian retailers. Brief analysis is presented below, highlighting the main international forces that need to be analyzed and evaluated. Despite the global recession, the huge Russian retail market remains one of the most attractive globally; the retail industry is one of the most promising areas of the country’s economy. According to the estimations, Russian retail market in 2008 was worth over $500bn, and rose in value by over 28% year on year (from 2006 to 2009) (Gis, p.2). In 2009, Russia was ranked the second most attractive retail market in the Global Retail Development Index (PriceWaterHouseCoopers, p.10). One of the most significant characteristics of the Russian retail market is its high fragmentation; according to analysts, the top ten players on the scene accounted for less than 10% of the market jointly in 2008 (Gis, p.2). Even though there were enacted changes in favor of consolidation of the retail market, overall, 2009 did not spark many mergers on the Russian market on either domestic or global scale (Gis, p.2). From the one hand, Wal-Mart’s strategy of Merger and Acquisition (M&A) seems to be not very effective because of the low consolidation level and thus low market shares of the domestic players; from the other hand it gives an American discount retail store an opportunity to focus on the niche strategy and provide discount products (Gis, p.3). The Wal-Mart’s saving strategy is very suitable for the Russian consumers, who have demonstrated great caution with regard to spending, in result of economic recession (Gis, p.4). Because of financial crisis, undue reliance on credit and vast investments resulted in certain changes in shifts between major players on the retail market scene of Russia (Gis, p.3). Thus, the fact that several major retail companies eventually were forced out from the market, provides Wal-Mart with an additional opportunity for growing market share (Gis, p.3). One of the major constraints for making M&A is lacking good-quality, effective and not overvalued retail assets in Russia, because Wal-Mart Inc. is interested in buying assets which would give the company an advantageous position on the market (Gis, p.3). Additionally, the current general economic downtrend in Russia might stimulate Wal-Mart’s M&A activity in the retail industry. Potential acquisition targets for Wal-Mart are the retailers that have encountered severe financial problems and have frozen up all capital-intensive projects (Machnicka, p.4). While for Russian retailers it is a significant problem, for American retailer it is a huge opportunity for M&A activity. There were identified 10 largest market players in Russia by evaluating sales revenue ($m) 2008 (Gis, p.3). There were only two retail companies with the foreign investment from France and Germany, eight others were the Russian based companies. Thus, the major Wal-Mart’s alternative partners are: Tander, Eldorado, Euroset, Lenta and Dixy Group (Gis, p.3). Two major retailers: Euroset and Tander were identified as the potential Wal-Mart’s merger partners. Even though there still is not a significant share of foreign investments in the retail chain stores of Russia, many global competitors are evaluating the perspective of entering a new emerging market. The major global retail competitors of Wal-Mart today are Britain’s Tesco (considering entering Russian market) and French Carrefour (opened its retail store in Moscow in June 2009) (Machnichka, p.3 and PriceWaterhouseCoopers, p.10). This information is strategically valuable for the Wal-Mart while considering acquisition of the retail market in Russia. While analyzing the international forces of the Russian market, Wal-Mart is recommended to consider number of important legal and tax issues. While the provisions in Russian legislation on M&A transaction are quite complex and cover a broad scope of information, below are summarized only the key legal and tax issues, that might be helpful while evaluating Russian business environment. The Russian legal system is based on statutory law; the main legal acts are the Constitution, federal laws, government regulations, presidential decrees. The Constitution recognized the norms of international law and international treaties (PriceWaterHouseCoopers, p.7). Considering the Wal-Mart’s retail business activity there should be taken into account the new Russian Law “On Trade”, which prohibits retailers with a market share of over 25% and annual revenues of over RUB 1 billion in each Russian city from increasing their market share (PriceWaterHouseCoopers, p.10). The government is to lower administrative barriers to foreign investment (PriceWaterHouseCoopers, p.20). In response to the world economic crisis, Russian tax authorities have changed some tax provisions, mainly: Profits tax was reduced from 24% to 20% from 2009 (KPMG, p. 1); Unified Social Tax was replaced with maximum 26% rate by insurance premiums of the same rate (KPMG, p. 1). It is important to take into account that starting from the 2011 the total rate of insurance premiums will be significantly increased (up to 34%) (Russian Law Online, 2010); Transfer Pricing rules are under development; current Russian tax law does not provide for tax consolidation of separate legal entities, however government plans to include this tax (KPMG, p. 1). Under Russian tax legislation, the tax authorities are entitled to control prices used in the following types of transactions: transactions between related parties; barter transactions; cross-border transactions; and transactions in which the price differs by more than 20 percent in either direction from the prices used by the taxpayer with respect to identical (similar) goods (work, services) within a short period of time (Russian Tax Code, art. 40, p. 2 cited by KPMG, p. 1). Wal-Mart has also take into account that tax clearances in Russia refer to the Russian tax legislation (KPMG, p. 4), and tax consequences depend on the preferred acquisition vehicles (joint venture, local branch, etc.) (KPMG, p. 4). Additionally, while evaluating M&A activities, Wal-Mart management has to consider such non-tax factors as company law, anti-monopoly, and currency control provisions, labor laws, intellectual property rights, etc. (KPMG, p. 7). Analysis of the international structure of the Russian Federation also plays or can play a significant role in current and future perspectives, respectively. International Structure of the Russian Federation covers a broad variety of international and regional agreements, including: Organization for Security and Cooperation in Europe, Permanent Court of Arbitration, Council of the Baltic Sea States, Shanghai Cooperation Organization, CIS and CIS structures Economic Organizations, United Nations Conference on Trade and Development, World Trade Organization (observer), International Bank for Reconstruction and Development, International Development Association, International Monetary Fund, and many others (PriceWaterCooperHouse, p. 16). While considering targeting Russian customers, Wal-Mart management should develop specific model for retailing, relying on the habits, and behavior of Russian customers, rather on the American. Wal-Mart has already applied its American-Breed models in many countries, and in most cases it resulted in failures (cases in Germany, China). Thus, Wal-Mart is recommended to take into account socio-cultural forces of Russian customers as well, because this type of international forces is hardly possible to standardize. Also, it is important to mention about high level of corruption in the country, comparing with U.S. level of corruption (Russia – 154th place, score- 2,1 – highly corrupt; the US – 22nd place, score 7,1 – relatively clean; data provided by Transparency International, 2010). Table 1. Major risks and benefits of international acquisition/merger of the Russian retail company RISKS BENEFITS and potential advantages Taxation risks An increase in cost efficiency due to: achieving economies of scale; combining complementary resources; garnering tax advantages; eliminating inefficiencies High level of corruption An increase in market share and revenue enhancement (Enotes, 2010, n.d.) Currency exchange rates Opportunity to supply markets from China (close transportation and entered trade cooperation between Russia and China); penetrating new geographic regions Political risks Increase market power by reducing competition (Enotes, 2010, n.d.) Wal-Mart Inc. management has also to consider the potential difficulties and problems of international acquisition/merger of the Russian retail company. These difficulties refer to the process of transaction evaluation, defining of the associated costs and benefits, and handling the resulting tax and legal issues (Enotes, 2010, n.p.). Also the company can face socio-cultural opposition toward American-bread retail store model. To avoid these difficulties and problems company is recommended to conduct a detailed analysis of all previously mentioned issues, and those that were omitted. Relying on the analysis on international market of the Russian Federation, the Consulting Group Company does recommends the Wal-Mart executive to enter Russian market by making acquisition/merger of one of the Russian retail domestic companies. The company’s management has to use an opportunity, caused in result of global recession. Additionally, Wal-Mart needs to take into account that the later it will enter the Russian market, the more fierce foreign competition it will face. For choosing the most appropriate Russian retail company for acquisition, Wal-Mart is advised to conduct additional research about the recommended companies and to negotiate with those. However, the American company needs to focus continuously on legal and political forces with a primary purpose to avoid taxation, political and other related risks. Also, Wal-Mart executives have to be ready for high level of corruption in the country and thus expect additional costs incurred by this socio-cultural aspect. Works Cited: Dorfman B. and Baertlein L. (2010). “Wal-Mart looks at many partners for Russia entry”, Thomson Reuters, p.1. Retrieved Dec. 5, 2010 from http://www.reuters.com/article/idUSTRE6525O020100603 Economy Watch (n.d.). “International Mergers and Acquisitions”. Retrieved Dec. 5, 2010 from http://www.economywatch.com/mergers-acquisitions/international/ Economy Watch (n.d.). “Benefits of Mergers and Acquisitions”. Retrieved Dec. 5, 2010 from http://www.economywatch.com/mergers-acquisitions/benefits.html Enotes (2010). “Encyclopedia of Small Business | Mergers and Acquisitions”. Retrieved Dec. 5, 2010 from http://www.enotes.com/small-business-encyclopedia/mergers-acquisitions/print Gis M. (2009). “Global crisis changes face of the Russian retail industry”. Report “Retail in Russia 2009. Market analysis and development forecasts for 2009-2011”. PMR Publications, Dec.2009, p.2-4. KPMG (2010). “Russia, Taxation of Cross-Border Mergers and Acquisitions”, Retrieved Dec. 5, 2010 from http://www.russianlawonline.com/law-firms-publications/M&A_Tax_Law_Russia.pdf Machnicka M. (2009). “Diverse opportunities for retailers in Russian regions”, Report “Retail in Russia 2009 – Regional Focus, March 2009, pp.2-5. Machnicka M. (2008). “Russian Retail: time to expand”. Report “Retail in Russia 2008”, Market Analysis and development forecasts for 2008-2011. Regional Focus, May 2008, p.3. PriceWaterhouseCoopers (2010). “Doing business and investing in the Russian Federation 2010”, pp. 2-65. Retrieved Dec. 5, 2010 from http://www.pwc.ru/en/doing-business-in-russia/assets/Doing-Business-Russian-Federation-2010.pdf Transparency International (2010). “Corruption Perception Index 2010 Results” Retrieved Dec. 5, 2010 from http://www.transparency.org/policy_research/surveys_indices/cpi/2010/results Wal-Mart Inc. (n.d.). “About Walmart.com.” Retrieved Dec. 5, 2010 from http://www.walmart.com/catalog/catalog.gsp?cat=542412 Read More