China enacted its Property Law in 2007 to give individuals the same legal protections over their property as the state. The decision was seen as a victory for economic reforms and the rule of law. Yet in a country ruled by a political party whose name in Chinese (gongchandang) translates literally as “the public property party”, there is still scope for confusion about the boundaries between public and private ownership.
The People’s Supreme Court dished out various interpretations of the Property Law in 2016 and a year later, in another effort to improve the public’s “sense of wealth security” and increase the “impetus for entrepreneurship”, it ordered the review of two controversial cases involving prominent businessmen.
Back then we reported that the two cases were seen as a signal of a fightback by private sector firms against the expansion of state capitalism (see WiC393). In fact, the convictions of both the jailed tycoons were subsequently overturned. However, the duo’s comebacks were reported to be on very different paths this month.
Gu Chujun was one of China’s richest men in the early 2000s – when his firms Kelon and Greencool were key players in the white goods sector – but his career prospects changed dramatically when he was jailed for corruption. Since his release, he has persisted with a relentless campaign to clear his name (more on Gu later).
Wumart’s Zhang Wenzhong has seemed less bothered with legal vindication since his own release than resurrecting his business empire – something he has achieved with remarkable speed. Indeed the retailer he founded is set to complete a deal that could help to reshape China’s supermarket sector.
How has Zhang bounced back?
Born in 1962 in Heilongjiang, Zhang was a postdoctoral scholar at Stanford University when Deng Xiaoping rebooted China’s economy with his Southern Tour in 1992.
Zhang returned to China and established a business selling point of sales (PoS) systems in Beijing. When few retailers showed much interest, he set up his own shop to showcase his products. However, as Zhang watched the arrival of major foreign retailers in China, he grasped the immense potential of the country’s new consumers and that single shop became the Wumart chain.
The brand grew quickly by taking over a number of state-owned rivals. By 2004, it controlled about a third of Beijing’s supermarkets. But its expansion ground to a halt in 2006 when Zhang was arrested on allegations of bribing officials. He spent nearly 10 years behind bars until his release on bail in 2013 (see WiC413).
Zhang’s ‘lost decade’ also marked a golden era for foreign retailers such as Germany’s Metro. By the end of last year the Frankfurt-listed firm had opened 95 stores in China, with more than 11,000 employees. Yet in an announcement that surprised some insiders last week, Metro said that it had agreed to sell an 80% stake in its China unit to Wumart in a deal that is believed to have valued its Chinese operations at about $2.1 billion.
The Metro unit will keep its brand name and existing managerial team (including a number of German executives). But it will operate in a new joint venture controlled by Wumart, cooperating with Dmall, an e-commerce firm started by Zhang in 2015, as a technology partner. Besides a 20% stake in the new JV, Metro will hold two of the seats in a seven-member board.
While it has not been uncommon to see foreign retailers sell control to Chinese partners (see WiC458), news portal Huxiu saw something different in this latest deal. “The attention was focused on the sellers’ brand value in previous deals. This time round the most eye-catching name is Wumart’s Zhang Wenzhong,” the portal suggested.
What is Zhang getting from the deal?
Reports about Metro wanting to sell its Chinese operations have been circulating for nearly two years, with internet giants Alibaba and Tencent mentioned as potential suitors, as well as retailing rivals Suning and Yonghui Superstores.
Hong Kong’s South China Morning Post reported in July that Wumart and Yonghui had been shortlisted for the final round of bidding. “Metro put their China operation on sale not because they have been performing badly,” Zhang told a forum last week. “They have been carefully selecting a partner and we are lucky to have won.”
In July Carrefour sold an 80% stake in its China business to Suning for Rmb4.8 billion ($700 million). That valued the French firm’s 210 hypermarkets at roughly half the price that Wumart is paying for Metro. According to Huxiu, that’s because Metro is in better shape than most of its foreign counterparts. Carrefour China operation was lossmaking last year, for instance, but Metro’s China business has stayed profitable.
Since its entry into the Chinese market more than two decades ago, Metro has operated a membership system. Customers pay a member fee upfront, which has been a hot topic in the retail sector recently after the stellar debut of Costco’s megastore in Shanghai (see WiC468).
A 20-year track record with this business model, plus the customer data that comes with it, are seen as invaluable assets by Wumart.
Also importantly, Metro insisted on owning its own supermarket premises from day one in China. It hasn’t provided a detailed breakdown on its fixed assets in the country, but the asset base must be valuable, Huxiu says, because many of the properties are in major cities (they include not just the megastores, but warehouses as well). These commercial sites represent “a very scarce asset in a market where commercial rents have been rising more than 5% a year,” Huxiu adds.
So why is Metro selling?
The foreign retailers have struggled to keep growth going at the same pace as in their early days in China and many have opted for a back seat by forging alliances with local partners.
Similar to the deal between Wumart and Metro, Carrefour retained a 20% stake in a new joint venture after it sold control of its China operation to Suning. That 80-20 structure seems to be the golden formula for the foreign brands looking to soldier on in China with a local partner. The trend actually began in 2014 when British retailer Tesco sold 80% of its 131-shop network to state-owned giant China Resources. Two years ago American fast food chain McDonald’s struck a similar deal, selling an 80% stake to a consortium led by another major SOE, Citic Group (see WiC351).
There has been quite a lot of dealmaking in the sector. In 2017 hypermarket chain Sun Art Retail (from Taiwan) sold a 36% (direct and indirect) stake to Alibaba for $2.9 billion. Walmart, the world’s biggest retailer, has teamed up with Alibaba’s archrival Tencent. Both firms are strategic shareholders in JD.com, the country’s second largest e-commerce platform after Alibaba, with JD.com acquiring Walmart’s lossmaking online platform in China in 2016 (see WiC403).
Other foreign firms have retreated from the country altogether. Lotte Mart, most notably, sold its 22-store network in Beijing to Wumart last year, after its relationship with the Chinese government was holed below the waterline by South Korea’s decision to deploy the THAAD anti-missile system at a site owned by Lotte’s parent (see WiC357). That move led to a consumer boycott.
Why are the foreign retailers retreating from the sector?
Metro’s decision to do a deal with Wumart may have been driven by the need to unlock more value from its operations in China. In July it rejected a takeover offer from EP Global Commerce – to buy Metro outright – because its board said the €5.8 billion ($6.44 billion) price undervalued its global business. The close to $2 billion raised from the Wumart deal appears to vindicate that view, and also retains a foothold in the Chinese market for the German firm.
Companies like Metro and Carrefour arrived in China in the mid-1990s and enjoyed long periods of sales growth, explains CBN, a newspaper. But after securing more national scale, many of them started to run into stiffer competition from aggressive local rivals. In the supermarket segment, Carrefour and Walmart had a combined market share of 12% in 2012, it says. That had dropped to less than 7% last year and sales growth for the foreign franchises was slowing as well – to 9% by 2016 from 17% four years earlier.
More recent figures are likely to indicate even slower growth, thanks to the rise of a disruptive market force: e-commerce. And the foreign retailers also realise that they will have to get to grips with another major change: the rise of the era of ‘new retail’. Here, they will be competing with well-capitalised internet firms, who are making striking moves into bricks-and-mortar stores. Even logistics firms like SF Express are trying their hand, turning thousands of warehouses into retail outlets (see WiC241).
The rapid development of this “warehouse-to-frontstore” model is a major threat to the previously formidable foreign giants. Titans like Alibaba and Tencent are investing heavily in ‘new retail’ models that combine their leadership positions in social media and e-commerce with sales and distribution in local neighbourhoods. Advances in areas like Big Data are already giving the local operators an edge over their foreign competitors, according to Remi Blanchard at Daxue Consulting, who told the South China Morning Post this month that domestic firms have “the best understanding of the Chinese grocery customers – who they are, where they are based, what they buy, at what times, do they have children, etc.”
Another of their competitive edges, CBN notes, is that goods in the ‘new retail’ model are delivered to doorsteps within hours or even minutes.
“In comparison, the delivery service of the foreign hypermarket operators is far too slow. The outlet points in their networks are too limited and the advantages – in terms of store size – they once enjoyed have backfired in the new retail era,” CBN concludes, pointing out the foreign players’ smaller numbers of megastores can’t support the speedy nationwide distribution now demanded by consumers.
So the Metro deal will cement Zhang’s comeback story?
Wumart operates about a thousand retail outlets but the majority are smaller grocery-type stores in northeastern China. By taking over Metro’s business, Zhang’s firm will acquire a broader presence across the country in the hypermarket segment (backed up by large warehouse facilities that it has lacked previously too). Wumart also reinforces its position in the Beijing market and can now gear up against regional rivals – such as Shenzhen-based China Resources, Yonghui from Fujian, Sun Art in Shanghai and Suning from Jiangsu – to vie for business nationwide.
CBN points out that the grocery market remains as fragmented as the China of the Warring States Period. And while some foreign forces are making ‘truces’ via deals, more are coming. Aside from Costco’s promising debut this year, Metro’s German counterpart Aldi is testing the waters with two new stores in Shanghai (see WiC457).
But for Zhang, the Metro takeover is a signal he’s back in the retail business as a prominent player, Huxiu believes. Reportedly he kept his controlling stake in Wumart throughout his years of incarceration. The Hong Kong-listed firm was taken private in 2015 and the Beijing News reported last year that Zhang still owns as much as 97% of the retailer.
Nor has he shown much sign of adopting a lower profile since his release from prison in 2013, appearing regularly in the media.
“If you live in the past you are forever imprisoned,” he told state broadcaster CCTV in one of his interviews, adding that he was grateful for the chance of a second start at a business career, even if he is in his late-50s.
In comparison, Gu Chujun’s redemption story has been less heartwarming, especially for the regulators involved in his trial. His fall from grace hinged on the takeover of then state-owned Kelon (see WiC347). Following his release in 2012, Gu has embarked on a Don Quixote-like quest to challenge the China Securities Regulatory Commission’s decision to investigate the original takeover. Besides demanding Rmb50 billion in compensation, his lawsuit is incendiary because he wants the court to release the CSRC’s documents on the Kelon case – a move that would reveal the names of the officials involved and more details on their deliberations.
Earlier this month the Supreme Court ruled in Gu’s favour on the document declassification, although there isn’t a timetable for when the CSRC has to carry out the order (and the watchdog could still appeal against the decision).
Should Gu eventually get what he wants – and the Kelon case documents are released for public viewing – there could be an even more compelling comeback story on the cards.
© ChinTell Ltd. All rights reserved.
Sponsored by HSBC.
The Week in China website and the weekly magazine publications are owned and maintained by ChinTell Limited, Hong Kong. Neither HSBC nor any member of the HSBC group of companies ("HSBC") endorses the contents and/or is involved in selecting, creating or editing the contents of the Week in China website or the Week in China magazine. The views expressed in these publications are solely the views of ChinTell Limited and do not necessarily reflect the views or investment ideas of HSBC. No responsibility will therefore be assumed by HSBC for the contents of these publications or for the errors or omissions therein.