Graham Stack in Berlin -

With a downturn in the West but the big emerging market countries still booming, Wal-mart et al want desperately to get into Russia, but are finding they have left it late.

At the World Retail Conference in Barcelona on April 9-11, the global retail sector's biggest annual bash, there was not much of a party atmosphere. Carrefour CEO Jose Luis Duran summed up the prevailing mood by saying, "we are facing the most significant challenge in a generation."

The only light on the horizon, most participants agreed, were the emerging markets, particularly Brazil, Russia, India and China. Russia is the last of the BRIC countries still lacking one of the big three supermarkets - Tesco, Carrefour and Wal-mart - but participants agreed this wouldn't likely be for long.

Speculation that one of the big three will set up shop soon in Russia has reached fever pitch in 2008. In January, Carrefour was reported to be looking for a site in Russia's oil rich Tyumen region - and subsequently the company officially announced plans to open up two hypermarkets by the end of the year. Then in March it was reported that Tesco had been holding talks with Petersburg-based hypermarket chain Lenta. Finally, on April 14, in the immediate aftermath of the Barcelona conference, Wal-mart announced it had appointed the hypermarket-experienced Stefan Fanderl as president of Wal-Mart Emerging Markets-East to "explore retail business opportunities in Russia and neighbouring markets."

A piece of it

In its recent Global Retail Development Index report, AT Kearney ranked the Russian food retail market as the second most attractive emerging market for investment (after India) for three consecutive years. According to UniCredit research, the Russian food retail market is currently the fifth largest in Europe with a turnover of $193m in 2007 after the UK, France, Germany, and Italy. UniCredit expects the Russian retail market to become the second largest in Europe after the UK as soon as 2011, and to pass the $1-trillion mark in 2013.

So, in view of the current downturn on developed markets, the question for potential foreign investors is not when, but how? And whether through green-field development or acquisition? This is where the head-scratching starts.

Traditionally, the Russian listed retailer segment has been regarded as an M&A play, but Russian analysts are saying - think again. With growth rates of 40-50% per year set to continue in the medium term at least, none of the leading local names are in any hurry to sell out. And with major Russian brands established and growing, and some foreign majors such as Metro and Auchan also in the top 10 and doing very well, for even a global giant such as Wal-mart starting from scratch won't be easy. As one participant of the Barcelona congress was heard to say: "Is now the time for us to move into Russia? No. The time was five years ago."

In the words of Andrei Nikitin of investment bank UralSib: "Foreign retailers - Carrefour, Tesco, Wal-Mart - missed the opportunity of large-scale, unobstructed entry into Russia's retail in the 90s, and now face an uphill struggle to gain entry in a market where domestic players have a strong foothold at national and regional levels. This, coupled with Russia's inadequate infrastructure, real-estate related challenges, and administrative red tape, makes multinational retailers hesitant of building their own networks from scratch."

"It's difficult now to set up on your own," agrees Alfa Bank's Vitaly Kupeev. "The market is hot and competition is tough. Magnit, Auchan, X5 - all operate upwards of 20 hypermarkets currently, and the number grows every year."

The major bottleneck is simply getting the land to build hypermarkets on. And this is means a global giant like Wal-mart will have difficulties setting up large-scale operations straight off. "It's basically a land grab, with chains trying to acquire as much real estate as possible, trying to grow as fast as they can manage," says Brady Martin of Alfa Bank.

"Real estate is the major challenge in cities, especially Moscow and Petersburg," confirms agrees Nikitin. "There's a deficiency in every class of real estate. You're not just competing with other retailers, you're also competing with residential development and office space and hotels."

Russian bureaucracy, corruption and lack of infrastructure also slow down store openings. Moreover, labour is becoming an increasingly scarce resource as well.

Metro and Auchan, the two global names present in Russia, have done very well, says Brady, but Ikea and Germany's MediaMarket have had problems related to local conditions. Moreover, according to Alfa Bank research, although French retailer Auchan has exhibited the highest growth of the top -10 retailers at 80%, jumping to the fourth-largest player as of end-2007, many Russian players have demonstrated similar growth rates, and in absolute terms Russian players continue to dominate the growth of the market. Despite being the largest player in the market, X5 Retail Group had the highest growth rate of all the top-10 players 2007.

So Russian retailers are no walkover. Bu but neither are they are a sellout either. The gist of a slew of recent report is that, with cricket score growth rates set to continue, none of the Russian leaders are interested in selling in the immediate future. "Why would anyone sell when they are growing at 50% per year?" asks Alfa's Kupeleev. An Alfa Bank report published April 16 found that, "in our view, sale to a strategic investor is probably top of the list on the long-term exit strategy for owners of Russia's largest retail chains. However, as long as the companies are able to sustain growth in excess of 40%, we do not feel that the majority shareholders of these assets will be in a hurry to sell."

The other drawback to acquisition is that the Russian food retail sector is still hugely under-consolidated - both in terms of traditional formats such a small shops, markets and kiosks still counting for 70-80% of the total market, as well as within the 20-30% supermarket segment, where even major chains do not have market shares of more than 1.5%. "High market fragmentation undermines the validity of acquisition for the sake of market share," according to UralSib's Nikitin. Basically, you don't get much market share for your money.

The two companies most often touted as potential Wal-mart targets are market leader and listed company X5, and St Petersburg-based non-listed Lenta, According to Uralsib's Maria Startseva, however, X5's management stated recently that the company, owned by Alfa Bank, might indeed be sold to Wal-mart, "but at the earliest within 20 years." Wal-mart have said they might take a minority stake in a Russian company, and in February the owners of a 21% stake in X5 said they were interested in selling it. But Kupeev argues the stake is too small to make much sense for Wal-mart, and the deal would need to be approved by majority shareholder Alfa Bank, "and that will never happen."

Analysts, therefore, regard non-listed companies, especially Russia's fifth largest Lenta, as being the most likely candidates for acquisition. Lenta is known to have held talks with both Wal-mart and Tesco.

However, the problem with such companies is lack of transparency, according to Kupeleev. "Lenta don't even publish their IFRS figures." Such lack of transparency deters potential investors. Even in the case of Lenta, which counts the European Bank of Reconstruction and Develolpment among its shareholders with an 11% stake, everything is far from sweetness and light. The company's major shareholders, among whom bizarrely is a US deputy prosecutor from San Diego called August Meyer, are currently at each others' throats about who has the right to appoint the CEO. A court in the British Virgin Island made a ruling April 15 that confirmed the present CEO, but the dispute looks set to continue - and to hinder any takeover deal.

It can get worse than that. In 2007, UK electronics retailer DSG International, formerly Dixons, called off at the last moment a $1.9m investment into Russia' leading electronics chain, Eldorado, due to concerns about "political, economic and corporative risks." They obviously did their due diligence well, because on March 4 Eldorado was raided by Russian police, and two days later presented with a $327m back tax claim. This episode followed a tax raid of leading cosmetics purveyor Arbat Prestige in January that led to the arrest of its owner, together with a notorious international mafia boss, Semyon Mogilevich, whose wife turned out to be a major shareholder in the company.

This succession of raids is no coincidence: Russia's tax service have publicly stated they are launching a crackdown on the retail sector, which they see to be a major transgressor of tax and customs laws. Further such developments are expected - and potential investors are hardly amused. So that could mean another option gone for global retailers looking to move into Russia big-time.

The most likely remaining option for the big names is that which Carrefour is pursuing: patiently put together an extensive land bank, open hypermarkets one by one as you can, and play a long-term game. But such a long-term strategy is too late coming to counteract the downturn on developed markets.

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