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. Last Updated: 07/27/2016

Foreign Retailers Likely to Avoid M&A

After Carrefour’s stalled attempt to pair with a local grocer and unfulfilled rumors linking Wal-Mart to several top chains, global retailers are likely to go organic to capture growth in Russia.

Analysts had predicted a wave of mergers and acquisitions, expecting Russia’s sharp economic downturn would offer global majors a cheap ticket into a highly fragmented sector that has more growth potential than Europe’s retail market.

“I think that even now that prices for assets across sectors have dropped two to three times versus their highs 12 months ago, Russian food-retail assets of high quality are unlikely to sell cheaply,” Renaissance Capital analyst Natalya Zagvozdina said.

But strategic investors face the same dilemma as before, she said. “Pay up and get a sizeable exposure instantly, and then continue growing organically, or use the Auchan/Metro/IKEA model and grow by gradually opening stores,” she said.

And yet Russia’s high street bristles with new global brands each month.

A case in point is Carrefour, the world’s No. 2 grocer after U.S. chain Wal-Mart, which opened its first Russian store in June.

The French hypermarket chain has so far failed to clinch a deal for Sedmoi Kontinent, having offered to buy out its main owner, Alexander Zanadvorov, whose stake is collateralized with Deutsche Bank, for up to $1.6 billion.

Wal-Mart has been linked to multiple potential conquests — including grocers Lenta and Kopeika — but no deal has so far materialized. Investment bankers say the episodic merger talk shows Wal-Mart is checking out its options, if somewhat noisily.

“We continue to believe that this activity demonstrates that Russian food retail remains high on the mind of Wal-Mart management, offering an opportunity to round out its [Brazil, Russia, India and China] exposure,” UBS said.

In June, Wal-Mart said it had its sights on Russia.

An acquisition “would be in keeping with Wal-Mart’s recent international history as the majority of its expansion outside the United States has been through initial partial ownership stakes rather than greenfield development,” UBS said.

But it added that “market due diligence for entry into Russia will be of paramount concern” for the firm.

According to Citigroup, Russia’s four listed food retailers are trading with an 18 percent discount to their emerging peers, based on enterprise value versus forecast 2010 earnings before interest, tax, depreciation and amortization.

But deals are not forthcoming, as the investment case for Russian retail is not one of straight economics, analysts say.

“Strategic investors are not looking so much at multiples, but at price versus the quality of the asset as they look at each potential target to see what kind of returns they can get,” said an analyst with a Wall Street bank, who declined to be named.

What is frightening to a potential buyer, UBS said, is bureaucracy, tough logistics and the high property prices.

Marc Bartholomy, a partner and head of the corporate and mergers and acquisitions practice in law firm Clifford Chance’s Moscow office, said strategic investors were also scared away from Russia by tangled ownership structures, created in many cases to evade taxes.

“It’s not just price,” Bartholomy said. “A lot of the value of Russian retailers is in their real estate. … It’s the structure of what one can buy. The structures in Russia involve 150 shell companies. That does not meet buyers’ expectations on transparency.”

“The people sitting in New York or Paris say, ‘We don’t want this.’ Some of them are working on it. But it takes three to six months or more to do a good corporate restructuring.”

Russia is also notorious for bureaucratic hurdles, which have prompted Sweden’s IKEA, the world’s biggest furniture retailer, to freeze all new investments in the country.

Another frightening development for potential investors is a new draft law on retail, which aims to prevent gouging on food prices and protect suppliers and may put the brakes on expansion.