Money Growing: Evolution of Provincials

In the regions the process of mergers and acquisitions by trading companies is in full swing. Most active in the role of buyers of local retail chains are national retailers. Their main interest has become transactions in land, real estate, shops and the sales volumes of local dealers. The least they want is provincial brands, trademarks and technologies. For regional level retailers often any transactions are profitable. But not everyone dreams about sales: some people hope for a future in which they may become famous.

Russian national chains expand in order to draw the attention of international brands and consequently aspire to acquire as many trading companies in the regions as possible, Natalia Oreshina, director of the shopping real estate department at Cushman Wakefield/Stiles Riabokobylko (CW/SR) agrees. The retail market is not yet saturated, and now there is a peak in strict competition between strong players in the fight for the purchase of the weaker players. Thus the trading sector will develop for several more years while in the country the growth of the consumer ability of the population and an increase in retailer’s sales volumes will proceed.

According to the Ministry of Economic Development and Trade of Russia, in 2007, on average, the population spent 70 per cent of their income on consumer expenditures.

“National chains, having powerful resources and occupying a greater share of the market, can offer consumers more favorable prices and quality of service, than modest regional sellers,” Elza Rosental, president and sales manager at Torgovy Kvartal, does not doubt. Rapid mergers and acquisitions in the retail sector are quite natural. Foreign markets also experienced such a fever. In the US this wave hit in the 1980s-1990s.

Russian regional retailers, in turn, absorb each other to be liked by national retailers. They know that it is the regions that are the main resource for development of the whole trading sector.

At the 10th Trade in Russia International conference in Moscow last autumn, market players spoke about how the potential of some large cities had been exhausted, and how in other regions retailers do not have enough financing to transform their own ambitions into real projects. Chains of a national and international scale are capable of helping the sector of regional trade with investments for development, says Kiril Neginsky, deputy chief of management for the financing of real estate projects at Gazprombank.

The magnetism of the regions

From the moment the concept of retail chains was born in the country regional companies have grown and got stronger. While Moscow and St. Petersburg were carried away with their own development, other cities aspired to be like them. Now in almost every city - both million populated cities and small settlements - trademarks have been created by local businessmen. Gradually such companies have turned into operators, trying to build their business by the principles of a chain.

However, there is an opinion that in regional cities operators of shopping chains that correspond to international standards of business dealing have not yet been generated.

“Strong retail chains in the provinces are still a myth. Probably, in due course they will appear,” says Vladimir Galagury, director and co-owner of the Kaktus supermarkets from Chelyabinsk. “Market laws are that you either develop and possess a progressive idea or know-how, or you get bought. Regional retailers do not have the technologies and financial possibilities that national retailers have, and national retailers do not have those that foreign specialists have.”

Nevertheless in the last two decades strong companies have been assembled. For example, among operators of hypermarkets and supermarkets that have entered the market in other cities there are grocery networks O’Kei from St. Petersburg, Vester from Kaliningrad, Magnet from Krasnodar, Kirov from Yekaterinburg and trading-industrial company Bakhetle from Kazan. Holiday Klassik, the first large trading chain from Novosibirsk and the first in Siberia is an inter-regional player in the food retail market. Molniya, one of the largest Chelyabinsk hypermarket chains also owns shopping centers in the city.

Maxim Gasiev, regional director of trading real estate at Colliers International, lists the following among the largest regional trademarks: Viktoriya (from Kaliningrad, is engaged in food goods), Lenta (from St. Petersburg, cash and carry format), Matrix (from Bashkortostan, supermarkets and manufacturer of food goods), Alpi (from the Krasnoyarsk region, agricultural holding, chain of hypermarkets and a construction company), Santa House (from St. Petersburg, household and decorating goods, DIY format shops), Chudodom (from Siberia, DIY superstores), Domovoi (from Nizhny Novgorod, household goods), and Domo (from Kazan, home appliance stores). Such chains, first of all, are interesting to large players, who need not only material assets (in particular, real estate), but also sales volumes. In cases with all other retailers that represent small local trademarks, the interest of national operators is focused on real estate, Rosental confirms. The cost of a regional brand at a given stage of development of the market is minimal if we are talking about operators that only develop within the limits of a city, Oreshina notes.

“I do not see sense for a foreign or national chain of companies to buy regional brands,” Galagury reflects. “For example, Chelyabinsk chain Molniya is, perhaps, the only one that can be sold as a brand. But an operator of the level of Auchan or Metro will hardly become interested in its brand and technologies. From these positions it may be interesting perhaps to a large regional retailer, for example from Novosibirsk.”

In 2006-2007 in Russia some large deals were concluded. A good example of a merger was shown by two of the strongest operators – Perekryostok and Pyatyorochka. After the merge it turned into X5 Retail Group. The main shareholder of the new incorporated company, Alpha Group, in 2006, became the owners of Perekryostok. In 2005, Pyatyorochka had 326 shops under its management and 425 shops worked under franchising contracts. The Perekryostok chain of grocery supermarkets has about 130 shops in 38 cities in Russia and Ukraine.

Among the owners of both companies at the time of the merge there were already foreign shareholders. The main shareholders of Pyatyorochka Holding NV were Marie Carla-Corporation NV (16.78 per cent share) and Tayleforth NV (48.72 per cent), both from the Netherlands. International investment fund Templeton Strategic Emerging Markets Fund had a 7.1 per cent share in Perekryostok. In 2007, X5 Retail Group has expanded a little more, having integrated the Merkado brand of Moscow supermarkets and shopping centers into the chain. Ten shops have been opened under the Pyatyorochka brand and seven under the Perekryostok brand. X5 Retail Group has bought 100 per cent of shares in Metronom АG, operated by the Merkado chain.

In the last two years Moscow company StartMaster, a famous player in the computer retail market, has bought St. Petersburg company Rim and has opened eight shops on their premises. Evroset has bought the largest regional chain of telecommunication shops Ultra in St. Petersburg. SIMfoniya has joined with mobile communication stores Tsifrograd in Yekaterinburg, Kamensk-Uralsk and Novouralsk. National company З6.6 became the owner of the Sverdlovsk pharmaceutical chain Atoll-Pharm. Moscow’s Kopeika and Krasnodar’s Magnet together have bought the Nizhniy Novgorod grocery chain Natsionalny Torgovy Alians (National Trade Alliance).

Wolves and sheep

One of the consequences of the Russian process of mergers and acquisitions is the end of existence of local companies and the destruction of trademarks created by them. Practice shows that purchases of regional companies happens under two scenarios. Either trading companies on the verge of bankruptcy get bought for small change, or strong regional retailers are bought whose shops will bring to the new owner an increase in sales volumes.

But a national leader who comes to a regional city is not always more effective than the former owner of the stores. An example is the metamorphosis of the largest chain of the Ural region, Nezabudka from Chelyabinsk. The chain appeared in 2002. It specialized in the retail of foodstuff and accompanying manufactured goods. It included 33 shops in the discount or supermarket format under the Nezabudka brand (discounters offer a narrow assortment of goods, in soviet style supermarkets the spectrum of produce is wider and also the price is a little higher, in supermarkets there is a wide assortment and higher prices still, etc.).

At the end of 2006 the chain had approximately 80 stores, including Alye Parusa supermarkets and DarСity hypermarkets. The turnover of the company in 2004 totaled $40.3 million. At the start of 2007 the Grossmart national chain bought it (one of the divisions of the Marta holding, works in the format of neighborhood shops, local supermarkets, and hypermarkets), the deal was not public. According to local players, Nezabudka had debts to suppliers, but when buying it Grossmart allegedly agreed with these companies on the liquidation of the debts. However Nezabudka still has tens of millions of dollars debt to suppliers. It was not possible to reach the former owners of the chain on the phone. Presumably when buying this chain, Grossmart was counting on the volume of its sales. However it later sold the chain to foreign investors.

In 2006, 45 per cent of the chain was redeemed by two western investment funds - Baring Vostok Capital Partners and Eagle Venture Partners. Baring Vostok Private Equity Fund III has bought about 25 per cent of the chain, and Eagle Venture Partners another 20 per cent. In total for 45 per cent of the chain, by the estimations of experts, the shareholders of Nezabudka may have received about $30 million (here we are talking about investors, the funds are not foreign retailers, they only invest money in promising developing companies and then sell them with a substantial increase in price to either other investors who also plan to resell, or to profile retail companies - Vedomosti).

The investors have brought in a new general director at Nezabudka, the ex-chairman of the Russian Coca-Cola office and SladKo, Gary Wilson. They have also replaced the financial director, IТ-technology director, and other managers. Wilson's attempts to introduce international standards in the Chelyabinsk stores and take the chain to a new level have not been successful. Re-branding (changing the trade mark and image of a company) did not happen either. Local retailers say that Wilson has not managed to find a common language with suppliers and settle the debts of the chain. He simply took a plane and left the country. It is still not clear if re-branding will take place or not. The fact remains: in place of the large local brand, the beautiful national brand has brought nothing as effective. In this case the nationals have got a chain of shops together with a burden of financial debts and the mistakes of the previous managers.

Another example is the purchase of stores. Another Chelyabinsk chain, Sezam, that owns grocery hypermarkets, was bought by national level Mosmart (a chain of hypermarkets for the whole family) in 2006. After this purchase, in the city there were no Mosmart signs on the Sezam stores.

One of the bought hypermarkets continues to work under the same name. Most likely Mosmart was only interested in the possibility of being credited by potential investors after they hear about the purchase of the Chelyabinsk stores. The financial assets of Sezam can hardly interest a large national brand as the level of service of a local chain is far from the standards of national retailers. New signs will probably not be put up until the re-branding and re-equipment of the hypermarkets.

Before the purchase, the situation with Sezam was similar to the situation with Nezabudka: there were financial difficulties, debts to suppliers. Probably, the purchase of Sezam has not brought additional profit to Mosmart, but now there will be something to show to a larger international investor (for example before being sold to international investors in 2006 Nezabudka bought the Roskon chain of grocery shops in Magnitogorsk to show its success).

Chains not as large as Mosmart, Perekryostok or Pyatyorochka are left to get profit from their own sales. “Sometimes it is necessary to work more than 10 years to receive profit equal to the profit of the annual turnover of s chain,” says Galagury. And it is not so bad to earn at once all the money which should be earned in the next five or ten years.

According to Alexander Grigoriev, director of the corporate finance department at Unicredit Aton, regionals have three ways of development in the next few years: organic growth, attraction of partners and increasing the scale of the business, and the sale of the chain. The first variant assumes that the company cooks in its own juice, developing only from its own profit and credits, not involving other sources of financing. This means that the retailer will not grow in volume and will not occupy a larger part of the market.

However it is possible to be sold for much more if you offer not only material assets. In the opinion of experts, nationals are prepared to pay, for example, for IT solutions. The modern control system of supermarkets and streams of goods can be integrated into the system of a large chain. A store can be bought together with the equipment, if it is modern. The company-buyer is also interested in sales volumes. The higher the sales volume of the retailer, the more likely it will be bought exactly because of that. Buyers of chains are ready to pay for shops which visitors have got used to already. Nationals also have local retailers to thank for helping to enter the local market.

Brand or myth

However not all regional retailers see in their sleep how to be sold to national or foreign operators. At branch conferences they speak a lot about the price of brands, how to save them and the company together with all technologies and managers from ruin or sale. They defy the examples of companies that have grown into national scale operators, avoiding in due time, acquisition. But, in Galagury's opinion, such measures will not rescue regionals from acquisition, in fact for every large operator there will be another even larger. Besides, local sellers do not have the same financial resources as companies in Moscow where the main monetary streams are concentrated. Although, of course, in the provinces there are always small stubborn owners, who do not want to sell their business even if it has low profit. But it is necessary to understand that while Russian and international retailers need to increase their turnovers, the process of mergers and acquisitions will continue. Anther question is what and how will nationals begin to buy.

For everyone, even small operators, if they really want to build a chain and keep its trademark, they must adhere to international principles and standards of business dealing, considers Galagury. While in Russia at local levels there is a considerable number of manufacturers with recognized trademarks, there are only a few store chains with competitive technologies. So large chains theoretically have nothing to look for in cities, except for assets. “A brand, in the language of foreign players, is not just the name of a company, it is also a line in its financial balance, and a progressive technology of work,” says Galagury. “For example, everybody in the world knows Procter & Gamble is the king of soap. And in Russia everyone has heard about Makfa pasta: the make became a brand because behind its name is a manufacturer, technology and loyalty of buyers. This means that a brand can be sold for separate money. All the other variants can only be called a make. In the case with my business I realize that if I will be going to sell the supermarkets in the near future then most likely buyers will be interested in the shops themselves and the monetary stream they can generate after the purchase. They will not buy a chain. The chain is also part of the brand. This means that several shops are under one brand and are united with general quality standards of service. They extend to every shop wherever it is.”

For buyers, in Galagury’s opinion, a chain of supermarkets means convenience, a high degree of service in any shop of the chain, an assortment of quality goods, their constant presence on shelves and uniform prices. In addition, in a good chain there should be a goods purchasing department, a centralized logistics warehouse, an effective delivery control system: the necessary amount of goods in each shop in the necessary quantity for the time and at a coordinated price, and carefully established business processes so that employees do not behave spontaneously. “The reality is, that many Russian retailers are still very far from such organization,” he summarizes.

Giant-mania

The activity of the majority of national chains is explained by their preparation for an IPO (Initial Public Offering). The public placement of assets on a stock exchange is one way to look for a source of financing which the company can take advantage of. They may also be preparing for sale to foreign investment companies. Anyhow they aspire to get as much financial assets as possible (including real estate) from local trading operators that are not as strong as they are.

To attract investors a company should show that it owns a developed chain of shops, has national status, a recognized brand, large sales volumes, highly qualified management, and transparency at all levels of business. As Grigoriev notes, only four trading companies have appeared on Russian stock exchanges (X5 Retail Group, Sedmoi Kontinent, Dixi and Magnet) and one of them has joined the London Stock Exchange - X5 Retail Group.

To enter the international securities market, according to Grigoriev, the operator should have a turnover, i.е. earnings for the year should be no less than $2 billion. The retail trade market in Russia is third in terms of investment appeal to foreign companies after the oil and gas sector and metallurgy. Russian retail is valued even higher than similar companies in other developing, and already developed countries.

After pioneers Pyatyorochka and Perekryostok, other Russians have latched on to expansion. Trading companies-manufacturers have joined retailer groups. The Оst group (the well-known Voda iz Chernogolovka, alcoholic and soft drinks) informs that by the end of 2007 it intends to sell part of its non-profile assets and get almost 1 billion rubles for them. These funds the group will invest in the main business – the manufacture of alcohol. By 2009, Оst expects to almost double the capitalization of its alcoholic business to $500 million. The group has also decided to buy some local brands together with manufacturers. Analysts consider the purchase of brands and their assets in the regions as a competent step for Оst as many cities are a commodity market for the holding.

Another example concerns Wimm Bill Dann (WBD) which a year earlier bought the Omsk dairy factory Manros for $51.04 million, the largest manufacturer of dairy products in Siberia and the Far East. According to the managing directors of WBD, the holding will strengthen its positions in the quickly growing Siberian market thanks to the new strong player in the structure. The share of WBD in the Siberia and Far East market after the purchase of Manros should increase to 22 per cent.

But nationals nevertheless are not so greedy to indiscriminately acquire new comers to the regions. As was said at the Trade in Russia conference, investments in the retail trade sector of cities flow like a river when local companies show transparency of the business and high quality standards.

Galagury adds that in the regions brands and trademarks are more often observed among manufacturers and distributors of foodstuffs (for example Manros, bought by WBD).

Experts nevertheless think that in five years in regional cities there will be successful store chains and brands that will work successfully for a long time. They will start to work in a European way and involve financing for further development, when the Russian retail index will reach the market level of other countries, Neginsky considers. According to his information, the turnover of organized retail trade per capita in Russia is six times lower than in Western European countries. The share of modern retail formats of trade in the Russian market is 20-25 per cent, while in Europe it is 70-80 per cent. But first national and international companies will eat up regional companies.