Wal-Mart's Seiyu Quagmire

It has been almost exactly five years since Wal-Mart joined hands with Seiyu (8268) through the capital tie-up, in May 2002. Wal-Mart first started exploring the Japanese market in 1997. Since then, Seiyu has posted nothing but net losses while WalMart tries to figure out the right combination. WalMart has already spent about $1 billion acquiring a controlling stake in what to date has been money down the drain.

Wal-Mart last year admitted failure in Germany and South Korea amid criticism that it could not adapt to consumer tastes, with low ROI being a factor--but how about negative ROI? France's Carrefour pulled out of Japan in 2005 after admitting it couldn't get it right in Japan. Past attempts by other foreign retailers have also sputtered. Costco has opened several stores inthe Tokyo area but is struggling to make the concept work. Toys R Us has beenin the Japanese market for some time, yet still struggles. The UK drug storechain, Boots, was not able to turn a profit and has exited the market.

But Wal-Mart for some reason believes that Japan is a strategic market. However, Wal-Mart lost to Aeon in a battle to acquire Daiei several years ago. The only choice for Wal-Mart was to either give up and withdraw, or continue pushing forward. It appears Wal-Mart has decided to continue pushing forward, and now will launch a JPY100 bln tender offer for full control of Seiyu.

Seiyu's performance improved marginally with a reduction in losses from $754 million in 2002 to $67 million in 2003. By the first quarter of 2004, Seiyu announced that it had cut down 3.6% of costs compared with the same period the previous year. It had laid off 25% of its full time employees though voluntary retirement schemes. The company announced that it expected to make profits of $4.6 million with sales of $10.2 billion for 2004, but actually produced a JPY12.3 bln loss. Between FY03 and FY06, cumulative net losses have been JPY92.2 bln, and recurring income was minus JPY6.2 bln in FY05 and JPY1.0 bln in FY06. While a profit was forecast for FY07, it now expects another loss of JPY5.9 billion, bringing cumulative net losses to nearly JPY100 billion since FY03.

Despite this, Wal-Mart is launching a JPY100 bln tender offer for the remaining shares of Seiyu, despite the cumulative losses and interest-bearing debt of JPY329 billion on Seiyu's books.

The Outcomes: a) Success, b) Failure

Given the track record of foreign retailers in Japan, the most obvious potential outcome is failure, but it will be an expensive one for Wal-Mart.

The second scenario, although not immediately apparent now, is success. Japan could turn out to be a or even Canada. for Wal-Mart. Wal-Martstarted off in Mexico by making a small investment in Cifra and then spent several years studying the Mexican market. In Canada they made what was essentially a real estate transaction, buying the defunct Woolco stores. In both countries Wal-Mart was able to implement Retail Link, working initially with Retail Link savvy suppliers from the US, an advantage they will have in Japan. It took a number of years before the operations either in Mexico or Canada became profitable.

But in the course of doing so, Wal-Mart has become the largest retailer inboth countries, driving consolidation in the market but also dramatically improving the quality of both suppliers and retailers.

MOF Continues to Oppose Talk of a Japan Sovereign Wealth Fund

MOF officials continue to oppose talk of a sovereign wealth fund for Japan that ostensibly would invest a portion of Japan's $946 billion of foreign exchange reserves. The reasons could be that,

a) Forex reserves have traditionally been the MOF's cookie jar and they would like to keep it that way.

b) They may have designs on using these reserves to pay down the nation's ballooning public debt.

c) Japan already gave up on the FILP (fiscal investment and loan program) which used public pension money to invest in public works and govt. bonds, because the govt.-backed companies that ran these programs were rife with pork-barrelling and proved to be a disaster--creating only non-performing loans and worthless assets. Creating another fund may only encourage another inefficient government-sponsored body and more pork-barrelling.

Japanese Property: Polarization is Already Clear and will Intensify

According to the Nikkei, he average price of residential land in 19 of the country's 47 prefectures is less than 10% that in Tokyo, up from five prefectures in 2002, quotingto the government's 2007 survey of prefectural land prices. While 13 prefectures showed single-digit readings on the index (Tokyo = 100) in 2006, six prefectures -- Iwate, Niigata, Yamanashi, Okayama, Yamaguchi and Saga -- joined them this year.

The gap in land prices is expanding because property is now being priced on discounted future cash flow projections. Property values in Tokyo are expected to continue improving as people, goods and capital converge on the nation's capital. Deregulation has put Tokyo on a redevelopment binge, adding fuel to the construction of high-rise residential complexes.

On the other hand, property prices in local areas with declining populations, shrinking GDP activity and no new investment is expected to continue shrinking. While the local governments and the central government (particularly the LDP and the opposition party) continue to publicly wring their collective hands about this because they want the regional populations' vote, fiscal deficits essentially mean that regional cities are on their own, and must come up with their own countermeasures to attract businesses, workers and new investment.

Expected Public Fund Buying of Small Caps: Where's the Beef?

Stock prices in Japan's junior markets (JASDAQ, Mothers, TSE2, Hercules) have been falling for over a year, but are recently trying to bottom. News that the giant Government Pension Investment Fund would be expanding its stock universe to include small caps encouraged some foreign investors (and hedge funds) to test the waters in the junior markets.

So far, however, there has been more talk than action from the public pension funds. During the weak bounce from bombed-out stock price levels in September, the "street" in Japan was speculating that the GPIF had begun to buy small caps. What actually appears to have happened is that foreign investors were buying small caps in anticipation of buying by the GPIF.

In reality, the GPIF is still choosing who will be its small cap fund managers. In addition, they will be using the Russell Nomura Small Cap Index (RNSMI) as its benchmark. In reality RNSMI invests mainly in smaller cap TSE-listed stocks, not junior market stocks. TSE1-listed stocks account for around 79% of the index, the TSE2 5%, the JASDAQ 7% and the Hercules 2%. Thus the GPIF's impact on the junior markets could actually be quite limited.