How Wal-Mart got a foot in the door of retail market

Written by Reuters | Mumbai | Updated: Dec 6 2012, 09:23am hrs
Wal-Mart Stores prepared its entry into Indias supermarket sector in 2010 with a $100-million investment into a consultancy with no employees, no profits and a scant $14,000 in revenue.

The company, called Cedar Support Services, might have been a more obvious selection four months earlier: it began its corporate life as Bharti Retail Holdings, according to documents filed with Indias Registrar of Companies.

The Cedar investment is now the focus of an investigation by Indias financial crimes watchdog into whether Wal-Mart broke foreign direct investment rules by putting money into a retailer before the government threw open the sector to global players. Wal-Mart said it was in compliance with Indias FDI guidelines, and had followed all procedures. It said the central government had sought information and clarification, which Wal-Mart has provided.

However, several lawyers said the transaction appeared to violate at least the spirit of Indias long-standing ban on foreign investment in supermarkets, which it only lifted in September 2012. When Wal-Mart made the investment in 2010, it was legal for foreigners to own consultants but not retailers, so the shift in Cedars business description raised eyebrows.

This is a complete camouflage, said Hitesh Jain, a senior partner at ALMT Legal in Mumbai who advises retailers but is not involved with Wal-Mart. It can be looked at as a violation of FDI rules because Cedar also operates supermarkets, which was a restricted sector back then. The law, however, is murky.

Others stressed that the way Wal-Mart structured the transaction might make it legal. According to the documents filed with Indias registrar, the investment was in the form of debt that was convertible into equity. That clouds the issue of whether Wal-Mart took a stake in Cedar or provided financing.

Bharti and Wal-Mart both declined to provide additional details on how the transaction was structured.

Senior government officials said that the Reserve Bank of India (RBI) had asked the Enforcement Directorate, which investigates financial crimes, to look into whether Wal-Mart violated the law by investing in a supermarket retailer before foreign investment rules were relaxed. If Wal-Mart did break the law, it could face a penalty of up to three times its initial $100 million investment, they said.

That would not only be a setback for Wal-Mart, it would also weaken consensus-building efforts by Indias minority government, led by the Congress party. The party is desperate for more support from across the political spectrum after its decision to let foreign players into Indias retail market came under fire from the opposition and even some of its own allies.

Wal-Mart and other retailers lobbied for years to gain access to Indias market, lured by the promise of a middle class that will one day rival Chinas. But local opposition has been fierce because of concern that Wal-Mart and its peers will knock millions of mom-and-pop stores out of business.

Reuters pieced together details of Wal-Marts investment in Cedar by examining records from Indias Registrar of Companies and through interviews with government officials involved with the matter, as well as several lawyers who work with retailers.

The documents reveal a web of companies set up under the Bharti umbrella, which runs Indias largest telecom operator, Bharti Airtel. The group, which also has retail interests, signed a joint venture with Wal-Mart to run wholesale stores in 2007, shortly after India allowed full foreign ownership of wholesale retail operations. That same year, the Bharti group formed Bharti Retail Holdings, which in turn owned a subsidiary called Bharti Retail which operated supermarkets and hypermarkets.

In December 2009, Bharti Retail Holdings changed its business description to consulting services from retail, the documents filed with Indias Registrar show. A month later, the company changed its name to Cedar.

The timing of the change in name and business is significant because when Wal-Mart invested in Cedar in March 2010, foreign companies could legally own 100% of an Indian consulting firm but not a supermarket retailer.

Cedar issued compulsorily convertible debentures to Wal-Mart Mauritius Holdings, which would be exchanged for 49% equity 18 months after the issue date. The conversion date has since been pushed back twice, to September 2013, which would be after Indias relaxation of rules on retail investment.

Cedars cash flow statement for 2010 shows that the funds raised from the debentures were used to finance activities and an attached schedule to the balance sheet shows a transfer of R175 crore to its retail unit, raising questions over whether Wal-Marts money went into the retail business.

Wal-Marts Indian partner, Bharti Enterprises, said it had followed the rules but did not address specific questions.

We are in complete compliance of all regulations. All details have been shared with the relevant authorities, a Bharti Enterprises spokesman said.

Two senior government officials said there had been an initial round of communication between the RBI and the Enforcement Directorate. The RBI asked the law enforcement agency to conduct the investigation.

RBI believes there is a need to investigate, said a senior government official, who spoke on condition of anonymity because of the sensitivity of the matter. He said both Wal-Mart and Bharti were being investigated because Wal-Mart allegedly made the investment and Bharti allegedly received it. Separately, Wal-Mart said last month it was looking into bribery allegations in several countries including India, Brazil and China. It conducted an earlier probe in Mexico.

Prime Minister Manmohan Singh is under intense pressure to roll back the decision to permit foreign retailers. Parliament ground to a halt on November 22 over opposition to the reforms until the government agreed to a vote.

A year ago, political pressure forced the government to make a U-turn after it first approved foreign investment into supermarkets, an abrupt shift that brought into question Indias ability to build consensus behind long-awaited reforms.

When Wal-Mart made the investment in Cedar in 2010, Indian law permitted foreigners to own cash-and-carry wholesale stores, but they were barred from owning what India calls multi-brand retailers, or stores like Wal-Marts namesake supermarkets that sell a wide array of products and brands.

Whether the investment in Cedar violated Indias law depends on two issues, according to the lawyers: if Cedar was in fact a retailer rather than a consultancy, and how the investment was structured. Cedars articles of association filed with the Registrar show it called itself a consultancy, but a few pages later it describes a competing business as one involved in retail and operates supermarkets, hypermarkets and discount stores.

Even if investigators determine Cedar was a retailer, lawyers said Wal-Marts investment may still be legal if the transaction is deemed to be debt. Wal-Mart could then argue that it did not acquire a stake but instead extended a loan. But according to RBI guidelines set in 2007, compulsorily convertible debentures are considered equity. That would mean Wal-Mart jumped the gun, said Alok Dhir, managing partner Dhir & Dhir Associates.

It is not clear whether this transaction included such a clause, and Wal-Mart and Bharti declined to comment.