Tesco pulls back in China with Vanguard deal

A customer carries Tesco-branded shopping bags as she leaves one of the company's stores.
Simon Dawson | Bloomberg via Getty Images
A customer carries Tesco-branded shopping bags as she leaves one of the company's stores.

Tesco will slash its China exposure by taking just 20 percent of a venture with a state-run company, a deal that underlines the travails foreign retailers have had in the Chinese market and allows it to concentrate on turning around its domestic business.

Lured by the prospect of a rapidly growing middle class in the world's second-biggest economy, many foreign firms have waded into China's retail market only to find they lack local expertise, particularly in building strong relationships with suppliers.

Germany's Metro AG said in January it was pulling out of the consumer electronics business in China while Home Depot Inc said last year that it would close all seven of its big-box home improvement stores. Wal-Mart Stores Inc has also found it challenging to maintain growth in China, losing ground to Sun Art Retail Group Ltd.

(Read more: China's factories remain in deflation, producer prices show)

"Tesco has been struggling in China and has been losing money. Similar to Carrefour, they had issues in their home market which they had to resolve," said one Hong Kong-based M&A banker.

"This may look win-win, but in reality, Tesco is saying 'I can't figure out China'," he said.

Under the deal, state-run China Resources Enterprise Ltd , the country's second-biggest operator of hypermarkets including the Vanguard chain, will take 80 percent of the venture. Its Vanguard unit operates 2,986 stores, mainly hypermarkets or supermarkets, across China and Hong Kong, while Tesco, the world's third-biggest retailer, has 131 outlets.

The venture will allow the two companies to grow their hypermarkets, supermarkets, convenience stores, cash and carry business and liquor stores in China, they said in a statement.

CRE shares were up 5 percent at HK$25.05, outpacing a 0.5 percent rise in benchmark Hang Seng share index as of the midday break.

(Read more: Tesco Plans to Sell Its Fresh & Easy US Stores)

"Tesco...finally finds a big giant to salvage them," said Kenny Wu, an analyst at Societe Generale Ji-Asia in Hong Kong, adding that the deal also works for CRE which is keen to expand its market share and has the cash to do so.

CRE's partnership with the world's third-biggest retailer comes at a time when Asia's richest man Li Ka-shing is considering the sale of his Hong Kong supermarket business, worth up to $4 billion. CRE was seen as a potential bidder for that business, but some bankers said the Tesco agreement could keep it too busy to do another deal.

Wal-Mart is considering making a bid for Li's Hong Kong supermarket business, people familiar with matter have said.

This year, Tesco wrote down the value of its global operations by $3.5 billion and announced plans to exit the United States. Last year, it ended a nine-year attempt to crack Japan's tough retail market by effectively paying Aeon Corp , the country's No.2 general retailer, to take its loss-making business there off its hands.

Tesco makes about two thirds of its revenues in Britain, where online shopping, rising petrol prices and weak consumer spending have curbed the need for customers to visit larger stores and buy their big ticket items.

It also invested less than domestic rivals Sainsbury and Asda and is now in the midst of a 1 billion pound push to revitalise the business.

China's hypermarket industry will likely grow to 863.8 billion yuan ($141 billion) by 2015, from an estimated 659.6 billion yuan in 2013, according to Euromonitor.

The industry leader is Sun Art, a joint venture between Taiwan conglomerate Ruentex Group and privately held French retailer Groupe Auchan SA, which has a 13.6 percent market share, capitalising on its expertise in maintaining competitive prices with local suppliers.