Tesco to merge China business with SOE

Move comes as competition among foreign chains increases

Britain's biggest retailer Tesco Plc announced on Friday it had signed a Memorandum of Understanding with the State-owned China Resources Enterprise for a joint venture agreement merging their Chinese operations, amid tough competition among foreign supermarket chains in the world's second-largest economy.

The proposed deal, which would represent a significant scaling down of the UK company's Chinese operations, will merge Tesco's 131 hypermarkets, supermarkets as well as shopping mall business in China with the Hong Kong-listed CRE's almost 3,000 stores.

CRE, a major supermarket operator in the country that includes the Vanguard chain, will control about 80 percent of the venture. Tesco, the world's third-largest retailer, would have 20 percent. Both companies confirmed the move in statements to the stock market.

It would bring together "a deep understanding of local customers, an established nationwide infrastructure and proven track record with Tesco's global retail expertise, international sourcing scale and supply chain capabilities", CRE said in a statement.

It is still unclear at this stage whether the deal would mean the Tesco brand disappearing in China. Industry insiders forecast the agreement will allow Tesco to maintain a presence in the world's most populous nation in a way that eats up less capital.

Oceanne Zhang, head of Market Insights China, a division at consulting and research firm Kantar Retail, said Tesco is not alone in feeling pressure. Many foreign supermarket chains have been losing money in the Chinese market.

"The last couple of years have been difficult for foreign supermarket chains because of soaring operational costs such as rent and personnel," said Zhang. "Because more people changed their habits, spending more time shopping online, the physical retail market has shrunk substantially in the past few years."

The profit margin of the retail market in China declined from 5 percent in 2005 to nearly 2.5 percent in 2012. Tesco, Carrefour SA and Wal-Mart Stores Inc have all remained below that benchmark, according to Zhang.

Tesco has been in China since 2004 and had very aggressive expansion plans. Within just the last couple of years it said it would spend billions of pounds and open about 300 stores and scores of shopping malls.

But it has since slashed its exposure in China and is losing money in the country. It closed four stores last year and another this year. Last year its sales were about 1.4 billion pounds ($2 billion), a small slice of China's 190-billion-pound modern grocery market, according to an earlier report by the UK's Financial Times.

Against a backdrop of declining sales last year as the mainland economy slowed and shopping habits changed, French supermarket chain Carrefour shut two and Walmart, as the United States giant is branded, shut five stores last year, according to a report in the Southern Metropolis Daily.

Chinese operators are better able to weather the downturn, because they are more adapted to the local business environment and can enjoy supportive measures from local governments, Zhang said.

"Local governments tend to give more resources such as better locations and preferable policies to local companies to foster their growth," she said, adding that this new venture will enable CRE to imitate the multi-format model of Walmart and Carrefour.