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Why Wal-Mart's Expected Purchase of Massmart Could be Good Deal

|Includes:COST, HD, JCP, LOW, SHLD, TGT, Wal-Mart Stores, Inc. (WMT)
It was announced Monday that the world’s largest retailer, Wal-Mart Stores, Inc. of the US, has entered into exclusive negotiations to acquire Massmart Holdings, Ltd. of South Africa for R148 or about $4.6bn.  This transaction, if completed, is a potential game-changer in global retailing and goods production.

Unlike, say, ASDA, Massmart operates in over a dozen African nations where GDP growth rates are more than twice or three times that of developed economies.

Because of a lack of commercial capital, there is little supply of goods in these markets and lots of demand making even sundry items extremely expensive partly owing to lack of competition and cottage-industry businesses. Worse, the quality regardless of price is unusually poor. If this sounds familiar to small-town America and its low income urban counterparts before Wal-Mart's arrival, it's even worse.

Massmart recognized this two decades ago and has benefited handsomely for it.

One of the best metrics Warren Buffett says gets his interest is a company earning a return on equity of at least 20% per year consistently for 10 years.  Judging Massmart by such metric leads one to conclude it’s got an interesting business as exhibited below:

2010: 34.0%
2009: 41.7
2008: 50.7
2007: 52.3
2006: 48.9
2005: 44.2
2004: 42.8
2003: 35.4
2002: 27.6
2001: 19.1
2000: 24.9

These numbers are even better than Target Corp.'s very impressive figures.

Some may state that the above figures are boosted by inflation, which is true.  For an operator such as Massmart, moderate but stable inflation is actually a benefit as its carries a low-to-negative working capital balance; a cheap source of financing at sometimes negative costs similar Wal-Mart’s financing.

In addition, this transaction may accelerate the increase of local production in Africa as certain southern African states are already serving the continent from their local bases though this production may find stiff competion from Asian goods.  This could further complement Wal-Mart's ex-Africa businesses over the long-term to find competitive sources.

I've written here about why investors (rather than operators) in developed countries should avoid investing in emerging economies and provided a brief overview and history of such investments (see here “Emerging Markets? No, Thank You!” Part 1, Part 2, Part 3 and Part 4).

Though Wal-Mart Stores, Inc. has it's work cut out for it as the recent South African unions' opposition to the transaction demonstrates, if it goes through this looks to be a potentially good deal that combines a proven management team, a (virtually preexisting Wal-Mart) platform of low price-high volume, and extraordinary room for expansion with the decades-long technological and supply chain experience of the buyer.

One may question whether Africa's growth rate is sustainable (though we must remember it's comprised of over 50 nations) and setbacks such as Kenya's in 2009 will occur here and there, but the geographic diversity of 14 nations could help buffer that.  Meanwhile, there are no continent-wide retailing flagships and very few national champions to compete against on this scale.

Purchasing such an option for about one-third of a single year's net income is probably not a bad deal and provides Wal-Mart Stores, Inc. investors participation in an emerging continent's growth.  This is one of the best ways for a Westerner to invest in emerging markets.

Disclosure: The author owns no common shares in any of the aforementioned companies.