Wal-Mart Stores Inc. (WMT) has canceled much of a deal in which
Hong Kong's Li & Fung Ltd. (0494.HK, LFUGY) would supply goods
for the U.S.-based retailer's overseas stores, according to people
close to the companies, as Wal-Mart moves to buy more of its
products directly from factories.
The move dealt another blow to Li & Fung, which serves as a
buying agent for an array of goods, from toys to clothes, for
retailers such as Wal-Mart and Target Corp (TGT). Li & Fung's
operating profit fell 22% in the first half, prompting analysts to
slash their ratings on the company's stock.
A sluggish global economy and price competition are putting
pressure on the world's middlemen. Li & Fung clients, including
baby-clothes maker Carter's Inc. (CRI) and Gymboree Corp., have
also said they plan to buy more products directly from
factories.
In a Thursday filing with the Hong Kong Stock Exchange, Li &
Fung said Wal-Mart had terminated its option to buy Direct Sourcing
Group, a unit the middleman set up two years ago solely to serve
the world's largest retailer. Li & Fung said it would continue
to supply products for Wal-Mart's Sam's Club operations and for
certain categories of Wal-Mart's domestic and international
operations. The Hong Kong company said Wal-Mart no longer needed
the option to buy Direct Sourcing because of the companies'
"strong" partnership.
But Li & Fung told employees last month that it was losing
the sourcing business for much of Wal-Mart's international stores,
according to people who read an internal memo.
Wal-Mart spokesman Anthony Rose said Thursday that the retailer
maintains a "good relationship" with Li & Fung. Wal-Mart U.S.
President Bill Simon said at an analysts' conference in New York
this month that the Bentonville, Ark., retailer used Li & Fung
to "do things that are complicated for us but less complicated for
them."
Li & Fung declined to comment on the loss of Wal-Mart's
international business but said "the substantive terms" and
"nature" of the partnership "remains essentially unchanged." Li
& Fung said it would now be able to offer design, development
and distribution services for Wal-Mart goods in Latin America,
services the Hong Kong company said it couldn't provide before as
Wal-Mart's buying agent.
Li & Fung's shares closed at 12.52 Hong Kong dollars
(US$1.61), down 22 cents, or 1.7%, in Hong Kong on Thursday.
Wal-Mart's shares were up 20 cents at $74.57 in afternoon trading
on the New York Stock Exchange.
Li & Fung Chief Executive Bruce Rockowitz said in August
that even when retailers work directly with factories, they need an
intermediary to manage factory logistics, communications and
quality checks--services that Li & Fung is eager to provide
beyond supplying goods.
Li & Fung hasn't disclosed how much sourcing it does for
Wal-Mart's international operations or the revenue earned from such
operations.
But UBS analyst Spencer Leung wrote last year that under the
2010 agreement between the two companies, Li & Fung likely was
sourcing goods for stores in Wal-Mart's international operations,
in places such as South America and Japan. Wal-Mart, meanwhile, was
using its own staff to procure more than 70% of the company's
product volume, in countries such as the U.S., Canada and the U.K.,
he estimated.
Li & Fung's deal with Wal-Mart was seen by some analysts as
a catalyst for the Hong Kong company's growth. Goldman Sachs in
January 2010 called it a "transformational" agreement that could
double Li & Fung's business. "We think this partnership offers
the strongest proof to date that even at L&F's current scale,
growth does not need to slow down," Goldman Sachs said.
Other analysts questioned how profitable Li & Fung could be
under the agreement, given Wal-Mart's reputation for cutting costs
in its supply chain.
To handle sourcing for Wal-Mart's U.S. and international
operations, Li & Fung set up a separate company, Direct
Sourcing Group, and said the unit would employ hundreds of people.
The development was seen as part of Wal-Mart's move toward direct
sourcing, since the company had an option to acquire Direct
Sourcing and take over its supplier relationships in 2016. Wal-Mart
at the time said it hoped eventually to use its own staff to source
80% of private-label goods, such as Faded Glory clothing, cutting
costs 5% to 15% within five years.
Li & Fung had estimated that the deal would generate $2
billion in revenue in the first 12 months. But Direct Sourcing fell
short of this goal, generating $1.7 billion in revenue and
recording an operating loss last year.
HSBC analyst Chris Zee this week upgraded Li & Fung's stock
to "overweight," writing that U.S. monetary policy would provide
"impetus for a significant revival in earnings at Li &
Fung."
--Shelly Banjo contributed to this article.
Write to Kathy Chu at kathy.chu@wsj.com
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