Sogo starts pre-marketing

Valuation at a premium to European and US comps based on successful turnaround.

Three years after the bankrupt Japanese store was taken over by Hong Kong's Chow Tai Fook and real estate developers Joseph and Tomas Lau, the local retailer's turnaround is to be crowned by a $180 million to $200 million Hong Kong listing in mid-April.

BNP Paribas Peregrine is sole lead manager of the issue, which began pre-marketing yesterday (Monday).

The listed entity will be named Lifestyle International and is currently 50% owned by the Lau brothers and 50% by Chow Tai Fook Enterprises. The listing will represent around 25% of the enlarged share capital.

The store will be the dominant asset, but the listed entity will include a small shopping arcade close to the main store, the New Front shopping complex, which sells fashionable Japanese products. There is also Daiso, a $10 shop.

The future listco owns the building of the Causeway Bay store and specialists say this is a major plus since it insulates the operators from rent fluctuations and facilitates updating the store.

Proceeds will be used to upgrade the Causeway Bay store and to invest in a similar store, Shanghai Ongoing, in the Jingnan district of Shanghai. The size of the investment is not available.

The Shanghai store will not be able to use the Sogo brand name, however, since it was leased to mainland investors for 18 years after the Japanese group declared bankruptcy. The venture will hope to tap into the rising middle class in China's richest city, which has a GDP per capita of over $5000, five times the national average.

Sogo's business model is built around brand vendors, known as consignees, who are provided with floor space, and pay a commission on turnover in return. Sogo also has direct sales in the form of its supermarket, which sells high end foodstuffs.

Total sales proceeds from the Causeway Bay store were HK$2.9 billion ($371 million) in 2003, and HK$2.8 billion in 2002. The store's sales make up 16% of department store sales in Hong Kong. Turnover, the figure for the commission on the sales generated by the consignees and the proceeds of the direct sales in 2003 was HK$1.33 billion, practically unchanged on the previous year due to SARS.

Net profits were HK$270 million in 2003, substantially up from the HK$40 million in 2001, the year of the takeover.

"Since the takeover in 2001, the owners have slashed costs," says one specialist. "Administrative and distribution costs have more than halved. And inventory turnover stands at 13 days for Sogo, compared to 64 days for an average of retailers in the US, Europe and Asia."

Costs have also been reduced by getting rid of many of the frills which adorn Japanese department stores, such as elaborate gift wrapping services and troops of bowing assistants stationed at every door and escalator. These measures have helped net profit margins, which were in excess of 20% last year.

The high margins make finding comparables difficult, since no other store can boast such figures.

US department stores such as Sears, May and Federated all record net margins in the single digits, as does France's Layfayette. Britain's Marks and Spencer's stands at 6%. The average 'rest of the world' margin is just 3.7%.

Price earnings ratios also vary greatly across the world.

Chinese retailers, partly due to the distorted nature of their stock market, trade at a whopping 165 times 2003 earnings. Sogo hopes to list at a premium to US and European 2003 p/e ratios and expects strong growth from the Shanghai operation to kick in from 2005..

"We're expecting listing multiplie spanning the high teens to 20," the specialist adds. "This will be a premium to European retailers, which average about 15 times 2003 earnings and US retailers, which average around 17 times."

Where local retailers are concerned, the main comp is Eon, which runs Jusco, and is profitable but has much smaller margins. Wing On and Sincere have no 2004 forecast, and are losing money. The Hong Kong's retail sector's 2003 p/e was around 21. The Asian retail space's p/e ratio, mainly from Japanese and Korean companies, averages about 32 times 2003 earnings.

As regards Shanghai, Lifestyle International has two JVs. The first JV is a 50-50 JV operation involving the ownership of the building. The other JV is a 65-35 split for the operation of the store (there is no office space), giving Lifestyle International operational control. More than half of the complex will be taken up by the department store. The total floor area is bigger than that of the Hong Kong store.

Closer links under the Closer Economic Partnership Agreement last year have boosted Hong Kong's retail sales by making it easier for mainland tourists to come to Hong Kong. Once in Hong Kong, shopping for genuine labels is a favoured activity, since prices are lower than on the mainland.

The company should avoid the battering recent offerings involving China exposure have received, argue specialists, not only because of the all-new share nature of the issue, but also because of the high profitability track record and strength of the Hong Kong operations.

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