Costco Takes Control of Its Mexico Operations

by Will Ashworth | June 18, 2012 10:07 am

Costco (NASDAQ:COST[1]) announced on June 14 that it is acquiring its joint-venture partner’s 50% interest in Costco Mexico for $760 million. Could it be that Costco wants to avoid the same mess Wal-Mart (NYSE:WMT[2]) finds itself knee-deep in?

As part of the deal, Costco Mexico will issue a special dividend of $340.85 million, with its soon-to-be former partner getting half the proceeds. Costco will put its half toward the $760 million purchase price for the 50% it doesn’t already own. The move makes sense to me for several reasons.

Wal-Mart’s lawyers now believe the bribery allegations it faces in Mexico could run much deeper, possibly to Brazil, China, India and South Africa. Wal-Mart has operated stores in Mexico since 1991, when it entered into a joint venture with Mexican retailer Cifra. Six years later, Wal-Mart bought majority control and today owns 69% of Wal-Mart de Mexico (PINK:WMMVY[3]).

While there’s no way to know precisely when the alleged bribery took place, reports suggest it was sometime in the last decade, which would seem to indicate the alleged bribes occurred well after Wal-Mart took control of the Mexican operation.

However, it’s certainly possible that the seeds of these transgressions were planted while the division was operating under a 50/50 joint-venture agreement.

Wal-Mart currently operates joint ventures in China and India, as well as having majority, but not 100%, control in several other countries, including Mexico.

India and China would be at the top of anyone’s list as the most likely candidates for corruption and bribery. Clearly, Costco has the cash to fully consolidate the 50% it doesn’t already own of its Mexico unit, and given what’s happening with Wal-Mart, remedying that situation makes complete sense from a strategic, not to mention legal, point of view.

From an accounting standpoint, the move will make it much easier for investors, especially those new to the game, to understand a company where revenues are fully consolidated within the business rather than an as equity investment with earnings accounted for as “interest income and other, net” on the income statement.

That’s what Costco was doing until the end of fiscal 2010. Then the accounting rules changed, and the company was able to fully consolidate the Mexican business. As a result, its joint-venture partner’s share of earnings in 2011 was accounted for as “net income attributable to non controlling interests” on the income statement.

Those items won’t disappear entirely because Costco has majority-owned subsidiaries in Taiwan and Korea. But the operations in both countries are much smaller than those in Mexico, and if either becomes a significant piece of the puzzle, Costco would likely buy out the minority shareholders there as well.

Lastly, it says to Costco employees in Mexico that management in Seattle is committed to them as a team, value the job they’re doing and want them to be part of the company’s future.

I think both sides win here because Latin America and China is where the growth is, especially in retail. And Mexico and the rest of Latin America are experiencing a serious increase in their middle classes, the exact customers Costco is after.

Either the Wal-Mart situation spooked Costco into action or the Mexico buyout was in the works for some time and now proved an opportune time to jump further into the fray. Whatever the reason, it’s a smart move that takes advantage of a distracted competitor.

As of this writing, Will Ashworth did not own a position in any of the stocks named here. 

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  2. WMT:
  3. WMMVY:

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