37.Carrefour S.A.

513 Carrefour S.A. With total sales of (euros) EUR53.9 billion from more than 5,200 stores, Carrefour S.A. was Europe’s largest retailer in the summer of 2002. Over the previous four years, Carrefour’s growth, including several large acquisitions, had occurred almost entirely outside France. The company maintained retail operations in 26 countries across the globe. In funding its ongoing expansion, Carrefour faced an immediate debt-financing requirement of EUR750 million. Historically, Carrefour management maintained a practice of funding capital needs in the same currency as the respective business operations. Its investment banks, Morgan Stanley and UBS-Warburg, however, had recently suggested that Carrefour consider borrowing in British pounds sterling through the eurobond market in order to take advantage of a temporary borrowing opportunity in that currency. As a basis of comparison, the investment bankers pro- vided alternative rates across various currencies for a proposed 10-year Carrefour bond. The bankers estimated that the bond could be priced at par at a coupon rate of 5 1 ⁄ 4 in euros, 5 3 ⁄ 8 in British pounds, 3 5 ⁄ 8 in Swiss francs, or 5 1 ⁄ 2 in U.S. dollars. Carrefour In 1963 in the small French town of Sainte-Geneviéve-des-Bois, southeast of Paris, Carrefour transformed the world of retailing with the introduction of the “hypermar- ket” concept. This retail format combined a supermarket, drugstore, discount store, and gas station into one massive, one-stop-shopping megastore. The original Sainte- Geneviéve-des-Bois store boasted 2,500 square meters of retail space, 12 checkouts, and 400 parking spaces. Leveraging this concept, the company expanded rapidly in France and beyond, opening its first store outside France (Belgium) in 1969, and outside Europe (Brazil) in 1975. In addition to strong organic growth, Carrefour pursued selective acquisitions, including notable mergers with Euromarche and Montlaur in 37 CASE This case was prepared by Professor Michael J. Schill. It is based exclusively on public sources and contains some fictionalized content. It was written as a basis for class discussion rather than to illustrate effective or ineffective handling of an administrative situation. Copyright © 2005 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order copies, send an e-mail to sales@dardenbusinesspublishing.com. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any mean––electronic, mechanical, photo- copying, recording, or otherwis––without the permission of the Darden School Foundation. Rev. 1/09. bru6171X_case37_511-522.qxd 12/18/12 4:58 PM Page 513 1991 and Promodes in 1999. Exhibit 1 provides a history of Carrefour’s store port- folio from 1992 to 2001. Carrefour was profitable in all major operating regions. In 2001, the company generated operating profits of EUR2.8 billion on total net sales of EUR69.5 billion. Of that profit, 5% originated in Asia, 2% originated in Latin America, and 26% originated in Europe outside France, with the remainder of profits coming from French operations. The regional-sales breakdown was 7% from Asia, 12% from Latin America, and 32% from Europe outside France. For Carrefour, 2001 marked an impor- tant milestone as the first year that total international sales exceeded total domestic French sales. Carrefour was the largest retailer in France, Belgium, Greece, and Spain. Exhibit 2 details Carrefour’s consolidated financial statements. The company expected to maintain its expansion trajectory. Carrefour’s CEO, Daniel Bernard, stated that in 2002 the company would increase sales by 5% on con- stant exchange rates and increase recurring net income by 10% to 15%. He asserted that the company would continue to gain market share in most of the countries where it operated, notably in Italy, Belgium, Brazil, and Argentina. Carrefour’s Financing Policy With such broad international reach, Carrefour was highly disciplined with respect to its management of exchange rate risk. Within each country, Carrefour operated prima- rily within the local economy for sourcing its products. Any foreign-currency exposure on imported goods was generally hedged through forward contracts on the currency. A currency forward contract was a financial agreement whose value was determined based on the difference between a predetermined forward rate and the prevailing spot rate at a particular point in the future. For example, suppose Carrefour purchased a U.S. dollar forward contract on EUR1 million in one year that was priced at (U.S. dollars) USD0.891 per euro. The gain on the contract in one year would be equal to 1,000,000 multiplied by the difference between the forward rate of USD0.891 and the prevailing dollar-to-euro exchange rate in one year (the spot rate). Suppose that the prevailing dollar-to-euro exchange rate was USD0.90 per euro. If the dollar appreciated to a dollar-to-euro exchange rate of USD0.85 in one year, Carrefour would gain USD41,429 on the forward contract [(USD0.891 ϪUSD0.85) ϫ 1,000,000]. Car- refour gained in this scenario because it owned a contract that gave it USD0.891 for every euro in the contract when the prevailing exchange rate only gave it USD0.85 per euro. If alternatively the dollar depreciated to a dollar-to-euro exchange rate of USD0.95, Carrefour would lose USD58,571 on the forward contract [(USD0.891 Ϫ USD0.95) ϫ 1,000,000]. Carrefour lost in this scenario because it was locked into a contract that required it to receive only USD0.891 for every euro in the contract when the prevailing exchange rate gave them USD0.95 per euro. In summary, with this particular forward contract Carrefour gained if the dollar appreciated and lost if the dollar depreciated. Banks offered forward rates based on the equivalent rate that could be syntheti- cally locked in by borrowing and lending in the two currencies. For example, suppose that the prevailing dollar-to-euro exchange rate was USD0.90 per euro and the 514 Part Seven Analysis of Financing Tactics: Leases, Options, and Foreign Currency bru6171X_case37_511-522.qxd 12/12/12 12:02 PM Page 514 prevailing interbank one-year interest rate is 4% in dollars and 5% in euro. If the bank wanted a forward position of receiving dollars and paying euros, it could borrow in euros at 5%, convert the proceeds into dollars, and invest the dollars at 4%. In con- structing this “synthetic forward contract,” the bank would generate dollars from euros at a rate of (1.04)(USD0.90) Ϭ (1.05) or USD0.891 per euro. Through borrowing in euros and investing in dollars the bank could simulate the same forward conversion of currency as that of a forward contract. Since the forward contract generated the same currency conversion as the synthetic forward contract, it was sensible that the fair forward rate for the USD/EUR exchange rate was determined by the same synthetic forward pricing formula: where f T USD/EUR is the forward rate for T-years, s USD/EUR is the prevailing spot exchange rate, and R USD,T and R EUR,T are the prevailing interbank interest rates for T-year maturity in dollars and euros, respectively. The pricing relationship applied to all currency combinations and maturities. Another way of arriving at the same forward contract pricing formula was to assume that in competitive markets the borrowing rate in one currency could not be meaningfully different than the rate achieved by borrowing in another currency and hedging the exchange rate risk with forward contracts. This condition was commonly called covered interest rate parity. 1 In 2001, total Carrefour borrowings were EUR13.5 billion, of which EUR6.4 billion were in publicly traded bonds. Carrefour’s debt was denominated in many currencies. Exhibit 3 details the recent composition of Carrefour’s borrowings by currency. Foreign-currency borrowing was generally hedged so that total debt requirements were currently 97% in euros. Current Market Opportunities As Carrefour management considered the bond-denomination decision, it also considered the current inflation, interest-rate, and exchange-rate environment. 2 Over the previous three years, long-term bond yields had declined in all four currencies. The Swiss franc’s interest rate, however, had consistently been the lowest rate. The decision also hinged on future movements in exchange rates. Over the previous five years, f T USD/EUR ϭ S USD/EUR (1 ϩ R USD,T ) T (1 ϩ R EUR,T ) T Case 37 Carrefour S.A. 515 1 Standard international finance theory prescribed that the forward rate represent an unbiased predictor of the future spot exchange rate. The empirical evidence overwhelming rejected this notion, finding that forward rates were poor and biased predictors of future exchange rates (see Ken Froot and Richard Thaler, “Anom- alies: Foreign Exchange,”Journal of Economic Perspectives 4 [1990]: 179–92, for a readable summary of the empirical evidence). In fact, the research literature suggested that the current spot exchange rate was generally a better predictor of the future exchange rate than was the forward rate. 2 Because the bonds would be offered in the eurobond market, they would be subject to similar issuance costs, liquidity, and specifications regardless of the currency denomination. Eurobonds uniformly followed an annual coupon convention. bru6171X_case37_511-522.qxd 12/12/12 12:02 PM Page 515 the euro had depreciated against most major currencies. Should this trend continue, paying down foreign-currency debt with euro-denominated cash flow would become increasingly expensive. Exhibits 4, 5, and 6 provide information on trends in inflation, government-benchmark bond yields, and exchange rates in the various currencies. Exhibits 7 and 8 provide information on prevailing current spot exchange rates and the yield curve. 516 Part Seven Analysis of Financing Tactics: Leases, Options, and Foreign Currency bru6171X_case37_511-522.qxd 12/12/12 12:02 PM Page 516 Case 37 Carrefour S.A. 517 Source: Carrefour S.A., annual report, 2001. EXHIBIT 1 | Total Number of Consolidated Stores 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 France 485 546 828 840 761 805 1,256 1,703 1,726 1,295 Spain 40 43 46 50 53 56 58 1,858 1,939 1,952 Portugal 2 2 2 2 2 3 4 278 277 281 Italy 0 1 6 5 6 6 6 52 413 305 Turkey 0 1 1 1 1 2 2 14 46 99 Poland 1 3 13 23 60 Czech Republic 369 Slovakia 22 Belgium 129 Switzerland 8 Greece 146 323 338 Argentina 6 7 9 12 15 18 21 128 361 400 Brazil 28 29 33 38 44 49 59 152 189 222 Mexico 2 7 13 17 19 17 18 19 Chile 1234 Colombia 1235 United States 2 Taiwan 5 7 8 10 13 17 21 23 24 26 Malaysia 1 1 2 3 5 6 6 6 China 2 3 7 14 20 24 24 Korea 3 3 6 12 20 22 Indonesia 1578 Singapore 1 1 1 1 1 Hong Kong 1 2 4 4 Thailand 2 6 7 9 11 15 Japan 13 Total 568 636 936 968 919 996 1,489 4,448 5,423 5,233 bru6171X_case37_511-522.qxd 12/12/12 12:02 PM Page 517 518 Part Seven Analysis of Financing Tactics: Leases, Options, and Foreign Currency EXHIBIT 2 | Financial Statements (in millions of euros) 2001 2000 Sales, net of taxes 69,486 64,802 Cost of sales 53,875 49,920 Sales, general, and admin. exp. 11,729 11,236 Other income 645 763 Depreciation 1,702 1,685 EBIT 2,826 2,725 Interest expense 646 707 Income tax 586 650 Net income from recurring operations 1,594 1,369 Fixed assets 26,561 27,840 Inventories 5,909 5,716 Trade and supplier receivables 2,946 3,146 Other receivables 3,258 4,387 Cash and marketable securities 4,797 2,941 Total assets 43,470 44,031 Shareholders’ equity 8,192 8,932 Provision for long-term liabilities 2,027 1,772 Borrowings 13,471 13,949 Trade payables and other debt 19,781 19,377 Total liabilities and shareholders’ equity 43,470 44,031 bru6171X_case37_511-522.qxd 12/12/12 12:02 PM Page 518 Case 37 Carrefour S.A. 519 Source: Company documents. EXHIBIT 4 | Trends in Inflation Rates (GDP deflator) Data Source: Datastream. EXHIBIT 3 | Breakdown of Borrowings by Currency (in millions of euros) 2001 2000 EUR Euro 12,267 12,201 JPY Japanese yen 342 90 USD U.S. dollar 110 115 ARS Argentine peso 238 903 CHF Swiss franc 191 161 NOK Norwegian kroner 61 61 TRY Turkish lire 49 65 CNY Chinese yuan 39 28 BRL Brazilian real 35 143 MYR Malaysian ringgit 29 70 COP Colombian peso 26 7 TWD Taiwanese dollar 25 71 KRW South Korean won 15 30 Others 15 3 Total 13,471 13,949 –1% 0% 1% 2% 3% 4% 1996 1997 1998 1999 2000 2001 2002 2003 U.S. U.K. Switzerland France bru6171X_case37_511-522.qxd 12/12/12 12:02 PM Page 519 520 Part Seven Analysis of Financing Tactics: Leases, Options, and Foreign Currency EXHIBIT 5 | Trends in 10-Year Government-Benchmark Bond Yields Data Source: Datastream. EXHIBIT 6 | Trends in Foreign-Currency Spot Rates Data Source: Datastream. 0% 1% 2% 3% 4% 5% 6% 7% 8% Jan-99 Mar-99 May-99 Jul-99 Sep-99 Nov-99 Jan-00 Mar-00 May-00 Jul-00 Sep-00 Nov-00 Jan-01 Mar-01 May-01 Jul-01 Sep-01 Nov-01 Jan-02 Mar-02 May-02 Jul-02 EURO/EUR £/GBP SF/CHF $/USD 0.0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.6 1.8 Dec-98 Mar-99 Jun-99 Sep-99 Dec-99 Mar-00 Jun-00 Sep-00 Dec-00 Mar-01 Jun-01 Sep-01 Dec-01 Mar-02 Jun-02 Spot rate SF/Euro US$/Euro £/Euro bru6171X_case37_511-522.qxd 12/12/12 12:02 PM Page 520 Case 37 Carrefour S.A. 521 Data Source: Datastream. 1 Rates equal to zero-curve fixed-to-floating swap rates. Data Source: Datastream. EXHIBIT 7 | Cross-Exchange Rates (spot prices, 7/31/2002) EUR GBP CHF USD EUR 1.000 1.593 0.688 1.020 GBP 0.628 1.000 0.432 0.640 CHF 1.453 2.315 1.000 1.482 USD 0.980 1.562 0.675 1.000 EXHIBIT 8 | Inter-bank Interest Rates by Currency Denomination 1 (percent) Maturity EUR GBP CHF USD 1-year 3.514 4.258 1.125 2.099 2-year 3.816 4.622 1.713 2.767 3-year 4.110 4.910 2.172 3.432 4-year 4.342 5.088 2.498 3.922 5-year 4.530 5.190 2.743 4.308 6-year 4.688 5.249 2.948 4.619 7-year 4.819 5.292 3.120 4.873 8-year 4.928 5.331 3.267 5.081 9-year 5.017 5.358 3.394 5.264 10-year 5.087 5.374 3.499 5.413 bru6171X_case37_511-522.qxd 12/12/12 12:02 PM Page 521 . in 37 CASE This case was prepared by Professor Michael J. Schill. It is based exclusively on public sources and contains some fictionalized content. It was written as a basis for class discussion rather than. impor- tant milestone as the first year that total international sales exceeded total domestic French sales. Carrefour was the largest retailer in France, Belgium, Greece, and Spain. Exhibit 2 details. details Carrefour s consolidated financial statements. The company expected to maintain its expansion trajectory. Carrefour s CEO, Daniel Bernard, stated that in 2002 the company would increase sales