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South Africa: Odd Logic As Top Furniture Retailers Take Off in Opposite Directions

Tim Cohen

27 August 2007

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Johannesburg — IN BARELY more than a week, JD Group announced it was separating out its financial services business and African Bank Investments Limited (Abil) announced a bid for JD's competitor, Ellerine.

SA's two major furniture retailers almost simultaneously announced they were heading off in totally different directions. What's going on here?

It's an odd time for the financial services side of retailing businesses, and it's obvious that the ideal model remains a work in progress. Yet strangely, there is an odd logic to both sides of the arguments.

Much of the argument revolves around the defensive nature of past link-ups with financial services groups. In the evolution of financial services, often it's the retailers that take the initiative for lower LSM clients. In developing countries, particularly those where financial services are not as developed as they are in SA, the main credit card issuers are retailers. The more first world you go up the scale, the more the financial services companies have successfully entered this space.

In fact, in many first world countries, credit cards are nominally retailer issued, and they are principally marketing tools for retailers.

The actual financial services part of the business is outsourced, and it is GE Capital rather than any banking group that is the market leader in this arena.

SA's economy falls between these two poles, and consequently we are seeing a divergence of opinion about the right approach. Furthermore, South African banks have been tentative in the low LSM market, allowing retailers, which are arguably much closer to their clients anyway, to fill the breach.

And in case you think this is all small potatoes, The Sunday Times reported this week the estimate that credit extension from South African retailers far exceeded the combined consumer book of the big four banks. Furthermore, 65% to 75% of retailers' turnover takes place in their credit departments, obviously varying according to the market position of the stores.

So SA's banks have nibbled in this area, forging relationships with retailers, but you can't help feeling their enthusiasm for these projects is less than wholehearted, possibly because they are effectively splitting their margins with the retailers.

The problem is particularly acute for furniture retailers whose methods have been, shall we say, aggressive. Clothing and general retailers have been playing a much longer-term game, and seem to have developed a more acute ability to lend small amounts to poorer people cheaply. All this makes the prospect of an Abil-Ellerines merger much more interesting, partly because Abil does have expertise in making loans to comparatively poor people, but also because it's a much more wholehearted and aggressive approach to the problem. The deal also looks adequately priced for Ellerines shareholders.

Significantly, the market lifted Abil's share price modestly, suggesting it recognised synergistic benefits too, despite the implicit dilution in Abil's likely margins. The combined companies will have an advances book of about R16bn with about 2-million active credit clients, while Abil will increase its outlets total from 600 to 1900.

Good deal, you would have to say, and one that puts a bit of pressure on JD, which, it must be said, seems to have been toying with the issue a bit. But you do wonder whether in the longer term a merger between a retailer and a bank can really last, despite the crossover. As SA's market increases in sophistication, it doesn't seem impossible that the retailing arm will eventually separate again.

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