Exclusive leases: Profit pool for big retailers to be emptied
In April, at the Value Investor's Conference in Omaha, top rated investment researcher Pat Dorsey listed South African retail shares among a group of "sweet spots" globally. Their return on assets, he said, were massively higher than their international peers. Since returning, I've been trying to find out why. Sure, the retailers run reasonably good businesses, but there's no discernable difference between what's on the shelves at Pick n Pay or Tesco. And after he returned from his first visit to new parent Wal-mart, then CEO of Massmart Grant Pattison said the local retail industry was a decade or more behind. Today's interview on CNBC Africa's Power Lunch may hold the key. Major retailers tie up long-term exclusive leases with shopping centres which, in effect, blocks competitors. And less competition means higher margins. But as you'll read in this interview with Mava Scott, the Competition Commission is back on the case. Another warning sign flashing for owners of those high return retail shares. – AH
ALEC HOGG: Welcome back. The South African Property Owners Association has asked the Competition Commission to investigate the practice of long-term exclusive leases in shopping malls. Mava Scott, Spokesperson of the Competition Commission, is with us in the studio. Mava, we had Guy Haywood, the CEO of Massmart in the studio here on the 28th of August and he was talking about having to go to court on these exclusive lease agreements. You've looked into it. Just unpack it for those of us who perhaps didn't see that interview or don't know how these things work.
MAVA SCOTT: Well unfortunately, I didn't see the interview but I do know that there's a big outcry out there with regard to these long-term lease agreements, especially from Massmart. I can already mention that there was a court case with the High Court upholding such an exclusive agreement between Pick n Pay and a landowner or a landlord in the Cape Gate Shopping Centre in the Western Cape where the Massmart wanted to enter that market.
ALEC HOGG: So it stops competition?
MAVA SCOTT: It does, but what was before the court in that case was clearly, contractual obligations. They have undertaken to enter into a contract that had specific clauses, which are exclusive in nature and the court was looking at whether there was a breach of that contract. The concern is there. You will recall that the Competition Commission did undertake such an investigation I think, in 2011, but that investigation was broader. That one was looking at the entire market of supermarkets as a whole – the big chains such as Pick n Pay, Shoprite, and Spar across the country. We were really looking at whether their conduct contravened the Act in any way – Section 4 of the Act – and whether there were certain agreements between them, which had an effect of lessening competition, and whether they were sharing sensitive information.
We were also looking at whether there was abuse of dominance by these players in certain local markets, we were very concerned with that. We also looked at the lease agreements but at the end of that investigation, we could not really reach a conclusion. Based on available evidence, we could not reach a conclusion that there was conclusive evidence of anti-competitive behaviour.
ALEC HOGG: But now the Property Owners Association (Neil Gopal) wrote a very strongly worded piece that we published on Biznews yesterday where he said 'please, Competition Commission. Come help us break this exclusive lease agreement'. Why would the property owners who, presumably, should be benefiting in some way…?
MAVA SCOTT: Look, it's quite a relief that they are coming back. I just need to take you back to the investigation of 2011 because when we decided not to refer the matter to the tribunal because of the lack of evidence, we thought that we should take an advocacy route, engage the landlords and engaged the property owners. We'd say to them 'look, it is possible that you can enter into these agreements, maybe for a limited time'. I would understand a retail owner who invests in a new development and they would want…some security on their investment. However, it doesn't have to be perpetual as we see with the current agreements. The minimum is ten years. Others go into 14 years with an option to renew with the same conditions, so we're saying that's untenable but it's a relief that it's the property owners themselves that are now coming out and saying 'look, we want to accommodate other players in the market'. The Commission is really, quite keen to look into this matter.
ALEC HOGG: What can you do though, if there are already lease agreements and as you say, 14 years with automatic renewals or the option to renew? Can you change the law? Does the law need to be changed to change this situation?
MAVA SCOTT: If we decide to investigate after this investigation, depending on the evidence that we will get fresh from the Property Owners Association, if there is clear evidence that indeed, there is a contravention of the Competition Act, we will then have to impose some penalties. Going forward, we would have to prescribe certain things that they must not do, that would cause them to contravene the Act further.
ALEC HOGG: Penalties on whom? On the shopping centres or…
MAVA SCOTT: Yes, penalties on parties that were found to have contravened the provisions of the Act.
ALEC HOGG: So the turkeys could be voting for Christmas here. The property owners are coming to you and saying 'please investigate this'.
MAVA SCOTT: It could be, because there is really no reason to hold on to these exclusive lease agreements. The argument before, for the developers in particular, was that 'if we go to the bank for funding, say that we want to start a new development, and there are issues about anchor tenants saying that they want guarantees for funding'… Development now, is that the Banking Association has given us a written undertaking that exclusive agreements between these landowners/landlords and retailers are no longer a condition for funding, so you don't have to fear anything.
ALEC HOGG: But Mava, this is a dramatic change potentially, to the whole retail sector in South Africa.
MAVA SCOTT: It's a big one and we hope that something really comes out of it because we, as the Competition Commission, are concerned as well. It came out very clearly in our investigation in 2011 that these big retailers have enjoyed huge amounts of market power and they are clearly dominant in certain local markets. In addition, they have enforced these lease agreements where for instance, a landowner attempted to get a player to come in as I've just cited a case now in the Cape Gate Shopping Mall. It's quite an interesting terrain that we're entering for the second time and we hope that this time it will yield much better results, because we, as the Competition Commission, are concerned as well.
ALEC HOGG: It's very interesting and I have mentioned this on this program before. I was at Value Investors Conference in Omaha in April this year and Pat Dorsey, who used to be the Head of Research at Morningstar, was talking about the whole world. Of the whole world, he picked out South African retailers as a great investment he said, because their return on equity was the highest anywhere. This could be one of the reasons why.
MAVA SCOTT: We shouldn't compromise that kind of confidence and we really hope that if we can't get it right through the law, we should be able to get it right through advocacy, persuasion, and really trying to make people understand that competition is good for the economy. It is also good for the businesses themselves, to thrive as well as being good for the consumer.
ALEC HOGG: Have you tried to use moral persuasion with the big supermarket chains in this issue?
MAVA SCOTT: Yes, we have engaged quite a number of them, raising our concerns and giving them options to say 'look, you don't have to have an exclusive agreement'. It depends on the type of investment you make into a development. I did make the point that you could agree. You can term the period in which you have an exclusive agreement, but after that period, you then open up for other players to come in so that you make the competition.