Alibaba Raids the Clearance Bin

That's the right lens to consider Alibaba Group Holding Ltd.'s HK$22.4 billion ($2.9 billion) purchase of a 36 percent stake in Sun Art Retail Group Ltd., the 446-store bricks-and-mortar chain that's faced slowing sales as shoppers go online to buy high-margin goods like televisions and hair dryers.

The acquisition values Sun Art at HK$62 billion versus a market cap of HK$82 billion. The discount allowed Alibaba to scoop up the shares for around where Sun Art was trading back in June. The hypermarket chain's stock plunged as much as 14 percent in early trading in Hong Kong on Monday, before recovering to be 2.4 percent lower at the midday break.

Theoretically, the deal looks appropriate. Alibaba gets another advertising platform and picks up a few hundred physical locations to use as mini-warehouses, bringing the e-commerce giant closer to customers in smaller cities. Sun Art gets to learn from the master about how to sell stuff online.
But the reality is, physical retail is a hard business. Even Alibaba is going to have a hard time persuading shoppers to put gas in their cars and trek all the way to a store just to order the same commoditized mobile phone or microwave they could get via the web.
The other part of Sun Art's business, fast-moving consumer goods like food, toothpaste, diapers and detergent, are central to drawing in foot traffic and forging stronger customer connections, but they don't carry the profits needed to offset margins lost from electronics and other goods available online.
As for tapping Sun Art's retail space for Alibaba warehouses? The hypermarket operator owns only 31 percent of its properties, which means Alibaba will be paying rent on hundreds of prime properties in commercial centers that are more expensive than its current warehouses. It won't be a surprise if half of these stores are shuttered as leases expire.
There's a reason why Amazon.com Inc., with its pick of discount stores and hypermarkets, chose instead to spend $13.7 billion on specialty chain Whole Foods Market Inc. That acquisition wasn't about real estate, but about shoring up Amazon's inadequacies in a $1 trillion grocery business it's struggled to crack.
Sun Art probably won't be the same kind of transformative purchase for Alibaba that Whole Foods will be for Amazon. Still, as with its purchase of department store chain Intime Retail Group Co., Alibaba will be able to learn more about how to sell stuff to customers in the physical world.
And as with most clearance items, there's always the prospect of re-gifting to another buyer if the purchase turns out to be a bad fit.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.