Wednesday, March 3, 2010

Pumpkin Patch's Chinese Adventure: A Great Wall of Losses or the Road to Riches?



With a 50% higher net profit for the 2010 half year on lower borrowing costs, Pumpkin Patch Ltd [PPL.NZ] is in the news again.

I have often wondered when Pumpkin Patch Ltd would start opening stores in China and news out that they will open their first store there in Beijing has answered my question.

Clearly this is a big risk because China is a massive market with lots of potential competition but with that big risk comes big opportunity in a market that could sustain thousands of stores.

There have been many failures of Western companies entering the Chinese market then high tailing it out with big losses. Lion Nathan Ltd (no longer listed) did this around 15 years ago and lost a bundle. Various US car companies have lost shareholder moola by the Hummer load in China.

There have also been some big successes; Yum! brands [YUM.NASDAQ], Coca Cola [KO.NYSE], McDonalds Corp [MCD.NYSE] have all found riches on the road to China. YUM! ,the franchisor of KFC, Pizza Hut, Taco Bell and a number of other fast food brands is doing especially well, particularly for its KFC offering.

With Pumpkin Patch there is an advantage that many other companies operating there don't have. Their product is made in China so the only logistics costs are rooted in local distribution. Variables like currency fluctuations are also ameliorated and only exists in terms of repatriating revenue back to New Zealand where Pumpkin Patch is currently based.

Pumpkin Patch has strong and loyal brand recognition in all the markets that it currently operates in and is a ripe candidate to exploit the Chinese fascination with all things Western - except for perhaps democracy!

There are some big risks in this market. The sheer size of it means that the cost of expansion is likely to be massive and that is going to be a cost to the company and therefore every Pumpkin Patch shareholder. We have found that the cost of expansion thus far in the USA has cost shareholders dearly, with millions lost due to slow sales and the closing of multiple stores as a result.

Sure, growing a business, especially in a market you don't fully understand or currently don't operate in is fraught with risk but if you want a truely global brand and business, risks like this, done in a calculated, planned and sedate manner must be taken.

Greg Muir, Pumpkin Patch Chairman, was at the centre of a failed expansion as CEO of The Warehouse Group [WHS.NZ]in Australia in 2000 that cost the company hundreds of millions, so I hope that he has acquired the requisite expertise for the Pumpkin's Chinese expansion and doesn't repeat the same mistakes.

If done in an appropriate manner shareholders are going to be wealthy beyond their wildest dreams, if done incorrectly it will threaten the very existence of the company.

Pumpkin Patch @ Share Investor

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