Tesco to Pay $550 Million in Supermarket Deal in China HONG KONG - Tesco, the giant British supermarket chain that sold off its businesses in the United States last month, is turning instead to China. In yet another sign of how the rising spending power of Chinese consumers is reshaping the global retailing industry, Tesco said on Wednesday that it would pay 4.3 billion Hong Kong dollars ($554 million) to set up a joint-venture supermarket business in China with a state-run partner. The British company will fold its unprofitable Chinese operations - with 134 stores and net assets of about $1.1 billion - into the partnership with China Resources Enterprise, a huge Chinese supermarket and convenience store operator with about 3,000 outlets in China and Hong Kong. "Through this deal we have a strong platform in one of the world's most exciting markets, and it will move us more quickly to profitability in China," Philip Clarke, the chief executive of Tesco, said in a statement. Tesco also reported on Wednesday that its overall profit fell to £820 million ($1.33 billion) in the first half of the year, down 34 percent from £1.24 billion in the period a year earlier. In Britain, its largest market, sales at stores open more than a year were flat, and sales declined 5 percent in Europe, where the retailer has been hurt by economic downturns in countries including Ireland and Poland. In the 12 years since China joined the World Trade Organization, opening the door to foreign retailing joint ventures, multinational companies like Tesco (which has operated in China for nine years), Carrefour of France and Walmart of the United States have struggled to expand there. "This is a positive deal because of what it can mean for Tesco in the future," said David Gray, a retail analyst with Planet Retail in London. It allows them to stay in the market without the accompanying drain on resources it experienced in the past. It also has more potential of making the operation a success by working with a local partner. The market is huge and growing fast. Total supermarket sales last year were 1.8 trillion renminbi, or about $300 billion, a 10 percent increase over 2011, according to figures from Euromonitor International. Sales are forecast to rise another 25 percent by 2015, to more than 2.2 trillion renminbi. Despite this growth, the Chinese market has turned unprofitable for some large retail chains. In Tesco's case, the British company ranked as the fourth-biggest modern grocery retailer in China last year, behind Auchan Group of France, Walmart and Carrefour, according to Euromonitor. But despite operating in 11 provinces, including affluent and fast-growing areas like Shanghai and Tianjin, Tesco reported net losses in China of £238.5 million ($386 million) in the financial year that ended in February. That was worse than the £148.2 million loss it reported in China for the fiscal year ending in February 2012. "Tesco's losses are worse than we thought," Anson Chan, a retail analyst with the brokerage firm K.G.I. in Hong Kong, wrote on Wednesday in a research report. China Resources Enterprise believes Tesco's losses in China stem from a lack of scale, hampering its ability to fully utilize the supply chain, information system and operational expertise of Tesco's global network. Tesco's problems are emblematic of the challenges foreign retail chains face in China, including sprawling supply chains, wily and fast-growing local competitors, narrow profit margins and the fragmented nature of the market (the biggest supermarket chain has a market share of less than 5 percent). Moreover, the spending habits of Chinese consumers present their own challenges to the traditional Western big-box retail model that most hypermarkets rely on. In contrast with the pattern in the United States, for example, where a typical Walmart customer might visit once a week to stock up on supplies, Chinese people tend to shop more often, even daily, making smaller purchases. They also buy different things, according to a survey last year by McKinsey & Company, the consulting firm. Elsewhere, hypermarkets devote most of their shelf space to durable or household goods. In China, the focus is on food. Chinese consumers, McKinsey wrote, use hypermarkets like "a really big convenience store." Daniel Zipser, a partner in McKinsey's Shanghai office, points to the rapid rise of online retailing in China as another factor hurting the profitability of big-box retailers. "For hypermarkets, food drives the traffic to the store and nonfood drives the profits," Mr. Zipser said on Wednesday, referring to the margins on items like household appliances, electronic goods and apparel. So the most obvious challenge is definitely that the nonfood sections of hypermarkets have been severely impacted by the rise of e-commerce in China. Some hypermarkets have been more active than others in responding to this trend. In October 2012, Walmart raised its interest in Yihaodian, a major online retailer in China, to a controlling 51 percent stake. Given its challenges, Tesco had been scaling back its ambitions for the Chinese market. "We have adopted a more cautious stance in China," the company said in its most recent annual report, published in April. We still see an excess amount of new space being opened in the market - ahead of customer demand - and we have moderated our pace of development accordingly. By throwing its lot in with China Resources Entertainment, Tesco is hoping to benefit from having a strong local partner that can leverage a much larger networks of shops to increase profitability. Under the terms of the deal, Tesco will license its brand and own a 20 percent stake in the new, combined venture, which will be one of the biggest supermarket chains in China. The partnership plans to operate hypermarkets, supermarkets, convenience stores, cash-and-carry wholesale businesses and liquor stores. The deal also gives Tesco an option to increase its stake in the venture to 25 percent within the next five years or if the new company seeks an initial public offering. Hong Jie, the chief executive of China Resources Enterprise, said in a statement that the new partnership would be "a compelling combination of local customer insights and international retail best practice, creating success and value for both groups, as well as propelling the internationalization of China's retail industry." China Resources Enterprise is also one of the companies that has been identified as a bidder for the Hong Kong supermarket chain, ParknShop, of the billionaire Li Ka-shing, a sale that could command $3 billion to $4 billion. In August, China Resources Enterprise announced that it had started negotiating the details of a potential joint venture with Tesco, and executives said then that they would also consider joining Tesco in a joint bid for ParknShop. Completion of the joint-venture deal is scheduled for the first half of 2014 and remains subject to approvals from China's antimonopoly regulator, as well as shareholders of China Resources Enterprise. Morgan Stanley and UBS are the financial advisers to China Resources Enterprise on the deal.