On May 9, 2018, Walmart confirmed officially what had been rumored for weeks, as well as announced that it would pay $16 billion to larn a 77% stake inwards Flipkart, an Indian online retail firm, translating into a valuation of to a greater extent than than $21 billion for a theater founded simply over 10 years ago, amongst well-nigh $10,000 inwards capital. Investors are debating the what, why as well as what adjacent on this transaction, amongst their reactions showing upwards inwards a driblet inwards Walmart’s marketplace capitalization of around $8 billion. For Indian tech start-ups, the bargain looks similar the Nirvana that many of them aspire to reach, as well as this volition undoubtedly affirm their hopes that if they create an Republic of Republic of India presence, at that spot volition live large players amongst deep pockets who volition purchase them out.
The Players
The house to start, when assessing a merger or an acquisition, is yesteryear looking at the companies involved, both acquiring as well as target, before the deal. It non only provides a baseline for whatsoever assessment of benefits, but may supply clues to motives.
Of the 2 players inwards this deal, nosotros know a lot less well-nigh Flipkart than nosotros practise well-nigh Walmart, because it is non publicly traded, as well as it provides only snippets of information well-nigh itself. That said, nosotros tin utilisation that information to pull some conclusions well-nigh the company:
- It has grown quickly: Flipkart was founded inwards Oct 2007 yesteryear Sachin as well as Binny Bansal, both ex-Amazon employees as well as unrelated to each other, amongst well-nigh $6000 inwards seed capital. The revenues for the fellowship increased from less than $1 1000000 inwards 2008-09 to $75 1000000 inwards 2011-12 as well as accelerated, amongst multiple acquisitions along the way, to attain $3 billion inwards 2016-2017. The revenue growth charge per unit of measurement inwards 2016-17 was 29%, downwards from the 50% revenue growth recorded inwards the prior financial year. Flipkart’s revenues are shown, inwards Indian rupees, inwards the graph below:
- While losing lots of coin as well as burning through cash: As the graph above, non surprisingly, show, Flipkart lost coin inwards its early on years, equally growth was its priority. More troubling, though, is the fact that the fellowship non only continues to lose money, but that its losses receive got scaled upwards amongst the revenues. In the 2016-17 financial year, for instance, the fellowship reported an operating loss of $0.6 billion, giving it an operating margin of minus 40%. The continued losses receive got resulted inwards the fellowship burning through much of the $7 billion it has raised inwards upper-case alphabetic quality over its lifetime from investors.
- And borrowing coin to plug cash flow deficits: Perhaps unwilling to dilute their ownership stake yesteryear farther seeking equity capital, the founders receive got borrowed substantial amounts. The costs of financing this debt jumped to $671 1000000 inwards the 2016-17 financial year, pushing overall losses to $1.3 billion. Not only are the finance costs adding to the losses as well as the cash forcefulness out each year, but they set the company’s survival, equally a stand-alone company, at risk.
- It has had issues amongst governance as well as transparency along the way: Flipkart has a complex belongings structure, amongst a parent fellowship inwards Singapore as well as multiple off shoots, some designed to larn about India’s byzantine restrictions on unusual investment as well as retailing as well as some reflecting their multiple forays raising venture capital.
While the defense forcefulness that volition live offered for the fellowship is that it is even as well as hence young, the scale of the losses as well as the dependence on borrowed coin would propose that equally a stand-alone business, yous would live hard pressed to come upwards up amongst a justification for a high value for the fellowship as well as would receive got serious concerns well-nigh survival.
b. Walmart, Aging Giant?
Walmart has been publicly traded for decades as well as its operating results tin live seen inwards much to a greater extent than detail. Its growth inwards the 1980s as well as 1990s from an Arkansas big-box shop to a dominant US retailer is captured below:
That operating history includes 2 decades of stellar growth towards the halt of the twentieth century, where Walmart reshaped the retail concern inwards the United States, as well as the years since, where growth has slowed downwards as well as margins receive got come upwards nether pressure. As Walmart stands now, hither is what nosotros see:
- Growth has slowed to a trickle: Walmart’s growth engine started sputtering to a greater extent than than a decade ago, partly because its revenue base of operations is as well as hence overwhelmingly large ($500 billion inwards 2017) as well as partly because of saturation inwards its primary market, which is the United States.
- And to a greater extent than of it is beingness acquired: As same shop sales growth has leveled off, Walmart has been trying to larn other companies, amongst Flipkart simply beingness the most recent (and most expensive) example.
- But its base of operations concern remains large box retailing: While acquiring online retailers similar Jet.com as well as upscale labels similar Bonobos correspond a alter from its original mission, the fellowship even as well as hence is built about its original models of depression price/ high book as well as box stores. The margins inwards that concern receive got been shrinking, albeit gradually, over time.
- And its global footprint is modest: For much of the terminal few years, Walmart has seen to a greater extent than than 20% of its revenues come upwards from exterior the United States, but that number has non increased over the terminal few years as well as a meaning portion of the unusual sales come upwards from United Mexican States as well as Canada.
Looking at the data, it is hard to come across how yous tin come upwards to whatsoever conclusion other than the 1 that Walmart is non simply a mature company, but 1 that is peradventure on the verge of decline.
Very few companies historic menses gracefully, amongst many fighting decline yesteryear trying desperately to reinvent themselves, entering novel markets as well as businesses, as well as trying to larn growth. Influenza A virus subtype H5N1 few practise succeed as well as notice a novel lease on life. If yous are a Walmart shareholder, your returns on the fellowship over the adjacent decade volition live determined inwards large role yesteryear how it industrial plant through the aging procedure as well as the Flipkart acquisition is 1 of the strongest signals that the fellowship does non programme to become into decline, without a fight. That may brand for a adept painting present theme, but it tin live really expensive for stockholders.
The Common Enemy
Looking at Flipkart as well as Walmart, it is clear that they are really dissimilar companies, at reverse ends of the life cycle. Flipkart is a immature company, even as well as hence struggling amongst its basic concern model, that has proven successful at delivering revenue growth but non profits. Walmart is an aging giant, even as well as hence profitable but amongst piddling growth as well as margins nether pressure. There is 1 chemical factor that they portion inwards mutual as well as that is that they are both facing off against peradventure the most feared fellowship inwards the world, Amazon.
a. Amazon versus Flipkart: Over the terminal few years, Amazon has aggressively pursued growth inwards India, conceding piddling to Flipkart, as well as shown a willingness to prioritize revenues (and marketplace share) over profits:
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| Source: Forrester (through Bloomberg Quint) |
While Flipkart remains the larger firm, Amazon Republic of Republic of India has continued to gain marketplace share, almost catching upwards yesteryear Apr 2018, as well as to a greater extent than critically, it has contributed to Flipkart’s losses, yesteryear beingness willing to lose coin itself. In a prior post, I called Amazon a Field of Dreams company, as well as argued that patience was built into its deoxyribonucleic acid as well as the halt game, if Flipkart as well as Amazon Republic of Republic of India become caput to caput is foretold. Flipkart volition fold, having run out of cash as well as capital.
b. Amazon versus Walmart: If at that spot is 1 fellowship inwards the terra firma that should know how Amazon operates, it has to live Walmart. Over the terminal xx years, it has seen Amazon lay waste product to the brick as well as mortar retail concern inwards the U.S. of America as well as spell the initial victims may receive got been subdivision stores as well as specialty retailers, it is quite clear that Amazon is setting its sights on Walmart as well as Target, peculiarly later its acquisition of Whole Foods.
It may seem similar hyperbole, but a strong declaration tin live made that spell some of Flipkart as well as Walmart’s problems tin live traced to administration decision, scaling issues as well as client tastes, it is the fearfulness of Amazon that fills their waking moments as well as drives their conclusion making.
The Pricing of Flipkart
Walmart is simply the latest inwards a serial of high profile investors that Flipkart has attracted over the years. Tiger Global has made multiple investments inwards the company, starting inwards 2013, as well as other international investors receive got been role of subsequent rounds. The nautical chart below captures the history:
Barring a menses betwixt July 2015 as well as belatedly 2016, where the fellowship was priced downwards yesteryear existing investors, the pricing has risen, amongst each novel upper-case alphabetic quality raise. In Apr 2017, the fellowship raised $1.4 billion from Microsoft, Tencent as well as EBay, inwards an investment circular that priced the fellowship at $11 billion, as well as inwards August 2017, Softbank invested $2.5 billion inwards the company, pricing it at closer to $12.5 billion. Walmart’s investment, though, represents a meaning boundary inwards the pricing over the terminal year.
Note that, through this entire section, I receive got used the discussion “pricing” as well as non “valuation”, to depict these VC as well as private investments, as well as if yous are wondering why, delight read this post that I receive got on the divergence betwixt cost as well as value, as well as why VCs play the pricing game. Why would these venture capitalists, many of whom are onetime hands at the game, force upwards the pricing for a fellowship that has non only proved incapable of making coin but where at that spot is no low-cal at the halt of the tunnel? The response is unproblematic as well as cynical. The only justification needed inwards the pricing game is the expectation that mortal volition pay a higher cost downwards the road, an expectation that is captured inwards the utilisation of leave of absence multiples inwards VC pricing models.
The Why?
So, why did Walmart pay $16 billion for a 70% stake inwards Flipkart? And volition it pay off for the company? There are 4 possible explanations for the Walmart motion as well as each comes amongst troubling later thoughts.
1. The Pricing Game: No thing what 1 thinks of Flipkart’s concern model as well as its valuation, it is true, at to the lowest degree later the Walmart offer, that the game has paid off for before entrants. By paying what it did, Walmart has made every investor who entered the pricing chain at Flipkart before it a “success”, vindicating the pricing game, at to the lowest degree for them. If the essence of that game is that yous purchase at a depression cost as well as sell at a higher price, the payoff to playing the pricing game is easiest seen yesteryear looking at the Softbank investment made simply nine months ago, which has almost doubled inwards pricing, largely equally a number of the Walmart deal. In fact, many of the private equity as well as venture upper-case alphabetic quality firms that became investors inwards before years volition live selling their stakes to Walmart, ringing upwards huge upper-case alphabetic quality gains as well as moving correct along. Is it possible that Walmart is playing the pricing game equally well, intending to sell Flipkart to mortal else downwards the route at a higher price?
My assessment: Since the company’s stake is overwhelming as well as it has operating motives, it is hard to come across how Walmart plays the pricing game, or at to the lowest degree plays it to win. There is some utter of investors forcing Walmart to accept Flipkart public in a few years, as well as it is possible that if Walmart is able to bolster Flipkart as well as arrive successful, this leave of absence ramp could opened upwards up, but it seems similar wishful thinking to me.
2. The Big Market Entrée (Real Options): The Indian retail marketplace is a large one, but for decades it has besides proved to live a frustrating 1 for companies that receive got tried to travel into it for decades. One possible explanation for Walmart’s investment is that they are buying a (very expensive) pick to travel into a large as well as potentially lucrative market. The options declaration would imply that Walmart tin pay a premium over an assessed value for Flipkart, amongst that premium reflecting the uncertainty as well as size of the Indian retail market.
My assessment: The size of the Indian retail market, its potential growth as well as uncertainty well-nigh that growth create optionality, but given that Walmart remains a brick as well as mortar shop primarily and that at that spot is multiple paths that tin live taken to live inwards that market, it is non clear that buying Flipkart is a valuable option.
3. Synergy: As amongst every merger, I am surely that the synergy discussion volition live tossed around, oftentimes amongst wild abandon as well as mostly amongst zero to dorsum it up. If the essence of synergy is that a merger volition allow the combined entity to accept actions (increase growth, lower costs etc.) that the private entities could non receive got taken on their own, yous would require to recollect of how acquiring Flipkart volition allow Walmart to generate to a greater extent than revenues at its Indian retail stores as well as conversely, how allowing itself to live acquired yesteryear Walmart volition brand Flipkart grow faster as well as plow to profitability sooner.
My assessment: Walmart is non a large plenty presence inwards Republic of Republic of India yet to practise goodness substantially from the Flipkart acquisition as well as spell Walmart did denote that it would live opening 50 novel stores inwards India, correct later the Flipkart deal, I don’t come across how owning Flipkart volition increment traffic substantially at its brick as well as mortar stores. At the same time, Walmart has piddling to offering Flipkart to arrive to a greater extent than competitive against Amazon, other than upper-case alphabetic quality to maintain it going. In summary, if at that spot is synergy, yous receive got to strain to come across it, as well as it volition non live substantial plenty or come upwards presently plenty to justify the cost paid for Flipkart.
4. Defensive Maneuver:Earlier, I noted that both Flipkart as well as Walmart portion a mutual adversary, Amazon, a challenger masterful at playing the long game. I argued that at that spot is piddling gamble that Flipkart, standing alone, tin hold upwards this fight, equally upper-case alphabetic quality dries upwards as well as existing investors human face for exits as well as that Walmart’s slide into decline inwards global retailing seems inexorable, equally Amazon continues its rise. Given that the Chinese retail marketplace volition testify hard to penetrate, the Indian retail marketplace may live where Walmart makes its stand. Put differently, Walmart’s justification for investing inwards Flipkart is non they await to generate a reasonable render on their $16 billion investment but that if they practise non brand this acquisition, Amazon volition live unchecked as well as that their decline volition live to a greater extent than precipitous.
My assessment: Of the 4 reasons, this, inwards my view, is the 1 that best explains the deal. Defensive mergers, though, are a sign of weakness, non strength, as well as signal to a concern model nether stress. If yous are a Walmart shareholder, this is a negative signal as well as it does non surprise me that Walmart shares receive got declined inwards the aftermath. Staying amongst the life wheel analogy, Walmart is an aging, once-beautiful actress that has paid $16 billion for a really expensive human face upwards lift, as well as similar all human face upwards lifts, it is only a thing of fourth dimension before gravity industrial plant its magic again.
In summary, I recollect that the odds are against Walmart on this deal, given what it paid for Flipkart. If the rumors are truthful that Amazon was interested inwards buying Flipkart for unopen to $22 billion, I recollect that Walmart would receive got been improve served letting Amazon win this battle as well as struggle the local anti-trust enforcers, spell playing to its strengths inwards brick as well as mortar retailing. I receive got a sneaking suspicion that Amazon had no intent of always buying Flipkart as well as that it has succeeded inwards goading Walmart into paying agency to a greater extent than than it should receive got to travel into the Indian online retail space, where it tin await to lose coin for the foreseeable future. Sometimes, yous win bidding wars yesteryear losing them!
What next?
In the long term, this bargain may ho-hum the decline at Walmart, but at a cost as well as hence high, that I don’t come across how Walmart’s shareholders practise goodness from it. I receive got attached my valuation of Walmart as well as amongst my story of continued ho-hum growth as well as stagnant margins for the company, the value that I obtain for the fellowship is well-nigh $63, well-nigh 25% below its stock cost of $83.64 on May 18, 2018.
In the curt term, I await this acquisition to a accelerate the already frenetic contest inwards the Indian retail market, amongst Flipkart, instantly backed yesteryear Walmart cash, as well as Amazon Republic of Republic of India continuing to cutting prices as well as offering supplementary services. That volition hateful fifty-fifty bigger losses at both firms, as well as smaller online retailers volition autumn to the wayside. The winners, though, volition live Indian retail customers who, inwards the words of the Godfather, volition live made offers that they cannot refuse!
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For start-ups all over India, though, I am afraid that this deal, which rewards the founders of Flipkart as well as its VC investors for edifice a money-losing, cash-burning machine, volition feed bad behavior. Young companies volition become for growth, as well as even as well as hence to a greater extent than growth, paying piddling attending to pathways to profitability or edifice feasible businesses, hoping to live Flipkarted. Venture capitalists volition play to a greater extent than pricing games, paying prices for these coin losers that receive got no footing inwards fundamentals, but justifying them yesteryear disputation that they volition live Walmarted. In the meantime, if yous are an investor who cares well-nigh value, I would propose that yous purchase some popcorn, as well as relish the entertainment. It volition live fun, spell it lasts!
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