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When you are late to a party, you have to make a grand entrance. When Walmart’s investment in Flipkart does get announced, it will be a deal that will change the landscape of the Indian retail sector. According to a person with direct knowledge, talks are progressing towards Walmart’s taking “close to a majority” stake or a simple majority in Flipkart.
Walmart could pump in around $8 billion in a mix of primary and secondary purchase of shares, valuing Flipkart around $20 billion. It is emerging as the largest stakeholder in Flipkart, with a clear path to increase its stake and control over the Indian company in the coming days.
The Walmart deal would see Flipkart’s valuation rise as much as 70% or so within a year. And that would make this Walmart’s most expensive ecommerce investment by a wide margin.
Walmart desperately needs India, the final frontier for retail. The world’s biggest retailer, with annual revenues of $486 billion, is all but a footnote in the $672 billion Indian retail market. Regulations barring FDI in multibrand retail and a failed partnership with Bharti have restricted Walmart India to cash-and-carry wholesale only.
The small business unit reported $557 million annual revenue, minuscule in terms of Walmart’s global turnover as well as the size of India’s retail industry. Clearly, Walmart cannot ignore the fifth largest retail market in the world, which is growing at 12% a year.
“Walmart has been ceding geographies to Amazon. They could have easily made the move early when they were sitting on piles of cash. Itwas a low-hanging fruit,” says serial entrepreneur K Ganesh, now cofounder of Growthstory, a venture building platform, which is an investor in Bigbasket.
But there are three questions that have to be asked about Walmart. First, is the deal with Flipkart its best option? Second, what does it get for the money it will be spending? Finally,is Walmart’s obsession with Jeff Bezos and Amazon the right thing, given the retail sector in India has much more complex dynamics with some hefty offline competitors lurking in the alley?
A strategic investment in or an acquisition of Flipkart would be Walmart’s response to the rapid rise of Amazon. The retail giant is facing the heat from aggressive Amazon on the home front. While Walmart remains 2.5 times bigger than Amazon in terms of revenue, the latter’s pace could unsettle its larger rival. Amazon doubled its revenue in four years while Walmart hardly saw a 2% growth during the same period.
Walmart is paying the price for its late awakening in ecommerce. While Amazon dominates the US ecommerce with 43.5% market share, Walmart has a nominal presence with 3.6% share.
The Man Who Put .com in Walmart
Walmart’s understanding of the power of ecommerce begins with the acquisition of Jet.com in the US in August 2016. They not only expanded their online presence, they also got on board Marc Lore as their head of US ecommerce. Lore has a history with Bezos. He had sold his company Quidsi to Bezos, stayed in Amazon for two years before quitting to set up Jet.com.
Reports say he was not very happy with the way the Quidsi brand was handled. And now, with Walmart’s cash at his disposal, he can set up a new strategy to compete with Amazon.
The graph below charts out Walmart’s acquisition and alliance history since 2016:
A few things stand out:
1. Walmart’s online acquisitions have really picked up after Lore joined.
2. The acquisitions structure in US is simple — all cash, some shares. Barring strategic alliances, Walmart would have spent overall $4 billion so far.
3. The US acquisitions have been small. Apart from Jet. com, they have all been aimed at category expansion. There has been no whole-scale response to Amazon’s Whole Foods.
4. But the interesting point is about the international ones — Japan, China, India. In Japan and China, the alliances it has made are with horizontal ecommerce marketplace platforms, not with single category leaders. Take jd.com. Amazon started off with a 5.6% stake in jd.com, upped it to 10.8% in just four months and then increased it to 12.1% by February 2017.
Considering jd.com’s $64 billion market cap with $57 billion revenues and $18 million profits in 2017, this seems to have been Walmart’s biggest transaction so far.
Walmart is probably realising only now that small acquisitions like what it has done in the US won’t give it an edge. “For a company as big as Walmart, for a sector like retail and for a country as large as India, China or US, these (the ecommerce investments it makes) are all tinkering on the fringes. These are not going to move the needle. By this time, half their valuation would have come from ecommerce if they had moved fast enough,” says Ganesh.
In that sense, the Flipkart deal is no surprise. Flipkart fits Walmart’s acquisition target profile and it also needs someone like Walmart.
“Money was not an issue for Flipkart. With SoftBank backing, they have access to capital. It is the procurement, the sourcing and vendor network and infrastructure that Walmart brings that make the difference.
It also helps Flipkart to explore and execute its offline strategy. After the experiment with Bharti, I don’t think Walmart would want to play a role of a minority shareholder and that is why they are pushing for a majority stake,” says Satish Meena, senior forecast analyst, Forrester.
The India Story
There are clear differences, though, between Flipkart and jd.com, Walmart’s significant investment in China. Compared to jd.com, Flipkart’s financials look very different.
Flipkart made $3 billion in revenues and $1.35 billion in losses for 2016-17.
From revenue multiple point of view, the Walmart-Flipkart deal looks much more expensive than the jd.com one. Flipkart’s current base of 10 million active monthly users means they are valuing Flipkart $2,000/user. Walmart’s Jet.com acquisition in the US in 2016 for $3 billion cash and $300 million worth stock, which gave the retail giant a toehold in the domestic ecommerce market, looks much smaller compared with the yet-to-be announced Flipkart deal. Clearly, Walmart is paying a huge premium to have a slice of the Indian retail industry.
The value could still be justified if Flipkart gives them category leadership in India, the holy grail of retail. If not, this may be an expensive play for Walmart despite its free cash flow.
It’s Complicated
Flipkart’s leadership position in ecommerce is under question. Amazon’s customers in India spend almost double the time on the platform than do Flipkart’s customers, according to a September 2017 report by Morgan Stanley. Amazon’s app has higher downloads than Flipkart’s and its subsidiary Myntra’s.
The broader point: ecommerce still remains a very small portion of the Indian retail industry. It has reached the size of $15 billion (Morgan Stanley report), but this is just 2% of the overall retail market. It will rise only to 12% in 10 years’ time, according to the same report. Only apparel and consumer electronics are the two categories where online players could so far make their presence felt.
Satish Meena, senior forecast analyst, Forrester, concurs. “We have sold the story of one billion customers, but we know that the online retail customer base is around 90 million as of now. It will be a difficult task to take this to 200-250 million customers,” he says.
In comparison, organised physical retail in India is robust and growing rapidly, a market that Walmart is practically missing out on. D-Mart, the latest listed retail firm, is now one of the world’s most valued retailer with a market cap of nearly Rs 85,000 crore.
Meanwhile, Reliance Retail Limited has been posting triple-digit growth numbers and is the largest (but unlisted) retailer in India. For the December 2017 quarter, Reliance Retail made revenues worth nearly Rs 19,000 crore, up 116% year-on-year. In the nine months of FY18 ended December, the firm has already made Rs 45,000 crore in sales.
Walmart will appreciate this scale because it owns it in the US retail market. The fight with Amazon via Flipkart will be costly, small in scale and somewhat irrelevant to the larger retail story of the country. Consultants tracking the industry say that Walmart may be going in for a deal because it does not have any other reasonable option.
With foreign direct investment banned in multi-brand retail, Walmart cannot set up its own retail stores or acquire a modern retailer. Its plans for expansion in the wholesale cash-and-carry business will bring it to 50 stores by FY20, which will keep it a marginal presence in India’s retail industry.
“What are its options? That’s probably why they are paying a higher multiple,” says a consultant tracking the retail industry In essence, Walmart is making an expensive buy and its prospective payoff is not very certain. This is perhaps the price Walmart is paying for coming late into the Indian ecommerce game, according to Ganesh.
He says Walmart did not take advantage of its strong supply chain fast enough. “For instance, if Walmart had spent $300 million to make a fairly early-stage ecommerce acquisition in India, that would not have affected them. The downside is zero and upside is huge,” he says.
And the upfront cost that Walmart is going to make, which will be $8-10 billion, depending on the size of its stake in and valuation of Flipkart, would just be the beginning of a capital-intensive battle between two US giants on the Indian soil. Amazon has spent a substantial portion of $5 billion it has committed to India and is prepared to invest more.
Walmart will have its work cut out. Amazon dominates Flipkart in India’s ecommerce market by several metrics. While Flipkart, along with its apparel sales subsidiaries Myntra and Jabong, is ahead of Amazon by gross merchandise value and market share, the fight has become tough.
As of FY17, Flipkart has nearly 35% market share in ecommerce while Amazon has already reached 30%, according to Mumbai-based market consultancy firm Praxis Global Alliance.
The big boy from Bentonville will find itself smack in the middle of this brawl. According to Forrester’s Meena, “The focus will be on getting 100-150 million new customers online. In the next few years, these companies will be looking to expand their reach across the country by investing in logistics.
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