Just before traders congregated at the New York Stock Exchange on Wednesday, Walmart Inc. announced it will invest $16 billion (around Rs1.08 trillion) to buy a 77% stake in Flipkart, one of India’s largest e-commerce companies.
The US company’s investors weren’t impressed at all. Walmart shares lost around $8 billion in value on Wednesday, taking the total loss since April to $17.5 billion. It seems a large part of its Flipkart investment is already being considered a write-off by investors.
On a call with analysts, Walmart’s management was peppered with questions about Flipkart’s losses and how long the company expects them to continue. One analyst even chimed in, “Wait, we seem to be talking about the level of losses reducing; is making profits even on the horizon?"
Walmart’s stock reply to all of these questions was that it had thought really hard about the investment, especially knowing investors’ short-term expectations on cash flows and returns. Even so, it felt that the long-term opportunity in a country with a population of 1.3 billion was too large to ignore.
Besides, it is evidently impressed with Flipkart’s product portfolio, ranging from an e-commerce marketplace, to fashion retail, logistics and payments services.
What it didn’t say on the call is that the acquisition would also help it build a foundation in India, which will help when it plans a larger play in the country’s offline retail market, whenever it is allowed to do so. According to an analyst at a domestic institutional brokerage firm, it couldn’t say this explicitly because of the obvious political fallout.
Perhaps $16 billion isn’t too high to have a strong presence in a market that’s expected to reach $1.3 trillion in size in the next five years; this will also make India among the word’s five largest retail markets.
But for now, investors seem to think all of those are pie-in-the-sky statements. A big worry is Walmart’s own estimate of Flipkart’s operating losses. In fiscal year 2020 (FY20), the first full year of Flipkart’s operations under its new owner, the company has estimated an earnings impact of up to $0.45 per share. In absolute terms, this works out to $1.35 billion (Rs9,111 crore).
While some of this is on account of non-cash depreciation and amortization charges, it’s clear that cash burn will be well in the region of $1.1-1.2 billion/year, much higher than the level of $671 million the company reported in FY17.
Of the $16 billion investment, $2 billion will find its way into Flipkart to help its growth plans, said Walmart. But if cash will burn at the above-mentioned rate, Flipkart will need more infusions soon. With Amazon.com Inc. breathing down its neck as well, the need for cash infusions may become a regular affair.
The US retail giant said that it is in talks with other potential investors for a stake sale in Flipkart, which will reduce its own exposure. But even there, investors would be worried that press reports about an investment by Alphabet Inc. hasn’t materialized yet. Could it be that no other investor apart from Walmart was open to the high asking price that valued Flipkart at $20.8 billion?
Things have clearly turned around for Flipkart’s investors. Just a little over a year ago, a fund managed by Morgan Stanley had marked down its investment in Flipkart to $5.5 billion. But the same can’t be said about the company’s financials. While the value of gross merchandise sold rose 50% in FY18, losses have mounted. In FY17, when losses had been curtailed a bit, growth had slowed.
Walmart’s statement that it will support Flipkart’s growth acceleration plans will upset investor expectations of the company’s cash flows, which have steadily grown over the years.
And importantly, the discount-driven growth strategy of Flipkart runs contrary to Walmart’s long-standing ethos. The US retail giant operates on the business model called EDLP/EDLC, where it takes costs out of its business and passes on the savings to customers. Flipkart has funded discounts by regularly raising funds from investors. It remains to be seen where things settle when the two opposing cultures clash.