​Why Walmart could get severe indigestion from its Flipkart acquisition

Walmart's investors may not have the appetite for a prolonged battle with Amazon in India that will involve funding steep losses caused by excessive discounting.
Written by Rajiv Rao, Contributing Writer

About six days ago, Walmart undertook a historic acquisition and its most expensive one in recent memory when it swallowed India's ecommerce leader Flipkart by shelling out $16 billion for a 77 percent stake.

There is much for Walmart's investors to celebrate in the firm spotting the right opportunity at the right time to safeguard its place in a digital future dominated by the ever-rampaging Amazon. After unspectacular efforts in China and Japan, this US retail leviathan may never get another opportunity to assure itself of a captive, fast-growing and potentially mammoth audience for its wares in the online realm. India represented its last chance -- as it was Amazon's, following getting shut-out in China -- and the Bentonville, Arkansas-based retailer has been virtually forced to play this hand or risk regretting it forever.

Or so the narrative goes. The big question now making the rounds in the euphoric aftermath of the deal and putting a dent into that story is whether the deal will be worth it at all. Will it make economic sense for the company once you shove aside all the familiar hype about India's burgeoning middle-class? Naysayers who instantly weighed in after the deal announcement happened to be no other than the company's investors. Walmart's stock took an instant beating, losing 5 percent in early trade and wiping some $10 billion of its market cap.

What investors are undoubtedly looking at are two things: One, this is a whole new game being played in the world of bits and bytes and online purchases that is alien -- in fact, even anathema -- to a retail giant more at home in the brick-and-mortar world. The online business model is an eminently profligate one that is no doubt making Sam Walton fans grimace with its bitter aftertaste.

This is because Flipkart's strategy, which has attracted its current 100 million customers who have bought roughly $3 billion worth of goods in the last fiscal year, has been engineered by offering steep discounts funded through its large VC funding rounds leading to steep losses. These have totalled a staggering $3.6 billion in the last three years and Walmart will have to assume a fresh $900 million black hole for the remaining six months of this financial year for it will be regarded as the Indian company's new owner.

To put things in perspective, my former employer Business Standard carried an excellent analysis of what the future could hold for Walmart investors. For Flipkart to post a 10 percent return on capital so it can come somewhat close to the five-year 11.2 percent return on capital of its new parent, it would have to achieve a topline growth of $100 billion in just a matter of a few years -- something Amazon's global operations did only recently in 2015 and therefore an absurd expectation.

In other words, investors will have to patiently soak in the continuing considerable losses for years with the expectation that the tide will turn at some point in the distant future, making all of this worthwhile. And that, of course, will only be possible by pumping vast amounts of money into Flipkart while simultaneously warding off Amazon, who has already spent $5 billion in just a few years and is only beginning its innings in India.

The second big question revolves around when that "distant future" may arrive. Morgan Stanley predicts close to 500 million online shoppers in India in 10 years and industry estimates trumpet the retail industry scaling to $1.8 trillion by 2027. While India's gigantic population is undeniable, the fact is it still remains a very poor country with a per capita income just a little over $1,500 with low ecommerce average order values, terrible infrastructure, and requiring complex logistics. As Quartz notes, ecommerce in 2016 was just 2 percent of retail trade, but even when the share of online retail to overall trade is expected to double by 2026, it will still only be 12 percent.

Of course, there are positives. The firm would not have slapped down such a large sum without being comforted by the fact that real estate prices in India can get to stratospheric levels, neighbourhood stores where most Indians get their basic provisions command higher prices, and rural areas are not able to give their smartphone-toting, increasingly internet savvy customers the goods that they salivate over online.

However, reality bites with another distressing piece of information in Mint newspaper for ecommerce aspirants. Michelle Grant, head of retailing at Euromonitor International, said that in the largest five ecommerce markets, a clear pattern has emerged where one company is the clear leader followed by a distant second in addition to other much smaller rivals.

For Walmart to become that clear leader in India it will have to turn a blind eye to the tide of red on its income statements for years down the line while pumping its hard-earned money from retail ops to fund these losses, which will be exacerbated by vicious competition from Amazon.

It may not be the kind of fight that Walmart may end up having the stomach for.


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