Why Walmart investors have started writing off the Flipkart investment

Just before traders gathered at the New York Stock Exchange on Wednesday, Walmart Inc. announced that it would invest $16 billion (about Rs 1.08 trillion) to acquire a 77 percent stake in Flipkart, one of India’s largest e-commerce companies.

Investors in the US company were not particularly impressed. Walmart shares lost around $8 billion in value on Wednesday, bringing the total loss since April to $17.5 billion. Apparently, investors already view a large part of the Flipkart investment as a write-off.

On a call with analysts, Walmart management was bombarded with questions about Flipkart’s losses and how long the company expects them to continue. One analyst even chimed in: “Wait a minute, we seem to be talking about reducing losses. Are we even expecting profits?”

Walmart’s response to all of these questions was that they had really thought through the investment, especially because they knew investors’ short-term expectations for cash flow and returns, but they still felt that the long-term opportunity in a country of 1.3 billion people was too big to ignore.

In addition, people are clearly impressed by Flipkart’s product portfolio, which ranges from an e-commerce marketplace to fashion retail to logistics and payment services.

What the company did not say in the call is that the acquisition would also help the company build a base in India that will help it plan a larger foray into the country’s offline retail market, if that becomes possible. According to an analyst at a domestic institutional brokerage, the company could not say this explicitly due to the obvious political implications.

Perhaps $16 billion is not too much to have a strong presence in a market that is expected to reach $1.3 trillion in the next five years, which would also place India among the top five largest retail markets in the world.

But for now, investors seem to think all this is just a pipe dream. What is causing major concern is Walmart’s own estimate of Flipkart’s operating losses. In fiscal year 2020 (FY20), Flipkart’s first full year under its new owner, the company had expected an earnings loss of up to USD 0.45 per share. In absolute terms, this equates to USD 1.35 billion (Rs 9,111 crore).

Some of this is due to non-cash depreciation and amortization, but it is clear that cash burn will be approximately $1.1 billion to $1.2 billion per year, significantly higher than the $671 million the company reported in fiscal 2017.

Of the $16 billion investment, $2 billion will go to Flipkart to support its growth plans, Walmart said. But if the cash burns at the above rate, Flipkart will soon need more cash infusions. With Amazon.com Inc. also breathing down its neck, the need for cash infusions could become a regular occurrence.

The US retail giant said it was in talks with other potential investors about a stake sale to Flipkart, which would reduce its own exposure. But even there, investors would be concerned as there have been no press reports of an investment from Alphabet Inc. so far. Could it be that no other investor other than Walmart was willing to pay the high price that values ​​Flipkart at $20.8 billion?

For Flipkart investors, things have turned around significantly. Just over a year ago, a fund managed by Morgan Stanley had reduced its investment in Flipkart to $5.5 billion. But the same cannot be said about the company’s finances. While the value of goods sold increased by 50% in FY18, losses increased. In FY17, when losses were somewhat contained, growth slowed.

Walmart’s statement that it will support Flipkart in its growth acceleration plans is likely to upset investors’ expectations about the company’s cash flows, which have grown steadily over the years.

More importantly, Flipkart’s discount-led growth strategy is at odds with Walmart’s long-standing ethos. The US retail giant operates on the EDLP/EDLC business model, where it takes costs out of its business and passes the savings on to customers. Flipkart has funded discounts by regularly raising money from investors. It remains to be seen how things will settle down when the two opposing cultures clash.