Recently Walmart announced plans to acquire a 77% stake in India’s Flipkart for $16 billion. Flipkart is an Indian eCommerce company that was initially focused on book sales, but soon expanded into other product categories such as consumer electronics and fashion.
The story sounds similar to Amazon and the company has been able to fend off challenges from Amazon, a company that also started with a focus on books and then moved into all areas of commerce.
Given that Walmart is now positioned to capture significant sales in India and bring Flipkart’s technology to other markets, it could be surprising that the stock sold off on the news of the acquisition.
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Was the Deal Worth the Price?
On its surface, the announcement sounds as if it should be bullish. But, in its most recent fiscal year, Flipkart net sales grew more than 50% to $4.6 billion, but the company registers heavy losses as it battles Amazon for supremacy in the fast-growing eCommerce market.
The deal will have a negative impact on Walmart’s earnings in the short run. If the deal were to close in the second quarter, Walmart said its earnings per share would be negatively impacted by $0.25 to $0.30 per share. Walmart expects that negative impact to grow to around $0.60 per share in the next fiscal year as it ramps up investment in the company.
The deal seems to be predicated, at least in part, on hope. India is projected to be a fast growing market and Walmart is trying to buy its way into that eCommerce growth.
From 2017 to 2021, online retail in India is expected to grow 141% to more than $50 billion. This may explain why both Walmart and Amazon are interested in India, the country that has overtaken China as Amazon’s most important international market, as displayed by discussions on its earning calls.
Amazon currently has a market share of about 26.6% in India’s eCommerce market, behind Flipkart’s 34.3% market share. The question for Walmart is whether or not they can build on the current position in India.
India Could Be the Next Amazon-Walmart Battleground
India is the second most populous country in the world, just behind China. India is also home to a growing middle class. Household spending growth in India averaged 8.7% last year, topping the 7.9% growth reported in China and the 2.7% growth among U.S. households.
Analysts believe that a fragmented brick and mortar retail market in India favors online shopping where consumers can find a wider range of products in one spot.
That explains why Walmart and Amazon are both looking towards India. And, it explains why Walmart would be willing to pay so much to get into the market. Walmart significantly lags Amazon in eCommerce.
Amazon’s 2017 global eCommerce revenue of $108.4 billion dwarfed Walmart’s projected $17.5 billion in online sales.
A Possible Exit Strategy
In a regulatory filing several days after the deal was announced, Walmart noted that it may take India’s Flipkart public in as little as four years, providing details on a potential exit strategy for the first time on a deal that is Walmart’s largest acquisition to date.
The filing says that “minority investors holding 60 percent of Flipkart’s shares “acting together, may require Flipkart to effect an initial public offering” (IPO) four years after the close of the Walmart-Flipkart transaction.
The IPO should be done at no less a valuation than that at which Walmart invested in the Indian eCommerce firm, the filing said. The company’s 77% stake implies a valuation of nearly $21 billion for Flipkart.
The deal must be approved by India’s antitrust regulator but analysts don’t expect that to be a problem and the deal is expected to close later this year.
A Critical Time for the Stock
Walmart’s decision to buy Flipkart seems to indicate the company is intent on taking on Amazon. Prior to this deal, Walmart had acquired Jet.com for about $3 billion in a deal to jumpstart its online presence and obtain scalable technology.
Flipkart provides access to India, a company that Amazon’s conference calls indicate was a priority for the company. Walmart is obviously intent on challenging Amazon in India.
The stock price indicates that traders are expecting Walmart to move beyond its large, big box store base. The stock has sold off considerably in recent weeks.
If Walmart is going to recover, it will need to grow in markets beyond the U.S., in countries where big box formats are more difficult to implement, India’s roads and infrastructure make it difficult for big boxes to move goods efficiently. Similar problems exist in other countries.
Walmart could also benefit from online sales that carry higher profit margins than its traditional retail locations. Higher margins should boost the stock price, as would higher earnings.
This deal is significant for the long term but the effects in that time frame are not yet known. In the short run, it does seem according to Walmart’s announcement that that deal will weigh down earnings.
That all means that Walmart might not be the best investment opportunity right now, even for long term investors. Conservative investors can wait for the company to demonstrate that this deal makes sense. With an exit strategy at least four years away, there is time to wait for better news.
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