U.S. Markets closed

Walmart Inc’s Flipkart Deal Should Be a Home Run

Ian Bezek

Last week’s developments with Walmart Inc (NYSE:WMT) and Flipkart offer a large and tangible demonstration of an important point as we evaluate retail stocks in 2018.

Simply put, if you’re a bricks-and-mortar company, the market will penalize you for spending more money on your e-commerce business. If you’re an e-commerce-native company, the market gives you the benefit of the doubt. Hence, the weakness in Walmart stock lately.

Walmart stock dropped almost 5% last Wednesday following news that it would be taking a majority stake in India’s Flipkart. Amazon.com, Inc. (NASDAQ:AMZN) was also said to be interested in bidding for a large stake in the company. However, Walmart moved quicker and got the prize. The market reacted by dumping WMT stock.

InvestorPlace - Stock Market News, Stock Advice & Trading Tips

Why Walmart Wants This Deal

Walmart is currently present in India with its Best Price stores. It operates 21 of these. They are a membership-based model seemingly in line with the likes of Costco Wholesale Corporation (NASDAQ:COST) or Sam’s Club.

Needless to say, 21 stores is a near nonexistent presence for a country as large as India. It’s been blocked from opening more traditional Walmart-model stores due to government interference.

So, taking a majority stake in Flipkart does two important things for Walmart. Not only does it give them immediate access to a large e-commerce platform, it also helps them plan out and gain government backing for their expansion in physical stores in India.

Given the impact of big data in helping companies plan their expansion strategies, it should require little explanation how accessing Flipkart’s $4 billion a year in transaction data will help in planning its physical stores merchandise and supply chains.

And yes, despite all the hype for India, it’s several decades behind Latin America, let alone wealthier emerging markets, in terms of development. Thus, physical stores will continue to be huge there for a long time yet. For a concrete example of this, the overall e-commerce market is roughly the same size in Brazil and India. That’s despite India having five times as many people.

Was Flipkart Too Expensive?

On the digital side, Walmart is paying an aggressive valuation to get into Flipkart, but it seems justifiable assuming you’re thinking long term. Walmart invested about $16 billion in Flipkart to take a 77% stake in the company, thus valuing the whole firm at $21 billion.

What’s Walmart getting for that $21-billion valuation? For the fiscal year that ended in March, Flipkart did $7.5 billion in gross merchandise volume and, more reliably, net sales of $4.6 billion.

That puts us at 4.6x sales with a $21-billion valuation, which seems fairly expensive for an e-commerce retailer. But it’s certainly not an indefensible valuation, particularly considering what stocks like Mercadolibre Inc (NASDAQ:MELI) are doing lately.

Flipkart is also growing faster than most other pure-play online retail sites, with sales up about 50% annually. That gets the price/sales ratio down to a more reasonable value pretty quickly.

It also gets Walmart into India ahead of Amazon. Flipkart and Amazon have been in a brutal price/market share war in that market for several years. Amazon and Flipkart make up 60% of the overall market. Flipkart maintains a decent lead of 34% to 27% over Amazon as of 2017 Euromonitor data.

Walmart’s Powerful Partners

Walmart gets another big perk: star backers. Flipkart has support from Tencent Holding/ADR (OTCMKTS:TCEHY), Naspers Limited (ADR) (OTCMKTS:NPSNY) and Microsoft Corporation (NASDAQ:MSFT), among other sponsors.

If you’re going to war with Amazon, that’s a good set of allies. As we saw in China, Amazon is very capable of getting catastrophically blown out of a country. Amazon China was a massive failure, and Walmart, through its strategic acquisition of a major chunk of JD.Com Inc (ADR) (NASDAQ:JD), is well-positioned in that market by contrast.

Speaking of big backers, CNBC also reported that Alphabet Inc (NASDAQ:GOOGL, NASDAQ:GOOG) is looking to enter this funding round alongside Walmart.

Alphabet is reportedly set to put as much as $3 billion into Flipkart, which should, in theory, give it up to a 15% stake in the company. Needless to say, Amazon would have one of the more competitive battles of its corporate history up against that set of tech titans on the other side of the field.

Why the Street Doesn’t Like This Deal

That’s simple: it lowers earnings. Estimates suggest that Walmart’s earnings will be 5-11% lower over the next couple of years as a result of the Flipkart investment. That is compared to an alternate scenario where the funds went to further WMT stock buybacks.

This is a clear double standard. Walmart is expected to earn profits, whereas Amazon doesn’t need to. In fact, Amazon would lose a significant portion of its market cap if it stopped growing at all costs. An Amazon that maximized its earnings per share would be worth much less.

Walmart, on the other hand, announces a $16-billion investment, giving it a legitimately massive growth avenue and dominance in one of the world’s major economies. As a result, investors punished Walmart stock with a more-than-$10-billion market cap loss.

Had Amazon announced a deal like this, more optimistic investment bankers would have added $50 billion, $100 billion or who knows, maybe even more, to their future valuations of AMZN stock.

Walmart Stock Takeaways

I’m bullish on Walmart stock long term because management has much more vision than the market is giving it credit for.  Ultimately, I think most of the big tech companies are going to face much more regulation. Perhaps, regulators will even break them up outright.

Amazon’s free pass to ignore regulations, fair shipping rates, sales taxes, and who knows how many other obstacles will be coming to an end. And when it does, Walmart is one of the most likely players to take advantage. It’s already the (clear) #2 online seller in the U.S., and it is developing an increasingly strong position in numerous overseas markets.

It’s also worth noting that Walmart intends to IPO Flipkart as a majority-controlled subsidiary as early as 2022. Given the rate that Flipkart is growing now, and the price/sales multiples the public has been willing to pay lately for money-losing tech enterprises with fast revenue growth, this IPO should be a blockbuster.

Remember that Walmart and friends will still own the lion’s share of the stock. That will leave just a stub for the public to fight over. That should lead to a juicy (excessive) valuation, allowing Walmart to write up its stake pretty dramatically and look like geniuses publicly. Investors valuing Walmart stock just on its U.S. physical-store retail business are missing the story here.

More From InvestorPlace

At the time of this writing, the author owned JD stock. He had no positions in any of the other aforementioned securities. You can reach him on Twitter at @irbezek.

Compare Brokers

The post Walmart Inc’s Flipkart Deal Should Be a Home Run appeared first on InvestorPlace.