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Walmart to Snap Up Stake in Flipkart: Pros & Cons of the Deal

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The retail space had been on investors’ radar of late, courtesy of the most talked-about deal. In what has been hailed as Walmart Inc.’s WMT biggest ever deal, the company yesterday clinched contracts to buy an initial stake of 77% in Flipkart for roughly $16 billion. With the latest move, the world’s largest retailer defeated Amazon AMZN in its prolonged fight to snap up a stake in India’s leading e-commerce player.

Walmart’s stake in Flipkart will help the company to bolster its presence in the fast-growing Indian e-commerce market – which could emerge as one of the top five e-commerce markets in coming times, per sources. However, investors seem jittery as the huge investment in Flipkart is expected to weigh on Walmart’s profits for some time. Consequently, Walmart’s shares lost 3.1% yesterday, reflecting investors’ concerns over the viability of the deal.

So, let’s delve deeper and see how Walmart is placed after this bold move.

Walmart Buys Flipkart: Pros and Cons

Walmart is acquiring a major stake in Flipkart, while the remaining stake will remain with Flipkart’s co-founder Binny Bansal, Tencent Holdings Limited, Tiger Global Management LLC and Microsoft MSFT. The deal, which is expected to close toward the end of this calendar year, remains subject to regulatory approval.

Following the deal, both Walmart and Flipkart will continue operating as distinct brands, while retaining their operating structure. Flipkart’s financials will form part of Walmart’s international segment following the conclusion of the transaction. Further, Tencent and Tiger Global remain on Flipkart’s board, and will be joined by additional members from Walmart. Also, the investment by Walmart includes new equity funding of nearly $2 billion, which is most likely to propel growth at Flipkart. While both entities are in talks with other potential investors, Walmart will hold a solid majority stake in Flipkart.

Deal to Hurt Bottom Line in the Short Run

Walmart plans to sponsor the deal with a combination of cash in hand and newly issued debt, which will raise the company’s interest expense and hurt its bottom line. Evidently, management stated that if the deal closes in the second quarter of fiscal 2019, additional interest costs associated with this investment will dent fiscal 2019 bottom line to the tune of 25-30 cents per share.

Incidentally, during its last reported earnings announcement, management projected Walmart’s fiscal 2019 earnings to be between $4.75 and $5.00 per share, which is likely to be hit by the aforementioned factors. Also, fiscal 2020 earnings per share will be hurt by roughly 60 cents, including about 15 cents adverse impact from higher interest costs and 40-45 cents from operating losses. These factors also remain a threat to Walmart’s margins, which have been pressurized for a while now owing to costs associated with investments in e-commerce expansion and technological advancements, along with the mix impact from growing e-commerce operations.

Long-term Prospects Look Solid

Nevertheless, the company anticipates these losses to narrow and returns to be better in the mid to long term when scales and efficacies are realized. Notably, the move is likely to help Walmart extend its presence in one of the most promising retail markets in the world, while it will also help Flipkart enhance customer service and augment its business. In fact, Walmart’s backing may also help Flipkart transform into “publicly-listed, majority-owned subsidiary” in the long run.

Given Flipkart’s robust customer base, multiple customer-friendly payment options, solid net sales record ($4.6 billion in fiscal year ended Mar 31) and ventures like Myntra and Jabong among others, Walmart is sure to tap the long-targeted Indian market, where it currently operates on a meagre scale. Though Walmart already operates in India under 21 wholesale stores, its ability to establish its own stores gets restricted by the huge costs associated with setting up stores in a nation like India, alongside certain limitations on foreign ownership for multi-brand retailers. Hence, Flipkart seems to be the right option for the retail giant to strengthen its international presence, augment its e-commerce business and improve its position against Amazon.

Talking of Walmart’s international business, the company has been making solid efforts to allocate resources in profitable regions only. To this end, Walmart is merging its UK grocery unit, Asda with J Sainsbury plc JSAIY, while it also recently announced its decision to shut its first-party e-commerce business in Brazil. These moves reflect the company’s endeavors to shift focus from underperforming areas to markets with high growth potential. Evidently, the U.S. big box retailer has been expanding in China, as evident from its alliance with China’s JD.com Inc. as well as its moves to fortify Sam’s Club store base in Asia’s largest country.

Moving back to Walmart’s focus on India, takeover of majority stake in Flipkart will also help the latter by boosting its grocery business. Flipkart, which sells almost everything ranging from cosmetics to electronics, has been concentrating on the food and grocery space. At such a juncture, investment from Walmart is likely to be a perfect choice, given its vast experience in the space. Also, the deal bodes well for India, as such investments are likely to add jobs, support farmers, enhance supply-chain network and back small businesses. 

What’s Ahead?

All said, we expect both companies to ultimately benefit from each other’s strengths. Though Walmart may face some hurdles in the short-run, the long-term prospects from this deal look quite promising. Also, Walmart’s healthy financial status keeps it encouraged about continuing with its share repurchase plan and retaining its solid credit status. Let’s see if these factors can help this Zacks Rank #3 (Hold) company regain investors’ confidence. Markedly, Walmart’s splendid growth efforts have helped its shares rally 11% in a year, surpassing the industry’s gain of 7.8%.

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

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