Amazon Should Pay Off Walmart And Take Flipkart For Itself

Summary

• Is Amazon finally looking to end its battle with Flipkart?
• Analysis of the two scenarios - a Walmart acquisition and an Amazon acquisition.
• In the case of Amazon taking a stake in Flipkart, Alibaba could leave the market altogether.

A little more than a month ago, I had written how suitors were lining up to take a majority stake in India's Flipkart (FPKT) and how in the short-term this could give a bloody nose to Amazon (NASDAQ:AMZN) in its fastest growing market. If speculations are to be believed, Amazon wants to nip these ambitions of Walmart (NYSE:WMT) in the bud. The company is apparently gearing up to make a counteroffer after having held exploratory talks with the Indian e-commerce major. I discuss the implications of this new move in the ongoing chess battle between Amazon and its global peers.

(In the past, I have covered the Indian e-commerce battle in considerable detail through the following articles.

Alibaba Vs. Tencent: Competing In The Second Kingdom

Amazon, Alibaba Renew Battle In A New Geography

In India: Betting On An Amazon Victory

Links are provided for investors looking for a detailed read. This is a continuation of the Indian e-commerce series, and I don't intend to repeat previously discussed material here.)

Scenario Analysis

I projected a few scenarios and I am going to discuss a couple here. The only win-win is, of course, Flipkart and Amazon coming together to dominate e-commerce in India with an effective monopoly. But nobody likes sharing the first place and with both parties trying to convince each other that the future belongs to them, this is turning out to be a classic game theory puzzle!

Scenario 1: Walmart Picks a 40% stake in Flipkart

Scenario 2: Table by Author; Numbers in Billions of USD; Assumptions - Net profits were projected against each company. Figures for Walmart are based on a 40% stake. The losses in the initial rate increase at a 10% rate until year 8. Morgan Stanley estimates that the total e-commerce market in India would increase to $200 billion. A 2% Net profit margin leads to a figure of $4 billion in net profit for the entire market. Further, I assumed 50% probability of success due to which the profits get distributed between Flipkart and Amazon equally after year 8. Note the exercise is aimed at roughly guiding investors on how the two scenarios could pan out. Accuracy is not the target here. No one can project net profits over a 22 year period accurately.

This turns out to be a lose-lose scenario for both the players as they pursue a scorched earth strategy to get customers behind their back. Even after projecting figures for 22 years a positive NPV for both Walmart and Flipkart was hard to get. The reason is fairly simple. Neither company offering discounts is the ideal scenario but that is not the stable state of the system (also called Nash equilibrium). As long as either entity has an incentive to offer discounts (to take market share) they will pursue that strategy even if it damages both the companies.

Neither entity offers discounts	Only AMZN offers discounts
Only FPKT offers discounts	FPKT-WMT combine and AMZN both offer discounts

Click to enlarge

Perhaps understanding this, Amazon is trying to change the game itself.

Scenario 2: Amazon Pays off Walmart and takes a 40% stake in Flipkart

Scenario 2: Table by Author; Numbers in Billions of USD; Assumptions - Discounts stop immediately after stake acquisition and the company maintains a breakeven income statement until the market matures.

As seen above, if Amazon manages to grab a majority stake in Flipkart, it easily achieves the economic nirvana needed to justify an investment of ~$8 billion - $9 billion. In fact, it could set aside a decent sum of money to pay off Walmart to ensure it stops chasing Flipkart. Else Amazon could engage Walmart in a bidding war to ensure it pays a costly price for the acquisition. This would end up hurting Walmart shareholders.

The Biggest Loser if Flipkart merges with Amazon

If Amazon does succeed in absorbing Flipkart, Alibaba (NYSE:BABA) is likely to lose the most in the Indian market. From a valuation perspective, it doesn't seem like Walmart's stock factors in any possible expansion in India. The scenario would, therefore, be similar to not getting an asset one never had in the first place. And considering the prospect of a costly price war with Amazon, shareholders with shorter-term perspective would probably heave a sigh of relief that the company had to let go of this purchase. Flipkart had a loss of ~$1.5 billion over revenues of ~$3 billion last year.

A few days ago, Alibaba along with Softbank raised $445 mn for PayTM Mall at a deal valuation of $1.9 billion. Considering that the combined muscle of Amazon and Flipkart would have a market share greater than 80%, it is hard to see how PayTM Mall could survive in the aftermath. In the past as well, Alibaba burnt its fingers by writing off nearly a billion dollar investment in Snapdeal (DEALS). Importantly the company would be driven out of the Indian market entirely leaving it with the custody of the lone major market of China.

(Considering the slightly nuanced details, write in for any confusion about the argument presented above. The discourse must, of course, be civil for me to respond)

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Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.