flipkart gets global attention

The firm and its value

Flipkart was founded in 2007 spending Rs.400,000 on set-up costs. Today it is being valued at about $7 b (Rs.420 b) as a result of its recent capital raising. At least for these new capital providers the investment is about that big. 

That brings us to find out what kind of returns these investors are seeking. If we go by what the founders have in mind, that is about $100 b value in the next 10 years, the return is 30%. In 5 years it is 70%. Not bad, only if that happens.

Flipkart works with merchants to sell through its online platform (hosting third-party sellers) and earns a fee on sale. It is reported that the revenues last year were about $1 b and expected revenues this year are about $3 b; the growth is phenomenal. 

The market and its share

Nomura expects online retailing in India to reach $23 b in the next 4 years. China's e-commerce sales are pegged at $180 b currently which is 9% of the country's retail of $2,000 b, whereas India's online retail is less than 1% of total retail of $500 b. However, some expect that in the next 20 years it would be about 20% online. As per this report, online retail in India will reach $76 b by 2021 (that is 7 more years).

So it comes to two things: 1) Estimate the total retail market in the next 10-20 years; and 2) Estimate Flipkart's share in that market.

Revenues and margins

While revenues are growing, online retailers in India are not showing any profits yet. Revenues are one thing, but what really counts is the bottom line. Retail is a tough business. After all the years Amazon is not that profitable.

So how much can Flipkart get to where the barriers of entry are not that much? Amazon, eBay, Snapdeal, there could be many more in the competition, both local and global. 

Expecting that Flipkart would become profitable soon (how soon is estimation) is a reasonable assumption. However, the operating margins of online retailers are not very high. We can assign 5% pretax operating margin and 3.5% net margin. At present this is negative for the Indian online retailers. Return on capital for Walmart is about 16% and for Amazon is about 40%. Where would Flipkart be?

The $7 b value 

With starting revenues of $1 b, operating margin of 5% and return on capital of 25%, and a modest cost of capital, expected revenues in the year 11 would have to be $97 b for Flipkart to justify a valuation of $7 b today. I am assuming here that Flipkart is profitable from now itself which is not the case. There is also the assumption of the stable growth period where growth and margins are capped to more reasonable (stable) figures. The model shows that all the value is driven during the stable growth period because of heavy reinvestment that would be required during the high-growth period. Forget dividends; there aren't going to be any. In fact, Flipkart would have to raise capital a few more times during the period.

Amazon's revenues for 2013 were $74 b and for Walmart they were $466 b. From $1 b to $97 b in 10 years the revenues of Flipkart will have to grow at 58% annually. If the expected return (cost of capital) is higher (take your pick), revenues will have to grow at an astronomical rate; this is because revenues of $97 b will not be enough to justify $7 b. 

Of course, we can change any of the inputs and justify that, and that is left to anyone. 

Now, if we assume that in the next 10 years the Indian online retail market would be that of China's current, i.e. $180 b, Flipkart's share in the revenue would be about 54%. Can it pull it off? We just heard that Amazon is going to invest $2 b in its Indian retail operations. 

Alternatively, if we assume that Flipkart is not going to be profitable anytime soon, the model has to be revised. If we expect that it should take about 5 years to get to profitability, the minimum earnings will have to be about $1 b until perpetuity to get $7 b of market value of its equity. This assumes that Flipkart is in a stable growth phase until perpetuity which is really not the case, but the point is that you need those earnings to justify that value. Walmart had $17 b of earnings in 2013 and Amazon had $274 m.

The moral
The moral of the story is that I cannot value these firms since there are too many expectations to have beyond the boundaries. Having said all this it is kudos to Flipkart for getting global attention.