Morgan Stanley’s Markdown of Flipkart- Impact and analysis

After 8 years of discounting, Flipkart itself was discounted by Morgan Stanley by 38% to 9.39 billion dollars. The “mark down”, as they call it, was bound to create some ripples in the E-Commerce industry and the start-up community as a whole. Ripples were created. Confidence was shattered in some way. Reality was thrown open in front of every exuberant and potential investor. An issue to analyse and give opinions about was manufactured. Is this event part of a trend? A trend significant enough to generate doubts on the E-commerce industry as a whole? What is the feasibility of the business model of E-commerce companies anyway?

What did Morgan Stanley do to Flipkart exactly?

The poster boy of Indian Start-up Industry, Flipkart, was valued at $15 billion when it received $700 million from Tiger Global Management, Qatar Investment Authority and other investors last year. A share of Flipkart in June, 2015 was priced at $142.24. Morgan Stanley (MS) had other things in mind though. On 31st December, 2015, MS marked the Flipkart shares down to $103.97, taking away 27% of perceived value at one go. Things didn’t stop here. After the quarter ending on 31st March, 2016, MS marked the shares down to $87.9. A company assumed to be valued at $15 billion supposedly, came crashing down to just about $9.39 billion dollars in two quarters. A mark down of roughly 38%.

That’s strange. Why did MS do this?

As it happens, funds like MS frequently reassess their holdings and adjust it either up or down. The calculation that goes behind this differs from fund to fund. But largely funds consider the class of shares they own, anti-dilution rights, etc. They may even compare their holdings with some comparable peer and reach to a valuation, random to many outsiders. Crudely put, it’s just a fund’s internal value assessment method.

In this case, the markdown was part of a broader rout in Morgan Stanley’s valuation of Global technology and internet companies. Even Dropbox and Palantir lost some value in the process.

There was also an uncertainty among investors about whether Flipkart would be able to compete against Amazon, which is pumping money in India at exorbitant pace. (Amazon readied a war chest of $5 billion for expansion in India).

These all worked negatively for Flipkart.

What about the other funds? Did they do the same?

Yes and No. While some funds did mark Flipkart down, the degree of devaluation wasn’t as high. There were also some funds which maintained their initial valuations. Valic Co. and T Rowe Price marked down their holdings by 29% and 15% respectively. Investors such as Iconiq Capital, GIC, DST Global and Sofina Societe have maintained the valuations thus far.

What about other E-commerce companies?

Not a rosy picture for other E-commerce companies either. Snapdeal is finding it difficult to raise fresh funds at its preferred valuation. (It is currently valued at around $5 billion). Last month, an analyst estimated that Zomato was worth half the valuation at which it raised funding in September. A look at the revenues and massive losses of companies like Quickr, Ola, Paytm, Shopclues, etc. tells that their valuations are running way ahead of themselves. Hyperlocal companies such as PepperTap and LocalBanya have closed down while Grofers is reducing employee count gradually. Not many companies see a breakeven point in near future.

Seems a gloomy picture. What is happening with E-commerce?

The challenges the business model as a whole is facing can be summarized as below:

Entry barriers are minimum. This is because the products are undifferentiated and not much capital is required to start the business. This makes the industry very competitive.
Threat of substitute products. Consumers have so many options available. These options are equal, quality and performance wise, and the switching cost is very low. This makes the industry price sensitive.
Low brand loyalty. Consumers are always in search of a better deal no matter where it is coming from. There is no niche market for any company as they are selling more or less same products. This makes it difficult to retain customer base.
Abundance of Information. Every buyer has access to loads of information regarding the product attributes, its alternatives, etc. This gives them huge bargaining power. Again, detrimental for the companies.
Very few suppliers, which means whatever they are selling can be sold to multiple websites. Again, bargaining power shifts to suppliers.
Forbidding foreign-backed firms from owning inventory means these firms have little control over quality.
Other expenses. Indian speak more than 20 languages. This makes marketing a complicated affair. Indian roads are clogged and infrastructure decrepit. Add to this the huge geography of the country, it results into a costly logistic network.

Majority of these companies rely on Private Equities to get funding. The business model is such that none of the companies are profitable or nowhere close to being profitable in the near future.

Losses of some Ecommerce companies:

FY14 (₹cr) FY15 (₹cr) Loss hike (%)
Flipkart 508.5 1932.9 280.12
Snapdeal 264.6 1328 401.89
Amazon 321.3 1724 436.57
Quickr 200 440 120
Zomato 37.2 147.3 295.97
FoodPanda 7 36 614.29
Housing 48.9 279 470.55

Investors are no longer interested to burn their money if they don’t see a viable business model which can generate profits. Rather they would back companies with robust traditional business model and visible path to provide an exit.

The industry is also reaching a phase of consolidation as many big players like Flipkart and Snapdeal have started acquiring niche players to widen their offerings. This may result into approximately 70% of the E-commerce companies getting acquired or shut down over the next few years.

Investors would necessarily look for some new spaces in the E commerce industry in the near future. This may be a sector such as a specialized logistics providers to the E-commerce industry.

Enough of Problems. Anything positive out there?

It is being implied that there is an E-commerce bubble in the market and it can burst just as the dotcom bubble did. Flipkart’s marking down is largely being seen as a step in that direction.

What if this is a myth? What if the mark down is not a bubble burst?

Entry of foreign funds like Tiger Global changed the fund raising in many ways. There is a whole lot of money available with these funds and their portfolio is very spread out across startups in various industries and at various levels. Heavy funding by them has contributed into spike in valuations. The other effect is the fear of missing out they generated in Indian VCs. Indian firms could no longer afford to spend a whole lot of time doing valuations as the foreign firms would take the startup away in that duration. This contributed to some irrational over-funding at high valuations.

The scenario is changing now. Funds like Tiger global are retreating from Indian arena, and VCs are again back to doing due diligence. It is a good thing, and the valuations are just returning back to “normal” levels. A Giant like Alibaba is valued at only 1.1x its GMV, while Flipkart, before the mark down, was valued at almost 4x its GMV. This had to adjust someday anyway.

Macro economically, India has a tremendous potential for E-commerce sector as a whole. By 2030, more than 1 billion Indians will be online. 25% of the mobiles used currently are smartphones already. This number would increase only. Add to this the fact that India is world’s fastest growing large economy and around 65% of the population is below 35- one can see why Ecommerce giants are willing to burn some cash to gain the market share.

Sales are still insignificant at $16 billion in India. There is so much to do in terms of financial and Infrastructure development. Shopping malls and chain stores only account for 10% of retail share in the country. This leaves a huge room for the online retailers to expand. Income level of people would increase manifold in the next decade, resulting into more dispensable income in the market.

Estimates of market size of online retail

To increase revenues and organize the informal seller’s market, companies are also boosting the number of sellers on their platforms. That is from where commissions and shipping fees come anyway. To make the delivery more effective, companies are outsourcing some part of logistics to other efficient companies such as Dabbawallas, Delhivery, etc.

With decrease in government regulation in future, E-commerce companies would also have more room to expand.

Let’s wrap it up

The markdown of Flipkart should be taken with a pinch of salt. While there are some fundamental problems with the business models of Ecommerce companies, they are slowly and surely getting rectified. Companies with strong fundamentals, accurate planning and better execution would thrive in what promises to be a wonderful growth opportunity for the Ecommerce companies in India.

Written By : Nishant Shah
Nishant Shah is a PGP First year student at IIM Ahmedabad

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