Sunday, August 25, 2013

Company Valuation: How do you value Flipkart?

Flipkart's valuation: Will it increase if there is no IPO?

Since Flipkart is a marketplace, it does not own inventory of goods sold on its site. So inventory cannot become part of the book value of Flipkart. That leaves the Brand Value and investments in Technology as its part of valuation.

The customer base and their loyalty would be a pretty impressive figure for Flipkart. But the question is, will it keep growing or find saturation any time soon or see a negative growth with changes in the way of doing business.

For growth to remain to intact, following factors should remain same or get better.

1. Benefits to customers (Discounts, Delivery costs, Minimum purchase price) without impacting operational costs of the firm
2. Sufficient operational profits or new investment to fund growth and the the capital structure shall offer acceptable returns to the investors.

Let us look into those factors in detail.

1. Discounts, Delivery costs and Minimum Purchase Price

If we take a look at their revenue segmentation, books form a major category. Flipkart was almost unchallenged in selling books through online mode with its vast span of books listing and superior service quality. But the arrival of Amazon brings in a tough competitor. For now, free delivery irrespective of purchase amount would become a positive factor for Amazon (when prices match for the product on both websites). But if we assume that Amazon too will have to charge for delivery sooner than later, who will consumers will prefer, Flipkart, Amazon or the neighborhood bookstore? If the book is available off the shelf in a nearby bookstore, is priced less than Rs 500, then why buy them on portal, and wait for couple of days and cough up additional Rs. 50 for delivery? This is when discounts in brick and mortar stores match with the online portals. But the inflation will not let the delivery charges for online stores remain same. What will be the effect if the minimum purchase amount is raised or the delivery charges go up? Will they be able to maintain the sales figures?

India is a price sensitive market, so the customer loyalty can quickly change whenever there are changes in pricing. Whoever prices aggressively will have an upper hand. Let us see how one portal can price it lower than the other portal when the product is sourced from the same supplier? In case of books, a new book will have just one publisher, so the same source of supply. If we assume that online firms (vendors on Flipkart or Amazon or any other site) gets the same purchase price from publisher, then operational excellence will decide who can sell it at a lower price. Operational excellence would mean keeping the costs low by reducing wastes, overheads, optimizing the routes and keeping the firm lean. How lean one firm can get? What are the risks of operating with thin margins? Will investors be happy with those returns? It leads question of capital structure of those firms. Who has funds available at lower cost? The firm having a larger equity base would have an advantage over the firm which has to service the debt or offer higher returns to PE investors.

2. Operational Profit, Capital Structure and RoI

Due to intensity of competition, Flipkart will have to match selling prices with competition; else its revenue growth will slow down. With that acting as a ceiling, margins will be under pressure. It not only has to make profits per transaction but has to offer positive returns on investments. Currently Flipkart is funded by Private Equity (PE) investors. Since the successes of PE funds are measured with their exits, mostly with 5-7 years time span, it will apply to Flipkart also. Unless PE investors have a longer time investment plans for Flipkart, IPO would be the only exit route for current investors. For IPO to be successful, equity markets need to be in good mood. Are the stock markets conducive for IPO? If time is not right, then it will have to go for one more round of funding from PE or generate sufficient operational profits in order to survive. Increasing profits would mean lesser discounts or higher delivery charges to customer which will hit sales figures. Dropping sales would impact the valuation which is done now at higher sales figures and growth rates. 

However no one knows what the future holds, but we can think of three possible scenarios.

Best Scenario:

IPO happens at higher valuation, Flipkart gets good equity base. Amazon reduces its aggression, both Flipkart and Amazon will grow.

Worst case scenario:

IPO gets delayed, and there is no further funding available. Amazon steps up competition making use of its deep pockets. Flipkart will be forced to invest less in growth and start making profits to survive. Valuation drops from current level.

Likely scenario: 

Both Flipkart and Amazon reduce predatory pricing and look at having a balance with profits. They may work out exclusive contracts with suppliers to avoid selling the same product, wherever possible. Brick and mortar stores may find a relief with new operational models and peacefully co-exist. Flipkart's growth rates may reduce and valuation will also find it difficult to go up from here.