Welcome to Tencent’s Flipkart, Amazon’s new adversary

With its recent deal, Flipkart now has not just a bigger war chest in place, but also a new set of allies that give it the heft to challenge Amazon once again. Make no mistake: it has significant implications for the future of the Indian e-commerce market

“The enemy of my enemy is my friend” 

- The Arthashastra—a Treatise on Statecraft, 4BC

Just a few days ago, Flipkart announced it had raised $1.4 billion from a clutch of companies including Microsoft, eBay and China’s Tencent Holdings. It also announced that it will acquire eBay India. This represents another masterstroke for Tiger Global, the existing investor in Flipkart. It also sets the stage for a fundamental shift in the way Indian e-commerce will play out—in particular, the race with Amazon for dominance. 

Before I go into the details of the impact this deal will have, here’s a little backstory: In part one of my two-part piece on the Indian e-commerce landscape, I talked about how Tiger had pulled off a veritable coup in restructuring and reshaping Flipkart in a bloodless fashion. New leadership, rejigged management decks, cut in waste and burn, and a back to basics homecoming—Tiger reversed the spiral the business had spun itself into.

In part two, I said that the battle for the dominance of the Indian e-commerce market will be fought between the Americans and the Chinese and Flipkart sorely needed “permanent capital” on its balance sheet to stay in the battle.

Well, the battle has turned out to be even more spectacular—it’s not between the American and the Chinese. It’s Amazon vs. everyone else.

Tiger has befriended unlikely bedfellows and delivered a virtuoso performance in deal making. It crafted a transaction where everyone gets their cake and eats it too. Let’s see how:

• eBay, which had a flagging business in India and has worked through similar partnerships and swaps in other markets in the world, gets a winner by exchanging a flagging business for a stake in one of India’s top two e-commerce plays.
• Similarly, Microsoft in its renewed avatar under Satya Nadella wants to fight Amazon on the cloud business, gets a strong foothold in India as well as a large customer in Flipkart (in a way earning part of its investment back!).
• And finally, Tencent, which last week became the seventh largest company in the world in terms of market cap, walks into India along with its largest investor Naspers. Between them, they could become the largest shareholders in Flipkart.

Only regulatory filings for an initial public offering will reveal publicly the actual quid pro quo involved: What is the business deal with Microsoft? What’s the cash being paid to buy eBay India? What are the arrangements, if any, between Tiger and Tencent for a future buy-out?

Each investor got his pound of flesh and for Tiger, it is “mission permanent capital” accomplished.

So, any analysis of valuation for such a complex manoeuver will be quite pointless since no one is privy to the actual math, except for the headline number of $11.6 billion post the latest fundraise and the deduction that the pre-fundraise valuation is $10.2 billion.

Between the services contracts, stock swaps, ratchets, potential anti-dilution obligations and special rights to earlier investors (who invested at the headlinenumber of $15.4 billion), the true fully-diluted, all baked-in valuation is likely to be lower. I would expect it to be around 1.6-2X of gross merchandise value or GMV (estimated run rate at about $4 billion), which is more in line with prevailing multiples for strong e-commerce players.

I have always maintained that too much ink is wasted on debating Flipkart’s valuation. What was important was that it get a new lease of life and strong backing. The combined worth of its backers is now in the hundreds of billions and it is ready to fight Amazon.

The proposed deal to buy Snapdeal—which its biggest investor SoftBank is pushing for—has very little business rationale. The firm is a subset of Flipkart on most fronts with massive overlaps, except for Freecharge which brings a big base of wallets. Integrating these companies and their management itself will become a huge source of distraction, which Flipkart can ill-afford at this juncture. Do that and it will give Amazon a chance to swoop into any space that Flipkart vacates.

Very simply, the Snapdeal deal is a chance to add SoftBank to Flipkart’s armoury, and it gives SoftBank a graceful way out of an investment it no longer believes in. If Tiger convinces SoftBank to invest in the combined entity as well as buy out some of Tiger’s original investment (about $1 billion), both SoftBank and Tiger can ride the upside in Flipkart to a whopping return with their residual stakes.

Just for perspective, if Tencent wanted to buy out all of Flipkart today in an all stock deal, it would just constitute an issuance of less than 4% of its shares. In fact, the resulting bump in Tencent’s market capitalisation would more than pay for the acquisition. Clearly, Tiger is playing for an upside here and will sell when Flipkart commands a higher valuation. Equally, Tencent wants to retain Tiger in the game—and have it continue navigating the business. Makemytrip’s staged acquisition by CTrip, Tencent and Naspers, and its market cap jump of 5X in under a year is an example.

The fact remains that even if Flipkart becomes a strong and sustainable No. 2 in the market, it is a hugely valuable asset, especially to Tencent which is steadily collecting assets in India and will use Flipkart as a base to launch a WeChat clone in India. With payment systems, Aadhaar-based India Stack (the layer of technologies like unified payments interface built around Aadhaar) and consumer awareness going up and given WhatsApp’s reticence to open up to commerce, India is another place to build a formidable WeChat “super-app” kind of business. 

To conclude this part, Flipkart gets a lease of life and the hands on the table change to companies that together have balance sheets to rival Amazon’s bulk and commitment to win in India.

Net-net, Tiger has delivered a masterstroke. Fortunes have turned on a dime—Flipkart is backed with long-term capital. Competitive intensity goes down. Alibaba’s entry via Paytm is the only unknown Amazon and Flipkart both have to counter effectively (see box ‘Alibaba: The Joker in the pack’). For the moment, Flipkart is the only alternative to Amazon.

Amazon and (not versus) Flipkart

If you look back, what gave Tiger confidence was the way that Flipkart rallied ahead under the newly installed professional leadership. It managed a phenomenal festive season push, and then the double whammy of demonetisation and funding runway paranoia landed a hard blow to Snapdeal and the others. Suddenly, Flipkart and Amazon had pulled ahead of the pack, pushing Snapdeal, Shopclues and Paytm far behind. While the overall market growth stalled, the two players grew by eating into the share of the others.

Amazon has often been characterised as a villain of the piece and Flipkart the fallen hero who protests about the not-so-level playing field and unfair tactics—playing the victim almost. But that’s not the case.

Flipkart gave away the game to Amazon; it made unforced errors and self-goals. In my article from a year ago, Saving Private Flipkart—which led to a lot of debate—I had written how Flipkart’s fall was its own doing and not a result of anything that Amazon had done deliberately to hurt it.

The aces Amazon holds today are the ones that Flipkart has given it—Flipkart has not focused on content, habit creation, building regional language content and deep engagement, second-hand goods, creating a media offering, or creating loyalty/cash back programmes or wallets—all the aspects that could have been “defences”. 

Not much has been written about the systematic and focused manner in which Amazon has gone about building its business in India. Flipkart will have to follow and learn the same game—it has to replicate not just Amazon’s interface and ideas but more importantly, it’s unrelenting focus on customers and making their journeys simple and seamless.

That said, Amazon and Flipkart are nearly neck and neck, but have very different plays in the market. Flipkart continues to push smartphones, appliances and apparel, while Amazon is singularly focused on building habit.

Now we enter the next phase of the war: A long battle of attrition that will play out

Now we enter the next phase of the war: A long battle of attrition that will play out. The initial noise and soundbites are over, the spectators will fall silent and all you will hear are the swords clashing. The fight will be long and hard, the battle will have more twist and turns. But the spoils are large enough for both to walk home with a bounty—a $200 billion estimated market in the next 5-10 years (depending who is your favourite analyst) and a 30-50% market share of the largest accessible consumer market in the world. The market will allow for three-four strong differentiated plays.

The sprinting is over. Both the players now need to conserve their energies like ultra-marathoners. Running faster or ahead for a few weeks or months may grab the occasional media headlines, but both players know that it doesn’t matter. They are still in rough terrain and every move will have to be calibrated.

The market that vanished 

The little known truth about India’s e-commerce market was uttered at a conference in Delhi a few weeks ago. Flipkart’s chief executive Kalyan Krishnamurthy said that there are only 10 million monthly active buyers on e-commerce in India. This confirms what I have been saying for two years now—the market is simply too small.

The fallacy is that we compare per capita incomes with other markets. That is, we are a billion consumers, a $2.25 trillion economy, have 450 million internet users, and we take our smartphone penetration (300 million and growing) as a proxy for spending power.

In an earlier piece titled “How India’s digital economy can rediscover its mojo” I had talked about how India needs to be seen not as one country but three. Simplifying it even more—I call it the 1T, 1T and Zero economy.

• The top 15% (India One) constitutes a $1 trillion economy that has disposable income and ability to spend. The desire and charm of online shopping appeals only to the India One audience, and that’s where it will be viable to service them. They are the perfect audiences to sell convenience and selection to—the real promise of online commerce. They are comfortable using English, and are time-starved, well-paid, confident-of-their-future Indians.
• Another $1 trillion is spread across the next 40% of the population (India Two), which supplies and services the India One economy. The India Two customers will take longer to cotton on to online shopping—and they will shop for basic needs and deals. Flipkart and Amazon will both find that expanding in this market will prove to be a drain on their resources with little payback. It will be unviable to service them unless they start leveraging the power of the existing traditional networks (kirana shops, wholesale trade routes and the neighbourhood entrepreneurs).
• The final half of our nation barely gets by. They live on the periphery of our economy—calling them consumers itself is a travesty. They have negligible disposable income. Any growth in their incomes goes entirely towards sustaining their lives—roti, kapda and makaan. The India Three customers are serviced poorly even by our traditional networks—tiny hole-in-the-wall shops with limited supplies service the poorer villages. Their lot will improve only once the nation uses digital tools to leapfrog the chasm created by lack of physical infrastructure and decades of neglect, and empower them with jobs and basic income and infrastructure.

(To get more on how income disparity runs deep in the Indian landscape, read this excellent piece on how the incomes of the three richest states are three times the incomes of the three poorest ones.)

How this changes Amazon’s and Flipkart’s plans

Clearly, they both realise the waste has been colossal. The math is staggering. The players have pumped in over $15 billion so far to woo a customer base of 10 million regular monthly transacting users.....

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