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Analysts voice concern about Walmart's e-commerce prospects after Flipkart deal

Walmart Inc.'s $16 billion deal to acquire a majority stake in Indian e-commerce player Flipkart Online Services Pvt. Ltd. is making some analysts nervous about the retail giant's e-commerce prospects.

The Flipkart acquisition is Walmart's largest in the last 10 years at $16 billion, according to data compiled by S&P Global Market Intelligence. It is also Walmart's second pricey deal for an unprofitable e-commerce startup. It bought in 2016 for $3.3 billion and has yet to make the business profitable.

The Flipkart deal turns the spotlight on Walmart's first-quarter earnings due May 17, said Brian Yarbrough, an analyst at Edward Jones. Walmart reported U.S. e-commerce growth in February of 23% for the fiscal fourth quarter, down from 50% the quarter before. Yarbrough said that Walmart needs to report growth in the 30% range to keep the market optimistic about the company's e-commerce efforts.

"That makes e-commerce growth this quarter so important," he said in an interview. "Investors are going to want to see that there's some substance behind the claim that they can scale an e-commerce model successfully."

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The Flipkart deal, which Walmart said will weigh on its results for the next couple of quarters, will be dicey for a lot of investors, said Rupesh Parikh, an analyst at Oppenheimer.

"This deal adds new risk at a time investors have been looking at Walmart to streamline their business," he said. "This has the potential to really derail some of the progress they've made."

Walmart now has to scale and bring a new, more expensive e-commerce company to profitability, which will likely call for more investments beyond the $16 billion value of the deal. That is a tall order when the company has no proof it can do that in its core U.S. market, Parikh said.

"Walmart is walking a fine line between investment and profitability right now," he said. "Growing an e-commerce company is really, really expensive, and there's no guarantee that Walmart, or anyone, can do that very well."

Walmart declined to comment and referred journalists to its May 9 analysts' call on the deal.

Growing Flipkart's business could result in "sizable losses" for Walmart in the short term, analysts at RBC Capital Markets said in a note circulated to clients May 9. That is especially true as Walmart positions itself as an online competitor to e-commerce giant Inc., which also reportedly put in a bid for Flipkart.

"They are fighting Amazon on every product front, they bought the money-losing business, which added to their already-high operating losses in e-commerce and they are increasingly fighting for market share in grocery, primarily using 'price' as their main competitive weapon," the analysts wrote. "All of these are profit negative."

To be sure, there would likely be long-term benefit to the Flipkart deal, both analysts and Walmart executives said. Gross merchandise volume of online retailers in India jumped to $17.8 billion in 2017 from $4.5 billion in 2014 and is forecast to reach $28 billion in 2018, according to Indian management consulting firm RedSeer, which expects growth to continue to $50 billion in 2020.

Douglas McMillon, Walmart CEO and president, told analysts that Flipkart is a foothold in the growing Indian e-commerce market. Flipkart also has a logistics business and a payments business that has potential for the broader international segment of Walmart, said Judith McKenna, president and CEO of Walmart International, on the same call.

Both Yarbrough and Parikh said that the deal could set Walmart up to compete with Amazon in India, and that the investment has a chance to help Walmart grow in the long term.

"They just have to execute on e-commerce first," Yabrough said.

Walmart's Flipkart deal helps illustrate the significance of the Asia-Pacific region to global retail M&A activity. Year-to-date, retail M&A transactions have totaled $27.56 billion with Asia-Pacific accounting for $19.95 billion of the total, according to data compiled by S&P Global Market Intelligence.

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The Flipkart deal should not significantly hurt Walmart's credit profile, Moody's lead retail analyst Charlie O'Shea said, calling the impact "relatively benign." The rating agency views the deal "favorably," he said.

"As Flipkart is expected to generate meaningful losses for at least the next five years, this is clearly an investment for the future," he said.

Fitch affirmed Walmart's long-term issuer default rating at AA after the Flipkart announcement. The analysts said the rating reflects Walmart's "dominant retail market share position."

S&P Global Ratings, however, lowered its outlook on Walmart to "negative" from "neutral," based on "a potential shift in financial policy" resulting from the Flipkart deal, S&P Global Ratings analyst Diya Iyer said in an interview. The $16 billion deal will be financed with cash and debt, Walmart said. That is a departure from other large deals. The acquisition, for example, was funded largely with cash.

S&P Global Market Intelligence and S&P Global Ratings are owned by S&P Global Inc.