Flipkart IPO: Will It Be Smooth Sailing For Investors In The Wake Of Anti-US Sentiment, Policy Hurdles?

“…So, we’re not really getting hung up on the valuation in the short term. Over time, I think everybody will understand just how valuable that business in India is, whether it’s the Flipkart portion or the PhonePe portion,” Douglas McMillon, president, chief executive officer and director, Walmart, Inc

Now that we are a month into 2021 and the initial shock of the Covid-19 pandemic has worn off, public markets are buzzing and businesses seem to be entering one of the much-desired boom periods. Even in 2020, in the midst of a global shutdown and an unprecedented economic slide triggered by the coronavirus crisis, the likes of Airbnb and DoorDash had seen the biggest and the buzziest IPOs come off. Buoyed by the global outcomes, startups in India do not want to sit on the sidelines and miss out on the public market cash and valuations.

More than half a dozen tech startups and consumer-facing internet companies such as Zomato, Nykaa, PolicyBazaar, Delhivery, MobiKwik, Freshworks and Flipkart are looking to get listed later this year, an endorsement and trust transition from private investors to the open market. But out of all the startups scrambling to go public, all eyes are bound to be on Flipkart, the Walmart-owned e-commerce behemoth.

The reasons are many. To start with, Flipkart is gunning for a US IPO in Q4, 2021, says an analyst who had earlier worked on Flipkart’s acquisition deal. To meet the 2021 IPO deadline set by its parent company Walmart, Flipkart has reportedly hired investment bank Goldman Sachs and is preparing to divest 25% of its stake at a valuation of $40 Bn. Flipkart is currently valued at $25 Bn, which means it is aiming to raise $10 Bn through the IPO.

But there is more to it. Can Walmart fully rely on Goldman Sachs’ report as did SoftBank on Morgan Stanley’s IPO reports on Uber. Uber hired Morgan Stanley for its IPO plans and the latter valued Uber at $75 Bn and estimated the largest ride-hailing platform to hit a valuation of $120 Bn post-IPO. However, on its debut day, Uber’s shares dropped by 11%, resulting in the biggest first-day dollar loss in the US IPO history. The Uber IPO came to be known  as a disaster.

The question mark over Flipkart’s profitability should not hinder its IPO bid, either. The record success of Airbnb and DoorDash amply illustrates that both retail and institutional investors have learnt to accept cash-burning companies. Moreover, according to Walmart’s earnings report of 2020, Flipkart has already exceeded its pre-Covid gross merchandise value. “The number of monthly active customers for these platforms (Flipkart and PhonePe) is at an all-time high,” said McMillon while presenting Q3,2020 result for Walmart.

Then there will be an added zing. Several experts and analysts have termed Flipkart’s IPO at a US stock exchange as a ‘jackpot’ by drawing a parallel between Amazon and Flipkart (or Walmart, by default). Given the credibility of Flipkart’s US parent, it is expected to take care of all compliance issues while filing for an initial draft registration statement with the US Securities and Exchange Commission (SEC).

But everything may not be what meets the eye, and Flipkart’s IPO journey could be fraught with several hurdles. Inc42 analyses the pros and cons, and the probable outcomes.

The Policy Hurdles And What They Mean for Overseas Entities

According to experts, there are reasons galore why Flipkart will make a successful IPO debut in the US. After all, an Indian entity (with a US parent) will always get preferential treatment from US investors compared to Chinese entities. India’s political stability is another reason to bet big on a homegrown company, especially as it holds a dominant position in the country’s burgeoning ecommerce space. But none of these can negate the challenges the company is facing in terms of regulatory hurdles.

In the wake of rising demand from Indian vendors, sellers and their associations, the Indian government has come up with a slew of regulatory circulars and notifications in the past few years, curbing several popular practices adopted by both Amazon and Flipkart to attract more consumers and ensure operational ease.

On Dec 26, 2018, the Indian government notified an ecommerce FDI policy that curbed the deep discounts offered by these online marketplaces,  put a stop to deals which enabled vendors to sell exclusively on those platforms and also barred ecommerce entities from selling products through companies in which they held a stake. In brief, the circular aimed to do away with the control that ecommerce marketplaces used to have on inventory and pricing, either directly or indirectly.

Amazon and Flipkart were forced to restructure their India investment plans and revenue models to cope with the new policy. But the impact was bad enough. According to Morgan Stanley’s 2019 report titled Assessing Flipkart Risk to Walmart EPS, while the losses for Amazon could double in three years,Walmart could see an incremental loss of $280 Mn from Flipkart due to India’s ecommerce FDI policy. Amazon might have lost more than $4.53 Bn GMV due to this policy.

Expressing concern over its implications, Walmart spokesman Greg Hitt said at the time, “We certainly, as you would expect, have engaged the (United States) administration on this issue.”

The Congressional Research Service (CRS), a federal legislative agency that serves Congress Committees and Members of the Congress, also felt worried, says the Morgan Stanley report. “The US concerns about investment barriers persist nevertheless, heightened by new Indian restrictions on how ecommerce platforms such as Amazon and Walmart-owned Flipkart conduct business. From the US view, India’s weak regulatory transparency and other issues, such as IPR and localisation policies, add to concerns about FDI barriers,” the CRS was quoted as saying.

The US government also conveyed this to Indian officials, asking them to protect Walmart and Flipkart’s investments in the country, citing the “good relations” both countries share.

The analyst quoted earlier, however, said, “With the government adamant on implementing draft National Ecommerce Policy in spite of wide criticism, the concerns of Walmart have only grown in the past two years.”

The draft further aims to regulate cross-border data and also seeks a joint liability for counterfeit products, fulfilled by the ecommerce entity and the seller.

Going by these developments, the local-versus-global confrontation seems to be getting more aggressive over time. For instance, based on the complaints filed by the Confederation of All India Traders (CAIT), the government had categorically asked the Enforcement Directorate (ED) and the Reserve Bank of India to take necessary action against Amazon and Flipkart regarding  the violation of the Foreign Exchange Management Act (FEMA) and the FDI rules.

“Both institutional and retail investors in the US are now wary of the Indian government’s policy on ecommerce. They would prefer to wait and watch instead of grabbing the opportunity (to invest in Flipkart’s IPO),” says the aforementioned analyst.

Quizzed on the regulatory conflicts, Santosh N, Managing Partner of Duff and Phelps India and Anup Jain, Managing Partner at Orios Venture Partners say that these may not affect US institutional investors. Jain, however, thinks that investors are likely to compare Walmart’s issues and opportunities against Amazon, its No. 1 rival and a leader in the ecommerce space. Also, the fact that Walmart had missed the ecommerce wave in the US may not make it the most-anticipated investment option.

When The Swadeshi-Vs-Videshi Conflict Hounds Ecommerce

Known for his “Math didn’t help Einstein discover gravity” remark, railways and commerce & industry minister, Piyush Goyal, criticised Amazon’s India investment plans last year, stating that the company is “not doing a great favour to India” by investing a billion dollars and later backtracked from his comments. He, however, emphasised that these investments should not create unfair competition for small traders. Undoubtedly, this had set the tone of action much before campaigns like ‘vocal for local’ and Atmanirbhar Bharat came into being.

The CRS even termed India’s vocal-for-local campaign as “forced” localisation practices highlighting recent moves like in-country data storage, domestic content and domestic testing requirements. The report highlighted these practices as a barrier to Indo-US trade.

Interestingly, a popular notion among investors is that regulatory issues in India can be amicably resolved through effective lobbying. Walmart and Amazon have already brought in global investors like SoftBank, Tiger Global, Sequoia Capital and Naspers to push their interests. But so far, the lobby has performed poorly and the authorities have snubbed several business leaders. During his 2020 India visit, Amazon CEO Jeff Bezos was refused an appointment with Prime Minister Narendar Modi. In 2018, PM Modi had also turned down a meeting request from Walmart CEO Doug McMillon.

According to a Reuters’ report, the lobbying effort yielded no result as India went ahead with the above-mentioned ecommerce FDI rules from Feb 1, 2018. Walmart, Amazon had been lobbying against the FDI policy. “It came as a total surprise… This is a major change and a regressive policy shift,” Walmart’s senior director for global government affairs Sarah Thorn told the Office of the United States Trade Representative (USTR) in an email on Jan 7, 2019.

“Changing rules to hinder international business following major investments … will have important implications for India FDI goals and add unnecessary pressure to trade discussions,” Walmart said in its note.

Although Walmart and Amazon are now planning to bring in trade bodies like the Confederation of Indian Industry (CII) and the Federation of Indian Chambers of Commerce & Industry (FICCI) to voice their concerns, the government is not likely to change its stand and go against the ruling party’s associate groups like the Swadeshi Jagran Manch (SJM). This RSS-affiliated platform has frequently alleged that Flipkart and Amazon are circumventing ecommerce regulations and jeopardising the livelihoods of crores of small retailers.

Lobbying is an important instrument for sustained interaction between governments and businesses but Walmart had badly failed in this department in the past. And it had hugely impacted the brand globally. “There is no way that the company and the US institutional investors would solely depend on lobbying and repeat the mistakes of the past,” the analyst says.

It is worth noting that in June 2019, Walmart had to pay $287 Mn in penalties to settle cases involving allegations of graft for fast-tracking the opening of its stores in India, China, Mexico and Brazil.

The Elephant In The Room: Why A Fast-Spreading Jio Net Causes Concern 

Another undercurrent of concern about the fast-paced growth of Mukesh Ambani- owned Reliance in India’s telecom and internet space is often present in off-the-record discussions of many US investors, who try to gauge the real growth opportunities across the Indian market.

“It is a deadly combination if you are the largest internet service provider and have world’s largest internet companies as investment partners, at the same time. This destabilises the market competition and threatens the very idea of net neutrality,” one of the Silicon Valley VCs had earlier told Inc42. A large number of policies have been tweaked to benefit the oil-to-retail-to-telecom behemoth, and ecommerce just happens to be one of them, he said after Reliance announced its foray into the sector.

Offering a certain discount across all the products on its platform, the months-old JioMart from the house of Reliance has reportedly surpassed key competitors BigBasket and Amazon Pantry in terms of daily orders. As of July 2020, JioMart claimed to be receiving 250,000 orders per day compared to BigBasket (220,000) and Amazon Pantry (150,000) while another homegrown player Grofers reportedly clocks 150,000 orders per day.

Moreover, as an Indian player, Reliance has access to multibrand retail and maintains its own inventory. The draft ecommerce policy also favours JioMart and other Indian players in a big way, the VC from the Valley said at that time. “PM Modi’s focus on bringing foreign direct investment into the country has taken a ‘U’ turn. Until and unless the government does something different, it will not be easy to win the trust of late-stage investors.”

For a long time, Amazon and Flipkart have tried to delve deep into the Indian market with inventory play, grocery offerings and other popular ecommerce tools and practices. But now that India has taken a strong stand against predatory pricing (read deep discounts) and barred foreign companies from operating in multibrand retail, there is a clear limitation and disadvantage when it comes to competing with the likes of Reliance. Its acquisition of the Future Group’s retail, wholesale and supply chain businesses is viewed as a huge boost to its retail business and has already given it a certain edge over other players. The Future-Reliance deal however has been put on hold by the Delhi High Court on Amazon’s request. Amazon is a stakeholder in Future group’s unlisted firm, Future Coupons.

The Tata Group’s acquisition talks with BigBasket is another development that may lead to further loss of market share as far as the US players are concerned. “India is a large and diverse market, and there has always been room for multiple players to operate, unlike a winner-takes-all approach. But given the huge investments made by Flipkart and Amazon for customer acquisition (new players may not do it) and what is at stake here for them, the entry of every new and big player means both of them are bound to lose some market share,” said the aforementioned analyst.

There is still a silver lining, although the Indian government may soon roll out the national ecommerce policy. Now that the new POTUS Joe Biden has taken charge, Amazon and Walmart are reportedly leveraging their newfound bond with the White House to start a fresh lobby demanding a favourable ecommerce policy in India. (It was not possible in the Trump era as both companies faced the then President’s irk for siding with the liberals/democrats.)

However, this may take some time. Subrahmanyam Jaishankar, the Indian external affairs minister, is well known for his delaying tactics, and the US-India trade discussions will take longer than expected. It will also depend upon the priorities of the Biden administration.

When Growth Numbers Do Not Reach The Grassroots 

The above insights bring us to a more worrying question: Why the entry of new companies is sending shockwaves to decade-old incumbents in a market, estimated to grow at a CAGR of 27%

A close look at the Indian market may help unravel this puzzle. The biggest hype around Indian internet companies is based on the estimated number of internet consumers across the country – a whopping 400 Mn and counting. However, Sreedhar Prasad, a partner at Kalaari Capital and former head of consumer markets and internet businesses at KPMG, believes that the entire ecommerce game is limited to around 100 Mn users. “I do not believe that anybody beyond those 100 Mn is aggressively shopping, be it on Flipkart or Amazon. The volume game actually comes from the 100 Mn online shoppers in India.”

This is one of the key reasons why stock market investors in India have not shown enough interest in homegrown internet companies. Unlike conventional companies, investors are not sure of these new-age entities’ market base, users and their online spending capabilities.

Besides, there is no clear policy around the country’s digital infrastructure or internet accessibility. “Forget Jammu and Kashmir, look at Delhi-NCR, Haryana and Uttar Pradesh where the internet is shut down by the authorities the other day in the wake of farmers’ protests. This is virtually shutting down the internet market whenever the government feels so. The impact would be similar to how lockdown impacted conventional companies. This is happening even when the Supreme Court of India has recognised access to the internet as one’s fundamental right,” says the analyst on the condition of anonymity.

Profitability Matters In Listing; Is Flipkart Ready To Tick The Box? 

When listing on a US stock exchange, profitability has never been an issue for US-based companies. But for Indian entities, it may well be a cause for concern, albeit in a different context. The Indian government was mulling to enforce dual listing for companies who wanted to go public overseas but had to do away with it after much hullabaloo. However, this can be enacted in the near future as the vocal-for-local and other similar campaigns get stronger, believe policy experts who have worked with the Modi government in the past and have contributed in drafting some of its business policies. .

In the case of a mandatory (or voluntary) listing on an Indian stock exchange, profitability will play a key role as the Securities and Exchange Board of India (SEBI), the country’s capital market regulator, has stipulated certain eligibility criteria.  The profitability route seeks a minimum of INR 15 Cr as an average pre-tax operating profit for at least three years of the immediately preceding five years.

For companies which are not profitable, the SEBI has specified that the issue shall be through the book-building route, with at least 75% of the net offer to the public to be mandatory allotted to qualified institutional buyers (QIBs). The company will have to refund the subscription money if the minimum subscription of QIBs is not attained. It is not surprising, therefore, that India’s IPO regulations are perceived to be largely unfriendly for tech companies.

Of course, Flipkart’s revenue-versus-loss margin has narrowed down over the past couple of years. But going by the mainstream SEBI norms and restrictions, new-age companies like Flipkart are not ready to plan their IPOs in India, believe experts.

Jain of Orios Venture stresses that SEBI has already announced the framework for innovators growth platform for the listing of such tech companies and is expected to come up with the details. The regulator however should not impose any instruction regarding a company’s profitability plan, otherwise, these policy talks may result in downsides.

Should Investors Be Wary Of Double Taxation?

“The taxation is going to be an issue based on whether Walmart decides to raise new capital or sell its existing shares.” – Girish Vanvari, founder and CEO of Transaction Square

Finally, taxation is also going to play a critical role in the IPO listing, believe experts. It is worth noting that Walmart had to pay around $2 Bn to the Indian tax authorities as it acquired Flipkart Singapore. During Flipkart’s proposed IPO, both the US and India will be entitled to levy taxes on Walmart as it is now the parent company of the India-based ecommerce entity.

According to Section 9(1)(i) of the Income Tax Act, any income accruing or arising, whether directly or indirectly, inter-alia, through the transfer of a capital asset situated in India, shall be deemed to accrue or arise in India. Shares of a company, deriving substantial value from assets located in India, are deemed to be assets located in India. Thus, even indirect transfers are subject to what is popularly known as the Vodafone tax. Depending on the nature of the investment, the withholding tax might vary from 10-20% in cases of such indirect transfers.

S. Vasudevan, executive partner at Lakshmikumaran and Sridharan Law Firm, says, “Walmart may have to pay 20% tax on the capital gains arising from transfer of its shares in Flipkart Singapore to any other investor. However, any dilution of Walmart’s stake due to IPO may not per se entail any tax implications in India.”

The institutional investors, who neither have any right of management or control, nor have shareholding exceeding 5%, will not be liable to pay any tax to India, he adds.

Elaborating further, Vasudevan says, “When the IPO takes place, the company may issue some fresh shares and divest some portion of the stake owned by other investors. Thus, there will be two types of transactions which are likely to take place. Fresh issue per se will not result in any tax liability in India. If Walmart decides to divest its own shares, that is where the tax liability in India can arise under Section 9(1)(i) of the IT Act.

India and the US have already signed a Double Tax Avoidance Agreement (DTAA). However, the treaty’s provision relating to capital gains says that each country may tax capital gains in accordance with the domestic law, says Vasudevan. Hence, there is no treaty benefit given in this particular case.

Imagine the plight of Walmart if the Indian government makes double listing mandatory.

Understandably, there will be repercussions. The US has been known for its proactive and protective approach towards its own companies. Last year, amid the US-China trade dispute, the US even passed legislation, signed by then President Donald Trump, to remove Chinese companies from the U.S. stock exchanges if American regulators are not allowed to review their financial audits.

Popularly known as the delisting law, it enables the US SEC to delist Chinese companies on various accounts. As a result, several Chinese companies, including Walmart’s portfolio company JD.com, Jack Ma’s Alibaba and others, are looking at dual listing in Hong Kong and Shanghai besides listing in the US.

Interestingly, India, too, is notorious for tax controversies and how regulations are tweaked in favour of the government to squeeze businesses. The tax dispute between Vodafone (currently, Vi) and the Indian IT department is a glaring example of how an indirect transfer of assets (where both shares and India-based assets are transferred from one foreign entity to another; in this case, a deal between Vodafone and Hutch for the stake in another foreign company that held 67% shares of Hutchison Essar India) was brought under the purview of Section 9(1)(i) via a 2012 amendment in spite of the Supreme Court’s decision to the contrary.

Earlier, only direct transfers (share transactions, to be precise) came under this section, and companies had to pay capital gains tax for the same. Worse still, the 2012 amendment resulted in retrospective taxation where taxation predates the passing of the law. In the Vodafone case, the tax liability dated back to 1962 (when the IT regulation was passed) even though the amendment took place in 2012.

Late last year, a European court also ruled against the INR 22,100 Cr tax demand by the Indian government in the high-profile Vodafone case. But the government is yet to frame a response, according to media reports. Global businesses and investors are watching closely, and it may not augur well for Flipkart if the company opts for a US listing.

Will There Be A Roaring Response?

Flipkart’s IPO will be one of the biggest events for the Indian tech industry in 2021. The company has come a long way since its launch by the Indian founders — Sachin Bansal and Binny Bansal — and their exit by selling the company to the world’s largest offline retailer, Walmart. If the proposed Flipkart IPO indeed becomes a successful reality, it will unleash a chain reaction across the entire ecosystem that has very few success stories in terms of public listing. Walmart will certainly want its prized Indian possession to be counted among the likes of DoorDash and Airbnb, which registered blockbuster US listings in 2020. But given the challenging business environment the company faces in India, there is a lingering fear of meeting the fate of Uber, or in the worst-case scenario, that of WeWork.

If there is one company that is going to hard-sell the India story to the US in 2021, it is Walmart.

With inputs from Sanghamitra Mandal, Neeraj Thakur