Walmart’s Flipkart Buy Is World’s Most Expensive Facelift, Says Aswath Damodaran
The Flipkart-Walmart deal is one of the most expensive facelifts in history, said Aswath Damodaran, professor of finance at NYU Stern School of Business.
“Walmart invested in a company which is burning cash over the last 10 years with no end in sight,” Damodaran said in a presentation at the Nordic Business Forum 2018, which was held on Sept. 26-27. “With such expenditure, Walmart, a retail giant that was founded over 50 years ago, is trying to look young again.”
Also read: Flipkart Deal To Hit Walmart Earnings
“More value is destroyed around the world by the companies when they do not act according to their age. Young companies tried to act old and the old companies are trying to be young again. There is entire ecosystem which feeds these companies—consultants, bankers and more, I call them plastic surgeons of business,” he said, adding that the companies continue with their acquisition plans with this notion over and over again.
Prior to the deal was announced, Damodaran had told BloombergQuint in an interview on April 22 that the acquisition by Walmart will give the Indian unicorn a “second life”. “Head to head, Flipkart has no chance to get Amazon. Over time, Amazon would have outlasted them.”
In his speech, he reiterated that whatever business Amazon gets into, the rivals end up losing money.
Watch the full speech here:
Here are the edited excerpts from the speech:
Every company, just like human beings, is born, grows, matures, and like every human being, it declines. Just as human beings don’t like to age, companies don’t like to get old. So, the first message I want to talk about is the notion of the corporate life cycle and how trying to fight it is a dangerous thing a business can do.
The second message I want to deliver is the focus of company needs to change as it moves through the life cycle from the startup, to growth, to mature, to decline. More value is destroyed around the world by companies when they are not acting according to their age. Young companies try to act old and old companies are trying to be young again. There is an entire ecosystem which feeds these companies—consultants, bankers and more. I call them plastic surgeons of business. It is like I will give you a facelift and you can be young again. Companies keep buying into this notion, over and over again.
The third message I want to talk about is very specifically connected to valuation. For valuation, what comes to mind most of the time are the spreadsheets and numbers. That’s what we are trained to think of valuation as. In 32 years of teaching valuation, I have learned that it took me a while to get it. Valuation can never be just about the numbers. A good valuation always has a story embedded in it. One of the things I want to talk about is how the balance between the story and the company changes as we go from a young company to older company.
The final message I want to talk about is that we often talk about great CEOs. I am going to argue that what makes for a great CEO is going to change as you move through the life cycle. What makes for a great CEO for a young company is very different from what makes for a great CEO for a mature company which is different from what makes for a great CEO in a declining company.
When I teach finance, I use a couple of structures to bring through some of the broad lessons in finance. I find the notion of the balance sheet useful - not an accountant balance sheet but a financial balance sheet.
Let me explain how a financial balance sheet is very different from an accounting balance sheet. At one level, it looks very similar as it has assets and liabilities. But the assets in balance sheets, instead of breaking things down the way accountants do, the fixed assets, current assets, financial assets and intangible assets, I divide the assets of a business into assets in place. The investment it has already made as a company and growth assets. A company like Microsoft can have assets like Office, Windows and what they already have in place. However, the growth asset is the value which I am attaching to what I expect you to do for the next 5-10 years and forever.
In another side of the balance sheet, there are only two ways you can find a business—you can borrow the money or use your own money. We can call borrowed money as debt and using your own money is equity. We can dance around these two words as much as we want but you have debt and equity. Here is how that structure will help me think through the stages in the life cycle.
As I go through each stage in the corporate life cycle, I will go through a few examples and I would like you to think about your company and where it falls in the life cycle. For some of you, it could be depressing when you put your company is life cycle, but it is what it is. You can think about startups in different sectors. For instance, Artificial Intelligence is a sector where we might see startups. Last week, we had commotion in markets because a company called Tilray was to go public. It is a cannabis producing company and right now it is a hot business to be in. The company quadrupled in its first three days and lost 50 percent in the next two days. However, startups are young companies that are just coming up. There is a huge mortality rate. Most startups don’t make it.
If you do make it from startup, you become a young growth company. They are like teenagers and they do incredibly stupid things. When you see a company like Tesla or Uber when people jump on them and say how come you behave so immaturely. Remember they are teenage companies and they don’t look through consequences. But the future is full of potential.
Then you have young growth companies. This is when you are at the peak of your glory. This is when you can go to sleep at 3 a.m., wake up at 6 a.m. and still function. Then you become a mature growth company. These are the Facebooks and Googles of the world. You get amazing earnings and continue to grow. But you are still enjoying life.
Then comes the middle age. The middle age is something none of us wants to get to. But worst things are waiting for you if you think about it. You become a mature company.
Then comes the final phase which nobody wants to be in when you are in decline. Companies are born, they mature, and they decline. It is the nature of the process. If you think about where a company falls in this process, you can take not just how this company should be run but also how to value a company.
If you think about what causes this process to work, here is the way to think about it. Some businesses are easy to enter and scale up in. They don’t want a huge amount of infrastructure investment. They don’t need decades of building up and you can grow quickly. Some businesses take much longer to build up. That determines how quickly you can go from being a startup to a mature company. Once you become a mature company you get to reap the benefits of having built a business before you are going to decline. What allows companies to grow quickly is the ease of scaling up, how quickly you can enter a business and how little capital you need to grow. What causes companies to decline are exactly those same factors.
I will start with what has happened across the world that is changing the way we should be doing not just valuation but how we run a business. I think that the life cycles of companies are getting compressed. Tech companies age in dog years. A 100-year manufacturing company is an old company. A 20-year tech company is a really old company. Tech companies age in dog years in the sense that they grow from nothing to something quickly. They don’t stay mature for very long before they decline.
A few weeks ago, I got a call from a reporter on GE. They had a glorious history. But its history is mostly behind it. He asked how you would describe what GE’s future looks like. I said it looks like Bataan Death March. There is nothing hopeful you can see here. But before you grieve for its end remember that it had 125 glorious years of existence. GE was founded in the last part of the 19th century. It grew through much of the 20th century. It changed the way Americans use appliances. It became one of the greatest conglomerates in history before they went into decline in 125 years.
In contrast, take Yahoo. The company was founded in the early 1990s. Very quickly it became $100 billion company in a phase of seven-to-eight years. What GE took 50 years to do, Yahoo did in seven years. It stayed as a mature company for seven years before it went into decline and now all you have for Yahoo is a walking dead company.
I remember valuing Yahoo four years ago. I initially valued its basic business which is a search engine which nobody searches on. A mail program which nobody sends mail on. Essentially, in best days it is worth $3-4 billion. The company is trading at about $40 billion. There are two big hoardings. A 21 percent share of Alibaba which is worth $30 billion and a 35 percent share of Yahoo Japan. For some reason, Japanese search things on Yahoo. This is the company which went from being a startup to a large company to nothing in a phase of 25 years.
I could say the same story about Nokia or Blackberry. If you look at great companies which started in the 70s and 80s, it is in technology space, the life cycle of a company is compressed. We need to adapt to the way we think about business to reflect on these compressed life cycles.
Let me start on the first out of three things related to the life cycle.
If I am asked to describe the finance and corporate class, here is how I describe it. In valuation, I look at companies outside in. I look at companies as an investor as for how much would I pay for this company given the way it is run. That’s valuation. In corporate finance, I look at same companies inside out. If I were running these companies, how would I run them differently?
People are always surprised by it as they think, I write a lot about valuation as that is what is preferred. I prefer to teach corporate finance class because I have more degree of freedom. More levers that I can move around to change the value of the company. I can summarise corporate finance class in one page. This is all you need to know if you have never taken a corporate finance class.
There are three basic principles of driving a business. The investment decision—the projects you take which you invest in, and the principle that governs how you invest in is a very simple one. Go out and take an investment that earns more than minimum acceptable hurdle rate. That is the rule. How you measure the hurdle rate and return is full of details but that is a basic principle. It is the investment principle, take good projects.
The second principle is to fund them well. There are two ways to fund a business. One is to borrow money and other is to use equity. Find the mix of debt and equity which minimises the hurdle rate. It is better to have an 8 percent hurdle rate than 10 percent.
The third principle is called the dividend principle. If you cannot find an investment which makes your hurdle rate, give the cash back to the owners of the business. Let them find a better place for investment. The investment principle, financing principle and dividend principle. Every business has to make investment decisions, financing decisions and dividend decisions.
Let’s see how a focus of business changes depending on where you are in the life cycle.
When you are a startup, the only time you should spend on the decision is investment decision. How much money could a young startup afford to borrow? The answer is none. You should not be borrowing money. When you borrow money, you have to make interest payments. Those interest payments, you can’t make with potential. You can go to the bank and say I have a lot of potential; can I pay with potential? But it doesn’t work. If you ask how much I can afford to pay in the dividend, what dividend? You are a young startup, you have no cash available in dividend. Everything you do as a startup is built around making good enough investments. You have to build growth assets.
As companies mature, they should start thinking about the financing principle. What mix of debt and equity is right for me? As companies mature, you can see the finance part of business take a big role. Then you go to declining business. Your job is to give cash back to the owners, the focus shifts to dividend principle. The investment principle, financing principle, the dividend principle. Young companies should be focused on investments. Mature companies can think about financing mix, declining companies should be thinking about the dividend.
One of the biggest problems with companies is that they refuse to act their age. I describe them as the equivalent of 50-year-olds wearing hip huggers. It is not appropriate, but many companies try to act an age which is not right for them.
I don't get it when a young company goes out and borrows money. Why would you as a young company put your entire future at risk by going and borrowing money. I have been tracking Tesla as a company as it fascinates me. It is nice to have a CEO who is constantly throwing fuel on flames making it go up more. Two years ago, Tesla went to borrow $5 billion. I never understood it. Why would a company like Tesla, which is a money-losing company and which should be focused on building a business, should go out and borrow money?
Mature companies trying to go back and being young companies, I don’t get. Declining companies which try to reinvent themselves as a mature company, I don’t get it. In the process, they destroy value because they are trying to be something that they cannot be. So, next time when you see some company doing something big by doing an acquisition to be young again, the analogy is you are trying to be which you cannot want to be.
Walmart bought Flipkart. Flipkart is an Indian online retail company. A company which is a money-losing machine which is burning through cash in the last 10 years with no end in sight. I called it the most expensive facelift in history. That’s what it was. A $21 billion expenditure is what Walmart wants, to be young again. Like all facelifts, gravity works its wonders and three years from now, Walmart will be asking what we can do next. But here is when the ecosystem kicks. That ecosystem includes a great deal of what we hear about in management. Restructure yourself, reinvent yourself in a way. If you are a consultant or banker, you want companies which want to look younger. If you do this, you will be younger again. When companies refuse to act their age, investors pay a price.
It brings me to the cash flow side of the equation. If you are a young company, you are building your business, investing in a great deal, you are often losing money because you are building your business, you will tend to have negative cash flows. There is the notion called cash burn. Investors say that the company is burning through cash. By itself, there is nothing wrong in cash burn if you are a young company. Cash burn is a feature and not a bug for young companies. They have to burn the cash to build themselves up. But if you are a good business, at some point in time, that cash burn has to stop. You have to start to generate positive cash flows. I am not old fashioned. That is the basis for business as long as businesses have been around. It is not that you have to make money right from the start but eventually, you have to make money. If you look at a business, one of the ways to identify where a business is in its life cycle, then look at its cash flows.
Last week, I valued Amazon. This is the most difficult company in the world for me to value. The reason is I am not sure in what business it is in anymore. I used to think Amazon was a retail company. I have given up on that notion. Here is what I think it is. I used to call Amazon my “Field of Dreams” company. Remember the line from that movie that everybody walks out of the movie and still remembering it, “If we build it, they will come.” That was the Amazon theme song. If we build revenues, profits will come. For 20 years, Amazon has been run as a company saying we will build it then they will come. I thought Amazon was the retail company, I no longer think it is. I think it is a disruption platform that can go after any business at the face of the earth. Here is one thing which we can guarantee with Amazon—Whatever business they go into, I don’t know whether Amazon will ever make money but if there is another company in that business, I will guarantee you that you will lose money.
Any business Amazon targets, no bad things will happen to you. The day Amazon enters any business, collectively in that business everybody else loses billions. The day they entered the grocery business, collectively grocery business lost $40 billion in market capitalisation on that one day. Whatever business you are in, every night get down on your knees and say please God don’t let Amazon come into my business because they will destroy your business and leave nothing there. They are now a disruption platform with an army. The army is called Amazon Prime. A 110 million loyal members that they can turn lose on any business they want. I wanted to put Amazon in the life cycle, but I don’t know where it is right now. It is not behaving like a mature company. It is behaving like a young growth company with trillion dollars of market cap behind it. It is never seen before in history and I am not sure what is going to happen next. But it will be fun watching but it is not going to be fun playing against it.
The reality checks for young companies, you have to remember cash burn will happen and you can’t fight it. The mature companies will recognise things will start to slow down, you can’t fight the slowing down of growth and once you start declining, you have to think about how we give cash back to the owners.
There is a big debate in the U.S. about buybacks. About how buybacks are a terrible thing. When companies buyback stocks, that cash is not being invested back in the company to which my response is what is wrong with it. Do you really want GM investing your money back into their business? If you look at the 100 largest businesses in the U.S., I would say 60-70 percent of businesses are investing back into the business is a guarantee that money will burn through. There is nothing wrong with a company saying, there is nothing to invest in, take the cash back, the cash doesn’t leave the market. It just goes back to other business.
It brings to me on my third face which is the notion of connecting stories. When I started thinking valuation, I thought it is about the numbers. It is not about the numbers. Good valuation is a bridge between stories and numbers. When you show me a valuation and show me numbers and say why is it that number is what it is. My answer will not be because it is a 25-percent growth rate in the first five years and five percent their average. There will always be a story. Every number in valuation has a story behind it and every story that I tell about a company has a number attached to it.
With young companies, it is all about the story. When I valued Uber in June 2014, it was a startup. A young company losing a lot of money. My entire valuation was built around my story about Uber being an urban service car company. That drove my entire valuation. When I finished my valuation, one of Uber’s leading investors Bill Curley said, you got the story all wrong. Uber is not a car service company, it is a logistics company. Notice how words have consequences. By using the word logistics, he has tripled the size of its business. We can be in delivery and moving. He said we will not just be in urban but everywhere. He said we will not only have local networking benefits but global networking benefits. I valued the story for him. My value for Uber was $6 billion and his value was $53 billion. What separated us was the story we told. The words used to describe your business can mean a difference between a $6 billion valuation to $53 billion. For mature companies, it is the numbers which drive your valuation. It is like to be in chapter 34 in the 35-chapter book. I can’t reinvent the characters. If I am valuing Coco Cola, I can’t make you a young tech company and give you all the lead things. The older a company gets, the more the numbers drive the valuation.
The right CEO for a company, if you are a young startup, whom do you want as a CEO? It is all about the story which you want. Steve, the visionary. I gave the name Steve for obvious reasons. You are the storyteller. As you become a young growth company, you want “Bob The Builder” because you have to start building a business. As you become mature company, you want “Don - The Defender”. Then you become a declining company, you need “Larry The Liquidator” as CEO.
If you haven't seen the movie Other People's Money, I strongly recommend you to watch it. This is where the compressed life cycle kicks in. GE took 125 years from young to really old. Your CEO is passed on. Mortality kicked in. but if you are a CEO of a young tech company, you will find running a mid-short or declining company and the same CEO not might be the right CEO for you. I can make a prediction that you will see a lot more disruption in management ranks because life cycles have become compressed. You see this play out with Tesla. Was Elon Musk the right CEO? Absolutely! The guy has vision coming out of nose, eyes, every conceivable orifice but is he the right CEO to build an automobile company, I am not so sure. And this is something we will be face in a lot of companies, great founders suddenly being inappropriate CEOs for the kinds of companies. So get used to a lot more excitement in ranks if you are watching it from the outside. But if you are a CEO of these companies, get used to a lot more excitement from the inside. And it is not going to be as much fun.