How Flipkart sealed the deal with Myntra

Flipkart’s Sachin (left) and Binny Bansal (right) have agreed to keep Myntra as a separate entity that will retain its website and continue to be led by Mukesh Bansal (centre). Photo: Hemant Mishra/Mint

Bangalore/New Delhi: In May 2014, For Flipkart.com and Myntra.com, merging with each other is all about remaining separate. Flipkart, India’s largest e-commerce firm, announced that it had bought Myntra, India’s largest online fashion retailer, in the biggest deal ever in India’s Internet space.

The e-commerce business in India is valued at $3.1 billion, excluding travel services and tickets, according to a November report by CLSA.

The long-awaited, cash-and-stock deal is likely to value online fashion retailer Myntra at more than $330 million, one person familiar with the matter said, requesting anonymity.

Following two-month long negotiations that led to Thursday’s announcement, both sets of Bansals—Sachin and Binny at Flipkart and especially Mukesh at Myntra—were clear that for a merger to make sense, Myntra would need to be kept independent.

The lessons of the past two years showed that apparel, unlike books and electronics, is a product category that requires specialization, deeper understanding of fashion, aesthetic presentation and experience, rather than volume-focused approach of Flipkart.

“Mergers are risky and integration can be very dicey,” Myntra’s CEOMukesh Bansal said in an interview. “So it was very important for me to ensure that we would not be integrating anything. Most of the discussions were to ensure that there is absolute alignment about the management autonomy.”

He got what he wanted.

Flipkart has agreed to keep Myntra (pronounced Mint-rah) as a separate entity that will retain its website and continue to be led by Mukesh Bansal, co-founder Ashutosh Lawania and the rest of the current management team.

For Flipkart, which started selling apparel two years ago, the deal is about gaining size and keeping Amazon India, Snapdeal and others at bay. The company started selling fashion products only two years ago but fell way short of its target to be the No.1 in the category by October 2013.

The deal was stitched together over several meetings in March, mostly held at the coffee shop in the Grand Mercure hotel near Flipkart’s office in the Koramangala area of Bangalore. The two sets of Bansals talked about how the merger could be mutually beneficial.

“The Flipkart team reached out to us and expressed interest in a merger. So we got involved to understand what they have in mind. As we interacted over a month, I could see they seemed very credible and authentic,” Myntra’s Mukesh Bansal said.

They discussed various ways in which he could achieve his goal of generating $3 billion or Rs.20,000 crore in gross sales by 2020. It was clear he would need $150-$200 million more. If Myntra didn’t merge with Flipkart, it would need to raise possibly more because the market was only going to get more competitive with Amazon carving out aggressive long-term plans for India.

A powerful case

By early April, Mukesh and his senior management team were convinced the best way to secure the future of the brand he had built was to join hands with his cross-town rivals.

“We could’ve have tried to do this alone. But we have key battles ahead. The choice was: we can fight all the four players (Flipkart, Snapdeal, Amazon, Jabong) or we can join hands with the strongest player and collectively fight the two key battles. One is the dominance of the horizontal marketplace and the other is the dominance of the fashion vertical. As I saw it, it made more and more sense to use money to fight the other players together rather than burn money to fight each other. I was really convinced that 1+1 can be four,” Myntra’s Mukesh Bansal said.

He spent April discussing the merger and valuations with other board members, investors such as Accel’s Subrata Mitra, Tiger Global’s Lee Fixel and Kalaari Capital’s Vani Kola.

Bansal wouldn’t give details on the discussions and the valuation but said that there were initially some directors, who opposed the merger and wanted Myntra to continue on its own. “But by that time, considering all that we’d discussed, there was such a powerful case for merger that it didn’t take more than a few conversations to convince anyone. Our board culture has always been such that they give the management autonomy and if most of the management team supports a decision, they usually agree to go ahead with it,” said Bansal.

Myntra board member Sudhir Sethi, chairman and managing director at IDG Ventures India, said the board of directors evaluated other options such as a future initial public offering (IPO), but decided unanimously that there were “big benefits in merging with Flipkart”.

“The fact that there are common investors, the founder teams are comfortable with each other, Myntra would get well-capitalized and also that both the companies are based in Bangalore—all these factors played a role. Myntra will also get access to the large traffic that comes on Flipkart as well as its massive delivery network,” Sethi said.

Achieving success in fashion is critical as apart from offering the juiciest margins, it is also expected to be the largest category in e-commerce over next five years. Buying Myntra, with its strong brand, fashion expertise, experienced management team and deep relationships with apparel manufacturers and retailers, is a straightforward way of ensuring a leadership position for Flipkart.

Nerve-wracking crunch

The case wasn’t as straightforward for Myntra and Mukesh Bansal, at least not in January. The company just raised $50 million from Premji Invest and others in January, following a year when it was forced to burn most of its cash in fending off deep-pocketed rival Jabong and, guess who, Flipkart.

The worst was behind it and by then large, global investors had shown willingness, at least in private, to invest in e-commerce, so Myntra could have raised more cash this year.

Then there was the personality aspect: Myntra’s Bansal is seen as a mentor by entrepreneurs including his namesakes at Flipkart and is much senior to them in age and experience.

He had rejected a similar merger idea put forth (in informal conversations) by common investors Accel Partners and Tiger Global Management late last year.

But as Flipkart’s Sachin Bansal reached out to Mukesh Bansal over the phone in late February with a serious merger proposal, the latter’s thinking had already changed to some extent.

According to conversations with Mukesh Bansal, and investors at the two Bangalore-based firms, four things convinced Mukesh to sell: the presence of common shareholders Tiger Global and Accel Partners offered familiarity and comfort; the mutual respect between him and his counterparts at Flipkart; the guarantee of access to a significantly large pool of funds that is unique to Flipkart; and finally, the nerve-wracking experience of the January fund raising, which was closed just as Myntra was due to run out of cash within couple of months.

In 2013, Myntra was looking to raise fresh funds but because of a number of factors—the depreciating rupee, overall negative sentiment about investing in India, Flipkart’s and Jabong’s aggressive push in fashion—most of the investors declined to risk putting in money into the company.

“The feedback from most of them was: we are interested and we like what you are doing, but not now. But we needed money then so ‘not now’ was not very helpful. We had cash till early 2014 so we were not in imminent danger of running out but still, six months of cash is nerve-wracking,” Mukesh said.

When Flipkart came to him with a proposal in February, the lure of money—Flipkart has raised $560 million, including $360 million in the past year—was much stronger.

From there on, it was only a matter of time before the deal was done. Flipkart and Myntra together generate more than 50% of the online fashion sales and the companies aim to increase that number to 60-70% over time.

Mukesh Bansal on Thursday announced the merger in style. Coming on stage, Bansal said he had an “exciting” announcement to make. Then, pausing, he said, “Let me introduce two colleagues of mine.”

And out walked Sachin and Binny Bansal.

Why we don't invest in financial markets?

The Indian markets are in a buoyant mood. Hopes are high that the new government will be able to bring in big ticket economic reforms. Foreign institutional investors (FIIs) have already pumped in huge amounts of money into the markets. However, the market euphoria seems to have affected retail investors too. The optimism on the street is being driven by the hope of better days ahead. At such a time we would like to point out a sobering reality that may not change anytime soon. This reality has prevented investors from creating wealth.

As the chart below shows, the share of household savings in financial assets like stocks, bonds, mutual funds, bank deposits and pension and insurance funds, has fallen (as a % of total savings) since 2008. While the government has not released the data for FY14 yet, the situation is not likely to have changed much from FY13. As of today, nearly two thirds of household savings are in physical assets like Gold and Real Estate. Thus it is clear that retail investors have missed out on this market rally. It is indeed sad that when the markets were trading at reasonable valuations over the last three years, savings of Indian households did not find their way into the stock markets. Instead, a disproportionally large amount of savings went into Gold and property. Why did this happen?

Trust in financial savings has eroded
There is a two part answer to this question. Firstly, over the last five years, the Indian economy has suffered from negative real interest rates. In simple words, this means that the rate of inflation was higher than the interest rate offered by banks. Thus people had no incentive to keep their hard earned savings in bank deposits (or any other financial asset). To preserve their wealth, they moved their money into assets like Gold and property. The second part of the answer can be summarized in one word: Trust. Time and again, investors have been swindled by unscrupulous people and have lost their shirts in the stock markets. Even in the current up move in the markets, we have seen how brokers have tried to lure investors in to the markets with claims of high Sensex levels. Investors are being tempted by their so called 'advisors' to speculate in the markets with their hard earned money. Corporates, desperate to raise money, have already begun to draw up plans for expensive IPOs. We are all aware what can happen in times of euphoria. Rational thought is often sacrificed for quick profits. This can lead to huge losses as we had seen in 2008. It is such losses that scare away retail investors from markets. In a case of 'once bitten twice shy', they park their funds in so called safer investments like property and Gold.

However, the shift of household savings from financial assets to physical assets can have grave consequences for the economy as well. If savers prefer land and Gold over bank deposits and equity, then corporates will find it harder to raise money from banks and the stock markets. This has caused many corporates to delay their capex plans. In such a situation, corporates are unlikely to hire in large numbers. If the private sector does not create jobs, any economic recovery is  likely to be an illusion.

The only long term solution is to bring inflation under control as soon as possible and improve regulation in financial markets. A healthy combination of positive real interest rates and better regulation will bring back the trust of retail investors. We certainly hope the new government will not disappoint investors in this regard.

If you do not own gold, now is the time..

Imposing import duty on gold has been just one of the attempts of UPA government to arrest current account deficit (CAD). The policy may not have had a meaningful impact on the deficit. However, what it certainly did was bring down the gold import volume dramatically (down 80% YoY). Meanwhile, the quantity of gold smuggled into the country has also growth disproportionately. And that has in many ways defeated the purpose of the import duty. So in what may come as a huge relief to gold investors, the NDA government is contemplating to cut the import duty. Given that the sentiment towards buying gold is already muted, the government probably does not fear stoking CAD concerns. More importantly, the constant foreign inflows after the change of government have also eased deficit concerns to an extent. Further fall in gold prices, in the event of a duty cut, should be seen as an opportunity to buy more gold we believe. While investors may not want to speculate on near term trend in gold prices, holding 5 to 10% of one's assets in gold continues to remain important. And the duty cut will certainly tilt the risk-reward balance for gold firmly in favour of the latter.  

The Dubious Recovery

Post the 2008 financial crash, loan growth has been relatively much lower than it usually has been. The loan growth has largely been restrained below the 8% levels at peak and declining as seen in the chart below - much lower growth than it used to be coming out of recession. It indicates that the consumer has not been confident enough to borrow. The absolute condition of balance sheets matter and we should not be surprised that this is a factor weighing on consumer and business confidence. People are waking up to the fact that they can't randomly borrow their way out just on the basis of notional wealth which can quickly vaporize at the first signs of risks to the economy.

Chart: Total Consumer Credit

Some might argue that although growth has remained relatively muted it has now turned positive which is far better than the deleveraging i.e. paying off the debt to decrease the financial leverage, that ensued as a result of the aftermath of the crisis.

Yes, borrowing from consumers has been growing but the major contribution has been coming from federal government guaranteed student loans which is unlikely to add to consumption. The past credit boom came from the likes of credit card debt, the auto loans and the home equity line of credit; these are the ones still showing signs of deleveraging.


Source: FRBNY Consumer Credit panel / Equifax

But that's not all; many of those in their early 20s, seeing how hard it is to find a job, are staying in college for longer, amassing outrageous levels of student debt in the process. Consumer credit increased by US$173bn YoY as on March 2014, with federal student loans accounting for US$125bn or 72% of that total increase. It's indeed logical to see the interest on student loans rising by the day and are now at all time highs. The bulk of the credit is taken to pay for the burgeoning education fees and this will likely be a drag on the economy even over the long run as well. This is obviously not a sustainable solution.

One bright spot

We can clearly conclude that from a consumer perspective, it's been a weak recovery from an employment side and also the resulting ability of consumers to borrow and spend seems compromised. However, there is one thing that we are closely watching for - if there are any signs of economic momentum building up. It is worth noting that recent months have seen a bit of a pickup in the commercial and industrial (C&I) credit. Much of the increase in bank credit has been primarily driven by the increase in C&I loans. As of March 2014, the total bank credit grew at 2.9% YoY whereas the growth in commercial and industrial (C&I) loans was 9.8% YoY.

Chart: Bank Credit and Commercial & Industrial Loans Growth (YoY)

We would continue to monitor this space but it's unlikely to lead to an economic breakout. This pessimism is largely on account of a few signals already alarming caution. A survey of senior lending officers revealed a greater percentage of banks easing standards and reducing spreads on C&I loans to firms of all sizes. There's deterioration in contract terms and pricing and that's potentially the kind of behavior that drives a crisis...sounds familiar.

Rest, The recovery enthusiast

The improvement in consumption is also likely driven by people dipping into their kitty. US personal savings have fallen from 5.1% of disposable income in September 2013 to 3.8% in March 2014 is indicative of the fact that people have been forced to fall back on their savings to make ends meet as incomes are not enough if at all and they are clearly shying away from borrowing their way out. Clearly, a pickup in consumption does not look that convincing if it is only driven by a falling savings rate.

Chart: U.S Savings rate

However, optimists continue to point out at recovery in house prices and surging stock markets as signs of growth.

One important aspect of all the supporters of the necessity of QE is clearly the improvement in household balance sheets caused by the recovery in house prices and the surge in American stock market. With all the liquidity sloshing around it's not surprising to see asset markets increase in value. With housing, the story is always more complicated than the top-line numbers suggest. The all-important housing market pending home sales index has largely been in a declining trend. The new purchase mortgage applications index has also continued to fail to pick up in a convincing fashion.

There is one thing that high asset prices do accomplish, however: the so-called "wealth effect."Along with booming stock prices, higher property values make people feel rich - "notional wealth". This then encourages them to go out and spend money. The policymakers have been fueling an asset reflation story with a hope that they can keep the US economy going until income growth and employment growth finally pick up convincingly.

The striking problem with the asset inflation story is that it only furthers extreme wealth distribution. Corporate profits have skyrocketed and the stock market has rebounded, but these successes have not translated into widespread prosperity. The benefits are only accruing to those at the top - the 1% - while leaving everyone else to fight over the few opportunities available. This problem is not going to fix itself.

Digging deep, it really seems convincing that the recovery is indeed dubious. It eventually will fall out like a pack of cards and will likely have a domino effect on the financial economy when it hits the wall. It's pretty uncertain as to when the day of reckoning arrives but the outcome is going to be disastrous. An allocation to gold in such uncertain times is important for investors. I reiterate that the main reason to own gold is just the sheer fact that it is one of the good portfolio diversification tools and thereby may help you to reduce overall portfolio risk.

Data Source: Bloomberg, World Gold Council