News about India’s booming Internet marketplace in recent times have been about millions of dollars of investment or billions of dollars of valuation. This month, though, saw a few signs of scepticism coming to the fore. First, billionaire investor Rakesh Jhunjhunwala questioned e-retailer Flipkart’s business model and profit-making ability. And, two, Alibaba, the world’s most profitable e-commerce firm, reportedly called off a deal to invest in Snapdeal on valuation concerns.
The central question is: Are investors justified in valuing loss-making e-commerce companies in ever-inflating billions?
A recent Deutsche Bank report, comparing it with other markets, indicates the opportunity. It says, “In Western markets, the market cap for the e-commerce sector on a per Internet-user basis is nearly 15x (15 times) that of India. The ratio is nearly as stretched even when compared with similar emerging markets such as APAC, where the e-commerce market cap on a per user basis is nearly 10x (10 times) that of India.” “This,” says the report, “indicates the huge opportunity left for e-commerce penetration and growth in India.”
According to Morgan Stanley, the size of the Indian Internet market is likely to rise from $11 billion in 2013 to $137 billion by 2020, by which time, the market cap of such companies could touch $160-200 billion. It is evident that investors smell the opportunity. About $6 billion has been invested into this sector in the last two years, a fourth of which has flowed in during the last three months alone. Flipkart and Snapdeal have been the two major beneficiaries of the investments.
The pace of the jump in valuations is baffling. When Flipkart raised $210 million in May 2014, it was valued at $3.5 billion. By December, the company was valued at $11 billion, at least. This isn’t just a Flipkart-only occurrence, by the way.
“As per dialogues we had with investors, the e-commerce investments and valuations have been driven by the big foreign investors and hedge funds, which have tasted success in overseas markets. They are hoping to replicate similar success in India,” says Arun Natarajan, founder of Venture Intelligence, a research firm tracking private company financials, transactions and valuations in India.
The big monies that come in are being put to use to acquire customers in a market, which is becoming intensely competitive, especially with the coming in of Amazon. To be sure, globally examples have been mixed. Amazon made no money for the first 10 years and has been making very little money since. Alibaba, which does not own a single product, has made consistent profits.
A report by consulting firm PwC in February put the combined losses faced by e-tailing companies because of discounting at Rs. 1,000 crore. “With strong backing from investors, online retailers have been doling out discounts and special offers to happy customers like never before, even at the cost of hitting their business bottom line,” the report said.
But this may not be viable over the long-run.
“Investors are making assumptions about growth in giving such hefty valuations. They are giving profit metric a miss in the short-term,” says Ankur Bisen-Head, Retail and Consumer Products of Technopak Advisors. “However, in the medium-to-long term, profitability will be the key. Five-six years down the line, you cannot be saying I am not making profits.”
The cash burn (which indicates how fast a company could use up its capital) may not abate for another 12-18 months, according to Citi Research. But discounting isn’t the only cost worry e-ecommerce companies have. There are also costs related to warehousing, payment gateways, logistics, and, crucially, marketing.
Citi says online marketing costs have soared 200-300 per cent in the last 2-3 years. Also, the rate of churn can be as high as 50 per cent, as users delete apps. All this adds to the customer acquisition cost. Citi, therefore, reckons that “while the stated payback period is 1.0-2.5 years across companies, it actually is 2-5 years if one were to look at only the active user base.”
The other challenge is the conversion rates, i.e. of converting visitors to purchasers. In India, the rate is below 2-3 per cent. China, and other high-growth emerging markets has rates upward of 3.5 per cent.
K V Ramanand, Partner- Deal Advisory, KPMG in India, says, “The number of players and the valuation should rationalise going forward. One has to see how long the game goes on. In this industry, customer loyalties can change fast. Once the discounting fades and real pricing comes in, the real winners will emerge.”
Anupam Mittal, founder of People Group, which owns Internet ventures like Shaadi.com, Makaan.com and an early investor in Ola, agrees. “Of course valuations have skyrocketed in the last one month. Even for a start-up raising $1 million, it has now gone to $2-3 million. Valuations may look running ahead of fundamentals for Flipkart, Snapdeal or Ola. However, it will look justifiable in the coming 12 months given the growth rates these firms are witnessing,” he says.
“If you look at Fortune 500 companies, 50 per cent of valuations are given for intellectual property. The same holds true for Internet ventures. It is the network effect. One has to pick and choose the right winners in the game,” he says. Will the investors make the right bets?
Pointers:
About $6 billion has been invested in Internet companies in the last two years, a fourth of which has flowed in during the last three months alone.
Flipkart and Snapdeal have been major beneficiaries
A few signs of scepticism are coming to the fore. Rakesh Jhunjhunwala questioned e-retailer Flipkart’s business model and profit-making ability. Alibaba reportedly called off a deal to invest in Snapdeal on valuation concerns.
Combined losses faced by e-tailing companies because of discounting are estimated at Rs.1,000 crore.
Cash burns are expected to continue for the next 12-18 months, says Citi
Online marketing costs have soared 200-300 per cent in the last 2-3 years.
