Are e-commerce valuations justified, VCs debate

In the second episode of DealStreet, a VCCTV show where we go beyond news, our panellists discuss and deliberate on the topic: “India attracts world’s best tech investors – what next?”

Our panel comprises Mohan Kumar, Executive Director, Norwest Venture Partners, a global venture capital firm managing about $5 billion; Rehan Yar Khan, a prolific angel investor who has just raised a debut fund of $50 million, Orios Venture Partners; Samir Kumar, managing director at Inventus India Advisors which manages up to $200 million; Klaas Oskam, MD at boutique investment bank Signal Hill Advisors; and Pradeep Tagare, Director of Intel Capital, the corporate venture capital arm of Intel Corp, which has committed more than $300 million across technology investments in the country till now. Here is the edited transcription of the discussion:

Shrija: When savvy and world’s best tech investors are investing in India, does it attach some bit of merit to what otherwise looks like a bubble-in-the-making phenomenon?

Mohan: E-commerce itself is a growing sector in India. It is nascent—probably 3- 4 years old. If we take a 10-15-year view from now, there will be a lot of growth and at least 10 per cent of Indian retail will move to online. If you have a long term view and if you are cash surplus, then you can jump in and others who are not cash surplus and don't take a long term view, it probably will look like a bubble. My view is that in e-commerce, you got to keep funding them for the next 3-4 years and you need to have the wherewithal to do this till they reach profitability. 

Shrija: But what about the valuation... Are they justified?

Mohan: Valuation depends upon the investor. For somebody, it might be a high valuation and for someone it might be low. That’s the function of how much success you have had before. SoftBank has had great success in e-commerce industry before, as they came out of a pretty successful IPO of Alibaba. It took them 15 years to make huge gains out of Alibaba. And for them to get into another hot market like India after China is a different view altogether and if you ask someone else it may look like a bubble. 

Rehan: People have never seen these kinds of valuations and they are immediately thinking that this is a bubble. But things will look quite sane to people who have seen these valuations in other markets or even higher valuations in other markets. 

Shrija: Klass, what is your view? Both Rehan and Mohan argue that valuation depends upon the investor and that what looks irrational to one may look sane to another.

Klass: I think what’s happening in India is pretty similar to what has happened in countries like China where internet has taken people by storm. And all across the world, headline grabbing companies and market leaders in e-commerce tend to attract a large premium. 

Shrija: Pradeep and Samir, what is your view?

Pradeep: What is going on in the internet space in India right now is basically a land grab. The investors are rushing in to make sure that they get the right categories in the right companies. And most land grabs historically result in a bubble. While severity and nature of it is different, what is happening in India in the space is that you get some of these marquee investors and because of that you get a whole lot of other investors as well that I would call 'momentum investors' who just want to make sure that they are not missing out on something that other guys apparently see. And that is what leads to these bubbles where people are rushing in just on the fear that they are missing out on something that they don't know about. And that is what leads to a classic bubble kind of situation.

Shrija: But why do you call them momentum investors? These are some of the experienced teams putting money to work. Where is this view point coming from?

Pradeep: Well, it is coming from some of the categories of investors that we are starting to come into the market now. So clearly the companies that are experienced in the space like the names that you have mentioned are driving the front end of the market. My point is that we are seeing all kinds of investors behind these front end investors such as— pension funds, hedge funds and family offices—who have no or very little clue about what actually going on here. They are banking on the fact that category leading investors are coming into this space and they don't want to miss on what is going on here. And this is what I am worried about because this flow of capital can stop in a heartbeat.

Samir: I think the internet is for real here. If you look at the critical mass of 200 million internet users, about 40-50 million are active users. So internet is for real; transaction worth billions of dollars have already been created in the last seven-eight years; so I don’t think we can discount the internet phenomenon, and the fact that it is happening. I don't think we necessarily need other investors to lend credibility because data are there for everybody to see. But yes it is a very good recognition of the fact that Indian market has finally matured and billion dollar companies can finally be created.

Capital has come in and this has allowed certain companies to take bolder steps and go forward and faster to do whatever they need to do with this capital. Companies were built in India, before this capital came in, and companies will continue to be built in future. Let’s assume if it is not stable and dries up after one year, I don't see a big down side. Maybe, we will not see seven billion dollar valuation; I think we will still see half a billion, 1 billion and 2 billion valuations.

Shrija:  So, are we saying that India has arrived on the global tech scene and such numbers should not be looked at as novelty or rarity?

Rehan: Flipkart was reportedly at a billion dollar turnover last fiscal and if you compare that to the 7 billion dollar valuation and if I start looking at that on a slightly forward basis, it is not looking steep at all. What the media is not picking up in sufficient quantity is the incredible volumes which the company of that size growing—at 400 per cent for three years in a row.

Shrija: The growth is for real and unprecedented. But it looks like these investors are leapfrogging valuations?

Rehan: These are some very high quality teams. SoftBank is represented by Google’s Nikesh Arora in India. We have highly experienced investors from other markets.

Shrija: So are you saying that it is not a bubble?

Mohan: If you think about it in the context of 2020, retail is going to $500 billion in India. Even if you assume 5 per cent of that is online, it makes it $25 billion. If you believe the top two players will command around half of this, which will be close to $15 billion. At that time all these current valuations will look average. So what is looking expensive right now won’t be so five years down the line. 

Shrija: When did the investors think that the e-commerce really reached an inflexion point? What was that eureka moment that you thought that this is the time to join the great Indian e commerce party?

Rehan:  When a company about the size of Flipkart went from $1 billion to $4 billion in one year. It’s a macro effect that is taking place and the market leaders are benefitting the most from this effect.

Shrija: What is the company that you admire between Flipkart and Snapdeal as a business model and as a business being built?

Mohan: I’m not an investor in both of them, but I have experienced purchasing on Flipkart and their customer service is fantastic. So they have nailed that. In terms of business model there is no difference between the two as both (and even Amazon) are marketplaces. I think finally it will be a question of capital available, and who is going to be the number one in customer satisfaction.

Shrija: When investors like DST, SoftBank back companies like Flipkart and Snapdeal, it’s a huge stamp of faith. So, essentially a lot of traction is going to the market leaders.  What happens to the number 3, 4 and 5 companies?

Samir: In the investment business, winners always get disproportionately higher attention and value. And that is how it should be as well, because number 1 and 2 must have done something differently from the number 3, 4 and 5, that made them number 1 and 2. But there is space for a lot of different companies. They'll all have to specialise.

I think someone going head on as yet another horizontal marketplace trying to fight Snapdeal, Amazon or Flipkart, is unlikely to make it. But a niche company that excels in a certain space, in a certain vertical which these large players find hard to excel in, then I think that still has value. And in the US, we saw the companies like Zappos and Diapers, which were acquired by Amazon because Amazon was not able to excel or provide the services and the value that these niche companies could provide. So there are still a lot of opportunities in those spaces.

Mohan: If you look at the horizontal e-commerce space, there are Snapdeal and Flipkart. Another player can emerge if they can get equal or more funding than these players, but it is highly unlikely. But if you go vertically e-commerce like in travel you have MakeMyTrip and Yatra, which are big. There are also companies in furniture which have grown because it has certain complexities which cannot be handled in the horizontal platform; same is true about fashion. So there are these and a couple of other verticals where you will need specialised expertise and which has got the scale. They probably won’t command a premium like the horizontal space, but I think three or four other verticals will also see billion dollar companies emerge.

Shrija: So what happens to the others? There have been so many investments in e-commerce. Will those companies die out?

Pradeep: That is the million dollar question. As far as the markets are healthy, and there is availability of money, clearly these companies can continue to execute. I just hope that they get to a model that is self-sustainable earlier rather than later. And the reason again for that is supply of money. How long is it going to last? Will geo-political issues cause the market to freeze?

These are the questions for which we have to find answers. But clearly these business models today depend upon the availability of large amounts of money. If the flow of capital stops, then we have a huge problem.

Shrija: So the consensus is that this growth is real, even though it might look unreal and what is looking expensive now, will look start looking cheap in the next 3-5 years. Is that what we are agreeing to?

Mohan: For the market leaders, yes. In each of these categories, the market leader will get premium pricing, which is over a billion dollars. For the horizontal space it will be much higher.

Pradeep: So the question here is what do we mean by the bubble? Obviously it is not based on just power point presentation that these companies are raising funding. Clearly there is underline transaction; there is revenue being generated and so on. So what would I contend is that the nature of bubble is different because most people are completely overlooking the risk while looking at the potential upside, which is what the venture business is in a sense. But at the same time we have some real risk factors that somehow don't seem to be included in the equation, when people talk about this space.

For example, what is the exit environment? All of this is banking on the fact that these companies will be able to exit with the business model that they have and that will develop over the next two to three years. I don’t have a good enough answer for this in the sense that clearly the category leaders will be able to find an exit. But that exit is really going to be outside of India. Structurally, not all companies are set up to do IPOs outside of India. And even if they are, one need to assume that the US markets continue the run, which many in the US itself are questioning; so there are all these risk factors. Sure, for a category leader, I am pretty sure that we will look back and say that these valuations were cheap. But for the rest of the 80-90 per cent of the companies that are raising a lot of money, it’s a big question as to what we are going to say about such companies 2-3 years down the road.

Shrija: There is so much of interest in the online cab/taxi space. What is the kind of growth we will see in this space and are the billion dollar valuation of companies like Ola Cabs justified?

Mohan: I think this market is triggered by Uber, and if you look at its hypothesis, Uber is not going to be a cab company, instead it will be a logistics company in the future transporting anything you want like a food order or a package from one city to another. But that hypothesis is yet to be proven; so it’s premature to say whether the valuation is high or low, only time will tell.

If it transforms into a pure taxi company, then these companies don’t justify the valuations and will crash. If they transform in the next couple of years into a technology platform which can enable location-based logistics movement, yes they may be valued. So I think the jury is not out as yet.

Klass: As Mohan pointed out, there can be transformation down the line, but I think what we really need to look at is if adoption is really happening.

Shrija: Can you pick one segment of the e-com phenomenon which looks unreal to you?

Pradeep: A lot of these categories are starting out and so I don’t think by any measure you can claim that these categories have been proven in the market on a sustainable basis. So its early days and that is the nature of venture investing; it should take that sort of risks. But I would contend that the broader e-commerce category has been fairly well-established and the lever is there on how the business model can evolve.

But a lot of emerging verticals like online groceries, or to some extent the taxi aggregation category, these are still in their early and they still need some more time to get to the point where they really understand the levers that they have at their disposal to treat the business model. So I would contend that most of the categories where there is a fair bit of money going in are a bit early and basically a land grab is going on.

Mohan: For me it is the online cab/taxi car space. And the second one is the home rental space.

Shrija: Do you think that Flipkart and Snapdeal have reached a point where they are too big to fail?

Samir: I think the probability of that happening is very low. They have built some real businesses at high GMV. A billion dollar GMV is not something you can laugh at. I don’t these companies can shut down.

Mohan: I think there is a risk for them. If you find the Future Group, Reliance or Tata which are very large in the physical retail space, they actually get their acts together and ultimately have an online play- because they have physical presence and logistics. If they put up a fight I think these guys are under risk. So far I haven’t seen that happening.

Secondly, the Indian regulatory context for the movement of goods isn’t clear not only at the national but also at the state level, and if those get complicated I think that can be a drawback. 

(Edited by Joby Puthuparampil Johnson)

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