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Valuations may be theoretical, markdowns are not

09 May, 2016

There is very little science or math behind valuation of private companies. It is just a reflection of sentiment about supply and demand. Sentiment always tends to get ahead of reality but eventually reality catches up, and the bubble bursts.

When a company doesn’t have a differentiated position, it is difficult for it to grow. Amazon has a differentiated position it in India and Flipkart doesn’t. Discounting isn’t a differentiator. How much will you discount and sell?

In my view, all of Flipkart’s investors will review their position. Some of its existing investors have reportedly already marked down their valuation by 20-40%. This puts promoters on the spot as investors will use their reported 2x liquidation preference in the event of a sale. This means investors will take double their money first, before promoters get anything in a sale situation.

I understand that Flipkart has a yearly cash burn of about $600 million. So they can run for two years more without raising additional funds. But what happens after? The company has to raise funds before that.

It is wrong to say markdown in valuation is theoretical. All valuations are equally theoretical.

The average basket size of an e-com transaction used to typically be in the Rs 1,200 range on which an e-tailer got a Rs 120-180 margin. But Flipkart, probably driven by a need to find a way to get a higher valuation, moved to a GMV-focused model. They pushed mobile phones really hard  and in doing so, got the same Rs 180 margin from a Rs 6,000 sale. The GMV went up five times but the earnings remained the same. Essentially nothing changed in the business but the claimed valuation ballooned. Today, reportedly, half of Flipkart’s GMV comes from low-margin mobile phones. But investors saw through this sleight of hand

While many unicorns around the world, Flipkart included, are getting de-valued, it is interesting that Amazon has gone up 40% in the last six months. So it is not an across-the-board haircut, but a more specific company-based trend.

I would imagine that Flipkart has limited choices. In all probability, it will raise money at a down round. There’s a signal here: Existing investors who already have performance data about the company have marked it down by up to 40%, so it’s unlikely an outsider will pay more than an insider will. Going public may also be very difficult at this point in time. If their last round was at $15 billion, those investors will want a market cap of twice that to start with. But given current news of valuations at $9 billion levels, the market will not likely support such nose-bleed levels.

Then, of course, there is a third option that someone like an Amazon or Alibaba can buy them. I understand they may have already made offers in the sub $9 billion zone that were not well received. If I was in the shoes of Flipkart ptomoters, I might think, “hmm, maybe they have two years or so of life left before they run out of cash. What would I pay to put them out of their misery right now?” I imagine an answer is not likely to be in the $15 billion area.  To me, this may be the beginning of the end game in Indian e-commerce.

What has changed lately? Companies are being more realistically valued by founders today. The 21-year-olds who came to me a year ago and demanded Rs 20 crore at a Rs 100 crore valuation just on a PowerPoint and an Android app are now coming back after a year and saying “I think we can be okay with Rs 2-3 crore for 20%.”

To me, it may be the beginning of the end of whatever you call it, the Bangalore model or the Topi model, which basically holds that it doesn’t matter what the fundamentals are, or if there is actually a business here or not, but that there will always be some other fool who will buy it at a greater price.

(Mahesh Murthy is co-founder of early-stage investment firm Seedfund which has backed companies such as RedBus, CarWale and Chumbak. Views are personal.)

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Valuations may be theoretical, markdowns are not

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