Stop Blowing Our [Ecommerce] Bubbles

[Editorial Notes: Very recently we covered the seven deadly sins VCs are committing and here is a guest article reinforcing our belief that there surely is a herd scene going here. The article by Mahesh Murthy, cofounder of Seedfund brings his candid perspective on the ecommerce frenzy in India. A must read.]

I’M SUPPOSED to be the risk-taking investor, throwing caution to the wind, picking good teams with great ideas and zero revenues — then backing them against all odds in the hope of a high multiple. While the stock market and private equity (PE) guys are supposed to be the cool pros, weighing decisions based on established revenues, profits, multiples and such, making safer bets.

But this is identity crisis time — have I suddenly become a namby-pamby? Is the world speeding by and have I missed the shinkansen?

I hear that Flipkart, a loss making company with FY11 topline revenues in the sub- 100 crore range, is raising a round at a $1 billion (that’s 4,500 crore) valuation. And then I hear that its main rival, the similarly-sized Infibeam is doing exactly the same.

I’ve seen this movie before. In 2000. And 2007. A price-to-sales ratio of 50 times? A PE ratio of infinity? What could the logic be to value firms at these numbers? bubble

Have we not learnt our lessons from our earlier wounds? Are there any comparables here? MakeMyTrip (MMT) just announced gross revenues for the year of 550 crore, net revenues — if you take out the cost of hotel rooms they count as sales — of 270 crore and a profit of 23 crore. That’s about 8 percent on net.

A travel agency with 270 crore in revenues and 23 crore in profit is not likely to raise a bead of sweat on Dalal Street. But it’s raising thunderstorms on Wall Street. The stock goes up to a 4,000 crore market cap. That’s enough to buy two Kingfisher Airlines and have enough left over to buy a few Mallya-type yachts. Two hundred times profits? Fifteen times sales? What’s up with the Yanks? Do they know something I don’t?

Past experience says it must be the US myopia on India (“Let’s just buy the Indian expedia!” says a man in a suit in a glass-walled Manhattan office. “Sure, boss,” the underling goes. “And the Indian Google”. “Brilliant, boss”. Little do they know the Indian Google is… Google and the Indian Yahoo is… Yahoo. But I digress.)

US market myopia is perhaps the single cause of survival for our other bellwether Internet firm, Rediff.com. This 15-year-old company announces its third straight year of losses and would be slaughtered if it was listed in India. Once India’s no. 1 site, it’s now barely in the top 10. Four years ago, when the Indian ad market was around 650 crore, Rediff did one-fifth of it with 130 crore. Today, in a digital ad market of almost 2,000 crore, Rediff does less than 100 crore. Some idiot stock analyst in New York calls it “the Google of the Ganges” and clueless punters take the stock price up to a market cap of 1,300 crore.

I never knew calls with analysts would be so easy. Three years ago, Rediff told them: “Wait for broadband, then see.” We did, and nothing happened. Now they say “Wait for 3G and see”. In all this time, Yahoo has grown past it — and Google is now almost 10 times as big as either. My prediction? After 3G is passe and the others have grown even bigger, they’ll say, “Wait for 4G and see”. And some fool on Long Island will take the stock even higher.

Market cap to me reflects two things — either the value of the earnings or cash flow discounted into the future — or a proxy for the cost of replacing the company if one were to rebuild it from scratch. With no earnings, no growth and just losses to speak for, discounted cash flow (DCF) is not the issue with Rediff. And would it really take 1,300 crore to build out a portal like this with 100 crore in flat-lined revenues? Not a chance. Most of us venture capitalists (VCs) wouldn’t offer even 1/25th as much if someone approached us with such a plan. So why is the “safe” public market offering much more than what us “risk-taking” VCs are? Maybe it’s tulip time again.

Applying this same logic to MMT and Flipkart brings the same conclusion. Does either have such a lock on the market that it’ll take 4,000 crore or more to dislodge them? Nah. They are barely ekeing out a living — neither shows much customer loyalty, both compete every day on price. Each has stiff competition. So what’s with the valuation insanity?

Is it some big Internet boom? Well, I think the boom’s already happened. We’re at a 100 million plus users now. And will be at 150 million in a year or two. And most of that growth will come through mobile devices, not landline-driven computers. So do I see an incredible jump in air ticket sales only through MMT only through phones and tablets to justify a 15x multiple? No Sir, I don’t.

Public markets have their own hysteria and I’ve learnt over time to stay away from the madness. But private markets?

If a private equity firm is valuing Flipkart at $1 billion now, this must mean they see it worth $3 billion sometime soon

If a private equity firm is valuing Flipkart at $1 billion now, this must mean they see it worth $3 billion sometime soon — either to an acquirer or to the public markets when they flip it. Who would pay 13,500 crore for a loss-making e-commerce portal? Amazon.com? Unlikely — from what I hear, they are already well underway setting up in India.

(But I will take this aside and talk of nonsense accounting practices at some of these e-commerce firms. Here’s how it works: a book has an internal cost price of 100. Offer it at 120. But at the same time, offer a coupon or such for 30, so you finally realise only 90. But show the selling price as 120, count the 20 as net positive income and show the 30 coupon as “long-term amortisable marketing expenses”. One day, some big four accounting firm partner will go to jail and then this loophole will be plugged.)

Coming back to why private equity chaps are going bananas. Perhaps they think they can pull off an MMT or Rediff by listing it overseas. Where Joe Schmoe will be told “it’s the Amazon of India” and hence in a frenzy mortgage his home and plunk out big greenbacks for it, in the hope that a greater fool will take it off him at a higher price.

Yes, there’s money to be made in this madness — but not by me. I’m not a speculator.

It is ironic that we say the Indian stock market is full of speculators and overseas markets are far more rational than us. I see exactly the reverse happening.

The men in Manhattan are chasing unicorns, while Mr Patel in Surat is asking in puzzlement where the rokda is.

Stay calm, Mr Patel. This world will fall apart soon enough. My guess? Another six to 12 months till valuations come crashing down again. And till investing bargains come by your way and mine.

So till then, don’t buy these stocks or stories. Instead, buy a book or a high-fashion bauble at a ridiculous discount from any of these firms.

That’s where the real bargain is — and that isn’t going to last much longer.

[Mahesh Murthy is a founding partner at Seedfund, and has over 26 years of marketing and communications experience, of which 15 years are in online marketing.The article first appeared in Tehelka. Follow @maheshmurthy on Twitter.]

[Image credit Steven | Alan/Flickr]