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Opinion

Is the Indian Internet a Bubble?

With the valuation at Flipkart going to $1bn, that is the question. $1bn is 4,500 crores, more than the other “real” internet company listed in India, Info Edge, which is currently valued at about 4,000 cr. $1bn, for a company with less than 100 cr. in FY11, with potentially some losses.

Mahesh Murthy writes at Tehelka about the potential bubble in valuations, and while I started to tweet my response, the blog format is better. First, Ma-Mu says:

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?

But two Kingfisher airlines is not much, because as far as I know, KFA is in a deep mess (it’s biggest asset is “deferred tax” which is taxes it will save in the future from the losses incurred).

In terms of travel agencies, if you consider that MakeMyTrip is like a Thomas Cook, then consider that Thomas Cook makes 300 cr. in revenue, 50 cr. in profit, and is currently available at a valuation of 1000 cr. There is an enormous bubble in MMYT valuations and I can’t agree enough with Mahesh here.

He also pummels Rediff.

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.

Rediff is hardly relevant anymore but the bubble story of India continues.People truly believe in the US, that to participate in the Indian growth story, you should pick up an Indian stock, any stock.

Get real, folks. India’s economy has, on a rupee for rupee basis, grown over 80% in the last four years from Rs. 45 trn to Rs. 80 trn.

How much have our top stocks grown? The Nifty is up 20% in absolute terms since August 2007. If we stay at this level for another three months, our stocks would have a negative return, despite our economy nearly doubling. There is something wrong with the notion that you can just buy anything in a growing country and it will go up.

Now to Flipkart:

My thoughts in a list:

1) Amazon’s coming.

2) Barrier to entry is very low. Warehousing space + Logistics have become hugely professional with for-hire availability.

3) There is a huge P/E potential if they list because there’s no one else. Assuming Naukri like valuations of 80+ on listing they need to make Rs. 50 cr. in net profit to justify the $1bn valuation today. This translates to around 1000 cr. topline, which is very aggressive. (At 5% net margins)

3.5) But if they’re valued at $1bn now, obviously a listing should value them at $5bn or someting. Even $2bn is tough, because that means 2000 cr. in revenue. Short answer: Bubble.

4) In the age of increasing interest rates, people might move away from the expensive malls to cheaper products online. But sales will not rise exponentially.

5) Unless they get into toys. People will pay anything for good toys. I have paid insane amounts of money for good toys. Even in a recession.

6) If they weren’t valued so aggressively today they could have IPO’ed in three years. Pound of flesh means horrible IPOs – even one that would easily have gathered money – Micromax – has been pulled out supposedly due to PE investors not liking the valuations they can get today.

Will Amazon Buy?

The big valuation metric seems to be in 1) above.

a) Amazon’s coming so, b) it will buy someone and Flipkart’s it.

But 2) above says it – you don’t need too much to set up a Flipkart anymore, especially if you are Amazon. Delivery with Cash-On-Demand is now a menu option in the seriously professionalized world of logistics – this is the real story in India (buy the Blue Darts). Don’t believe me? Infibeam’s done it, as has TheItDepot.com , as have the RMA services for Seagate, Western Digital and a ton of other companies. If you have the dough, they’ll roll it out for you.

Is payment infrastructure big? Again, no, if you have the ability to set up accounts in different banks really fast and learn to code a little. Amazon totally rules here, with their current ability to bill credit cards anyhow, all they need to do is to add a layer for debit cards – technology that isn’t complicated, and a bank balance that will cut through red tape.

For Amazon to come in and buy someone for $1bn (or more!), it has to counter the cost it will incur setting up the whole thing by itself.

But there’s not that much cost. Amazon is already in India – they have an office is in Bangalore, next door to my house, so I know.

It’s not just $1bn

No; who invests at a valuation of $1bn just to sell the company for $1bn? They expect much more, perhaps $3bn. Will you pay $3bn for a Flipkart – perhaps a bigger one?

Of course you will. If they put ads on TV you’ll buy anything. You probably bought Reliance Power also, at Rs. 450. You will consider how much listing gains are there and buy. (Note: I know you’re smarter than that. Just saying) But eventually – and here’s the point – we don’t know when, sanity will come and take the stock down.

But When?

That fate is awaited of most other players, including Media companies. NDTV and Network18 have been losing money consistently, and hand-over-fist, over the last three years. Reliance Power hasn’t made much money. Even Naukri, although more profitable now, is valued at a P/E of 40, which is way above their 3 year CAGR (and again, there’s no serious barrier to entry in their business).

There is altogether too much madness and overvaluation in the market, not just the internet; we value an Infosys at a higher p/e than Apple computer, we value banks at valuations that makes even Goldman Sachs look cheap. It will end, but not predictably. In 1998-99 when internet stocks were already in serious bubble territory, people said it would pop in the next few months – it took years, and bankrupted the shorts before it popped.

Is there a defense?

Indus Khaitan says come on, this is game-changing. He may be right, of course. But he assumes that India is still behind in terms of the setup infrastructure, which in my opinion isn’t true.

Second, he quotes India’s OTA as having created mass air travel – you have to note that mass air travel was good, but literally no stock has profited from air travel in India. (and across the world, I think). The airline industry has seen losses after losses, ever since the Wright brothers. But we have better airplanes. What this means: You can have an awesome online experience tomorrow, with players like Flipkart still making huge losses because the game simply refuses to be dominated.

Again, you have to note, that Amazon was *the* last bubble. Henry Blodget called that stock up to $400, it went there, and then he got in trouble for having said internally that he didn’t really believe net companies were that cool. So it doesn’t matter that Flipkart is part of this bubble; it could still become an Amazon and create the next big thing.

Focus on Price/Features

Flipkart has a model: it discounts. It needs to stick with that. The discounts are good; but not the best. I’ve used India Book Store to find out where books are cheaper, and in many cases, others are cheaper than Flipkart. Because of the now-far-better reliability of the logistics companies, I trust any one of them to deliver books after buying online (except a couple). This is where Flipkart needs to buck up and be the cheapest. If the advantage of Flipkart is thought to be reliability, it is not so; I think that field has been levelled. The advantage has got to be pricing and then, availability of the long tail of books, local language titles, school bundles and so on.

The advantage of Flipkart is not the interface – firstly, it doesn’t have the rich cataloguing that Amazon does, nor does it have great recommendations for me. Even if the interface were better, it wouldn’t be the interface. Cleartrip has a great interface, but when I find that booking online on the Spicejet web site is a) cheaper b) has less problems in refunds and cancellation and c) allows me seat assignment, I would have to be really drunk to use Cleartrip. (For people who don’t think seat assignments are useful, try travelling with an overactive 4 year old sitting in different rows.) It’s the features and the price.

What I’d be scared of is: will they go the way of Fabmall/Indiaplaza? Fabmall was an awesome and similar concept (i was one of their early customers in Bangalore and visited what was a tiny office then). They then reduced the discounts; they opened physical stores; they completely lost the plot.

Currently their biggest competition is Infibeam, which has similar pricing and reliability.

I’m saying …

I would still buy the stock if I can get it. I’m not smart enough to say I’m not a speculator. This is a bubble, but so what? I’ve bought bubbles before (note: 2007 – rode it up, 2008 Jan: rode it down) Bubbles are awesome when you notice them the first time. Bubbles are bad only when they pop before you’ve sold. So don’t get greedy, take a bite and don’t listen to anyone when you jump off.

(Note: I wish Flipkart had listed instead of getting the P/E funding. What’s 600 crore – peanuts.)

Footnotes

(Post twitter responses)

  • Is this a bubble if only Flipkart is at this value? Probably not, or it will only start the madness. But the mad valuation on internet assets is a worldwide thing. Linkedin’s value is obscene, and so are the valuations of Facebook and some other online players. What makes this a bubble is the worldwide situation around valuation – in fact even in India, players are saying that valuations are too rich at the early stage to even consider. The problem isn’t the number – it’s the price-to-sales multiple today and the expectation of tomorrow.
  • The valuation is also a function of loose money policies. When you get zero interest money in the US and Japan, that money flows towards “risky” assets as well, and pushes up asset values. It did it for mortgage prices, it did it during the dotcom boom, it did it for commodities, and now it’s doing it to the high end private market for stocks.
  • it’s also about how much money a VC can deploy and then return to investors. If you don’t hype, pump and dump it can’t be done with a reasonable CAGR.
  • Pantaloon Retail has a market cap of 7500 cr.; Flipkart worth more than half that? My take: Brick and Mortar versus Online, I guess; Amazon was worth more than Barnes and Noble when it raised the same kind of eyebrows.
  • Oh, forgot – Snapdeal got a valuation of 1,000 cr. recently. That was big, Flipkart is bigger.
  • Corrected the last line – it’s 600 cr. that Flipkart’s looking for at that $1B valuation. 600 cr. is still peanuts for the IPO market.

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