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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 , 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.)


(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.
  • niranjan says:

    This is wrong information.

  • Naren says:

    FY 10 Flipkart’s revenue was Rs 11.61 crores, with a loss of Rs 91.27 lakhs!

  • Raja says:

    Good that you touched upon the point of snapdeal. What is the damn groupon business anyways ? I seriously think that the business model is not for long term. How can we expect to tell the people to ‘what to buy’ and ‘when to buy’ and expect them to follow it over and over again. I don’t know!
    God help google to have offered them the crazy valuation. And i believe they were even crazier to refuse it.

  • Amit Prabhu says:

    Deepak, there are a lot of flipkarts in the market. I don’t mean online book retailers, but people retailing all types of things online. Take and or lets
    The barrier to entry is negligible in the online world and everybody wants a share of it all. Forget top line, most companies are incurring huge losses because of the discounts they throw in to draw in the consumers. Take flipkart for example, bought Arvind Adiga’s latest at 40% off. Now that about 150 bucks or so off. I doubt that leaves him with much margin, may be a little bit, because he must have taken pre orders and bought in bulk. But for sure, once you factor in the distribution cost and the IT cost and the overall overheads, its a loss. The more people buy, bigger the loss.
    The whole issue of saying, we are creating a customer base does not work, if the driving factor is a discount, because after creating a loyal base of say 10 Lac users over 2 years, you withdraw discounts to make more money, and a fresh player comes in the sort of discounts previously offered, most are going to make a beeline for the new kid on the block.
    Valuations have to be based on the unique opportunities offered by the website and not traffic. Yes, one major factor that is being overlooked is that there is greater penetration of the net in India, than in 2000. If they care to publish data in terms of the sales generated from tier 2/3 cities, it might help understand if the business is sustainable. I think in those places where you do not have a viable option in terms of brick and mortar retailing, online sales will flourish, especially with cash on delivery option.

    • Good points. The business can scale, but I think the discounting model runs well if it’s profitable, and the book business qualifies (vendor margins are 40% to 60%). It’s not so in mobiles, or appliances, or even computers and parts where margins are wafer thin. In the end if the pricing difference between what I can get at a local market and online is huge, then you will lose most of that market. Look at the relative success of Easyday or Reliance Fresh or Hypercity; they discount to the extent that even local veggie vendors will buy there.
      Online retail for, say, TV vendors involves working the channel, sometimes beyond the wholesale distributor model. Channel in India is horrible to work with because of family affilations (Marwaris get the best deals for instance through the community network) or because they simply don’t like large organized players. Samsung and Nokia have scaled to where no distributor can hold them custody, but many of the lesser organized manufacturers still don’t want to alienate their wholesalers or C&F agents. But I believe this is a great time for organized retail in that regard, especially where storefront space is at a premium.
      Think of dryers – in monsoons, clothes don’t dry. In winter, clothes don’t dry. So many people with internet access might be willing to pay for dryers, but go to a shop and they won’t stock ’em. Flipkart type of stores can help get that long tail as well. This, plus the fact that getting to certain types of stores is painful. Toys are huge here – stores just don’t stock.

  • The valuations are crazy for sure. Do not justify at all, especially if you look at the entry barrier and the low switching costs for people like you and me. And I think it all boils down to the “discount” games in India at least. If Flipkart is thinking they will build a loyal customer base by playing the discount games they are mistaken.
    Let’s still think their thought process behind all this. 1. They are playing the branding game here. But again they are doing this by just buying online ad space to attract loyalty in a short span. While what they actually need to be doing is a Zappos story. But that is a looong tail and with a VC sitting on their head they cannot think like Zappos when all they care about right now is IRR.
    2. They plan to grow beyond Books which they have already started. Although prices of these categories will be higher then Books it is the margins which matters. All these products (electronics et. al.) are mere commodities nowadays which means even lesser margins going forward. And if “discounts” is their play here then it won’t work out too well in the long term either.

  • Umang says:

    Amazing article! You have summarized the post-exit situation pretty well. BTW, Whats with repeated mention of toys? 🙂 Its largely an offline experience…

    • As a dad, I’ve started to spend serious money on stuff that is more or less standard. Like books, I notice stuff in shops, but they’re all expensive. I know margins on toys are 30-40%. This model can rock if you push it online

  • Amit says:

    I think its a very stupid article with author having no valuation understanding. The author has listed the factors like low barriers to entry, tech and logistic setup – easy, etc. … Can the author tell me how many companies in India have so far been able to create following of online buyers? Only Flipkart is the answer. The reason for their success is the understanding of Indian customers and delivering excellently on the customer expectations. What crap are you talking about comparing the valuation of to Flipkart … Naukri is already matured in a small market and Flipkart is still in early stages in a huge market. When we talk of market … How much do companies spend on recruitment commissions in India annually – Rs. 1000 – 2000 crore ? Now ask yourself how big is the retail space – Its over Rs. 12 Lac crore … Lets say only 10% market can be captured online where people buy goods with shelf-life online .. its still over Rs. 1 Lac crore … The comparison of two is like comparing grapes to mangoes.
    By the way do you know for how many years Amazon incurred losses? About 7-8 years .. its just not about building customer base that costs them. They spend a lot on building supply chain which is extremely difficult to build. Walmart which is more than 10 times of Amazon in revenues, can’t match Amazon in online retail because building because building online ERP and supply chain is altogether a different ball game.
    You have also forgotten that Flipkart is the first Indian retailer to start its self-delivery in 4 cities this year which will help them save significant costs going forward.
    The revenue figures you talked about were for year ending March 2010. Lets talk about March 2011 revenues … I am not sure how much that number is but I wouldn’t be surprised if the revenue has topped Rs. 100 crores !!

    • I disagree – there are others who’ve done well. I’ve named Infibeam and theItDepot. I know of nearly 10 others who’ve figured the piece out.
      Naukri and Flipkart are valuation comparisons – you might choose not to compare them, but they are Indian internet transaction plays. Not ads. That’s the similarity. If you want to pick nits then you can find differences, but to investors it’s a very very similar field, and comparable. You can wax eloquent about the size of each market, but to an investor, online play=online play. You still compare Amazon to other ecommerce plays.
      Online retail isn’t 12 lakh cr. Retail is 12 lakh cr. Walmart has nearly 10x the sales of Amazon, and nealry all of it is offline. Online retail is tiny in the US compared to offline retail, and it’s an even tinier part of Indian retail for the next five to ten years, IMHO.
      Flipkarts logistics service will turn out to be a negative, according to me. The logistics business is better served independently, for economies of scale and on the ground management style. But they have to do what they have to do.
      Revenue figures: we’ll get back once they file numbers to ROC. Let’s see if they’ve hit a 100 cr. in rev.
      I wish Flipkart the best, and I hope they’ll score big. I think they’ll hit a wall and will have to figure things out, in the next couple years. The valuations are absurd, and absurd valuations make a market. They’ll be a great trading play once they list.

  • Mayank says:

    Just read your article after your comment on mine. Quite a comprehensive analysis on this issue indeed. You just earned a loyal fan here.

  • Rohit says:

    I think you have missed the biggest point while mentioning about the point of Amazon entering India. 100% FDI is not allowed in multi-brand retail, so Amazon has to buy or tie up with a local company just like Groupon. With the increasing prospects of Amazon entering India (Hiring Madhu M and tweets about full scale hiring), valuations for local company will definitely soar up.
    Flipkart is the best company in online retail right now in India. Infibeam, or any other company doesn’t even come close to the reliability level of Flipkart. Pricing is not the factor which will define this market, it will be reliability. Millions of users have been using Amazon because of reliability and not exactly pricing.
    Also, people about talking about losses of these companies are being myopic. Online retail companies, if successful, become profit making several years down the line. Amazon being the prime example of this (6 years of initial loss making). Economies of scale is the defining factor for this business with respect to profitability.

    • True, the multi-brand issue is a problem. I do wish them luck but I think we’re too early – even multi-brand retail organized by Hypercity and Reliance are not exactly profitable (Walmart is, in the US, as are other large shops – tehy had their days) You might blame this on real estate costs, but remember these fellows have real estate really cheap in many cases – for instance the Piramals sold Pyramyd Retail but the family retained ownership of hte land the stores were built on; for the new owner the RE costs were huge, for the Piramals it was next to nothing.
      I think they’ll win on price. Amazon for the most part wins on price – if you see their annual report, their stated goal is to be the cheapest place to shop.

  • Yogan says:

    Hi Deepak, thanks for giving The IT Depot a mention! I’ve been growing the business organically for over 10 years and it’s been an incremental process since I’ve not approached or been approached by and P/E investors. It seems like VC’s seem to want to inject crores of capital to drive growth and sales and worry about profits much later on down the line. The IT Depot has been both offline and online since the beginning and what I’ve seen is these large companies like Landmark, Pantaloons, Big Bazaar etc. are scrambling to put up as many stores as possible and to hell with the profits – it’s like they are trying to set themselves up to become a more attractive buy to a foreign sugar daddy!
    When it comes to the online business it seems to all be about the price, sites like Flipkart are discounting heavily (thanks to the huge amount of P/E) but by my own calculations their margins must be razor thin! The only way they can become profitable is if the online market grows a lot quicker and faster than it has been in the last few years.
    Anyway, just my thoughts on the matter, thanks again for the small mention!

    • Yogan, much appreciate your comment here, and I’m happy to be a customer of IT Depot. I’ve just bought some RAM from you guys and probably will buy a lot more hardware as we go along. I heard of your company from Atul Chitnis and if he’s a happy customer, you guys must be doing something right!
      The only complaint I have about ITDepot is the charge to use credit cards 🙂 But margins are tiny, and I know other people do the same thing.
      Yes, I agree that it’s about the price. In fact recently when I wanted to buy a hard disk – my current one was nearly fried – I looked at a local guy who delivered a Seagate 1 TB HDD in 15 mins, but the price was cheaper than IT Depot by approx 200 rupees (including shipping and CC charges), which to me was significant for a deal of Rs. 3100. (I needed the disk urgently anyhow but I was surprised about the ticket price diff – even the base price for local fellow here was lower) For larger items, I would expect that a place like IT Depot would get a better deal than say a Reliance Timeout or something.
      Online is about volumes and it’s only now that there are SOME volumes. I hope there will be a lot more!

  • Dan says:

    check this old article out -> AMAZON.COM RIDICULOUSLY OVERVALUED – “For 1997 AMZN had approximately 140 million in sales, very large losses and a current market cap of near 1.8 billion dollars. The Price/Sales ratio is nearly 13.” –>
    numbers sound similar to Flipkart???