Sunday, May 31, 2015

Other People's Money! The E-Commerce Conundrum.

Two newspieces caught my attention.

First this -

and then this

What is common to both these stories is the presence of a common denominator - called Venture Capital. (or to use Robert Kiyosaki's term, Other People's Money).

There has been a lot of talk in the last few months about the E-Commerce bubble in India, and when (not if) it would burst. And not just in India. All over the world, crazy valuations have been driving economists (and prudes) insane. I genuinely do not understand how Flipkart could have a valuation of $11 Billion!! That's about ₹70000 crores. Anyone who's seen the way the E-commerce industry works, will know that they're working on a cut throat pricing model, and seldom do they have opportunities to make money after all the overheads that the business model entails. So when (if ever) will they break even, and when will they actually turn a profit for their investors? All those 'angels' who have put in millions of dollars into the 'burgeoning Indian market'?? 

The truth is  - probably never. With this on-paper valuation, the company will keep raising additional capital and giving out extra shares to its investors, and the paper value will keep being bought and sold at a premium / discount for the duration of the business's existence.

It is kind of like debt being sold and bought by banks to play with their NPA figures. Mallya's debts are a curse to several banks, but all they do is keep shifting it from balance sheet to balance sheet. For otherwise they'll actually have a P&L that's ridiculously in the Red and shareholders will slaughter them in the markets. 

One may argue that the entire stock market and the concept of forward earnings is based on hope of future profits that the company they're investing in may generate. A trading price of 14x to 18x is quite normal. Meaning company shares are valued at 14 to 18 times (or more or less depending on its brand value and market scenario at that particular moment) their earnings per share. As an example, Tata Steel has a current market capitalization of ₹31904 crores. The last traded price of TataSteel was ₹328.5. Its Earnings per share last results day was ₹66.3 (Earnings per share is simply put, total revenue divided by total number of shares available in the market). So 328.5/66.3 = 4.95. 
TataSteel is valued at just 4.95 times of its current earnings, which makes it quite cheap when compared to the market standard.

Lets go abroad and look at Apple; the world's most valuable company currently. Apple has a market cap of $750.55 Billion (or ₹4803520 Crores!!!) with a share price of $130.28. Last quarter's earnings per share were $8.05. So that makes Apple valued at 16.19 times - which is quite normal for technology companies. At one stage, Microsoft was valued at over 100 times - with hope that it would do miracles in the future, and it did. Companies like AutoDesk and Adobe are currently valued at 130-140 times their valuations based on the projects they have in their pipelines. Since stock markets are nothing more than a gamble based on hope (with a bit of knowledge thrown in), that's how its always been and will continue to be so.

Lets now revert to where we started.

Flipkart (just using that as an example since its the most visible brand in our E-commerce scenario) did a turnover of ₹2846 crores in FY14. And according to publicly available information, the company is currently losing over ₹2 for every ₹1 being spent on their portal. I couldn't find 2015 results, but here are 2014's.

And they surely know that they're not going to turn a profit anytime soon. None of them are. To keep the juggernaut rolling, they'll need to keep pumping in extra money quarter after quarter. And the juggernaut will become so big that just to keep it rolling will take up incredible resources. And all the time, nimble, smaller, specialty stores will keep chipping away at their market share. Yes, India has been blessed with an abundance of consumers and the pie will keep growing larger. But turning a profit in our crazy market isn't easy - as Big Bazaar, Reliance Fresh, Spencers, More, and others have been finding out year after year. 

Flipkart and Amazon are the visible giants. There are hundreds of smaller ones that open shop each month, and hundreds more that close shop. Some of the lucky ones make a good pitch and sell themselves off to a larger corporation with large investor pockets, and they take that money and retire. 

Refer to the Tweets on top of this article, FreeCharge was bought for an unbelievable valuation of ₹2800 crores. Not because they were doing roaring business (they aren't), but because expansion is the only way to survive in a market this competitive. Companies keep acquiring other firms either within their realm or providing services that are complementary to their own. Firms with a decent brand presence are wooed all the time. 2800 Crores for Freecharge?? Insane. Really!! And the second Tweet - GigaOm expanded, brought in money, and kept repeating the cycle till it swallowed itself! (Note - While GigaOm isn't an e-com company, the valuations across the board in the Tech industry are similar. So using it as an example is justified :) )

A friend of mine has an online flower and gift store. It does hardly any business. Has been so for a while now. But at a recent investor meet, the chap was offered an investment of ₹1.5 to 2 Crores, to expand the business. Call me old school, but I don't see why!! Hundreds of businesses are being offered crores to pump into floundering businesses - most of which won't see the light of a profitable balance sheet ever. All in the hope of striking Gold! Yahoo struck Gold with Alibaba. What they bought at a pittance has now become the cynosure of all business eyes across the world, and the founder Jack Ma has got a belly ache from laughing all the way to his bank(s). Yahoo is sitting on an incredible pile of money too - based on current valuations of the company after it got into the stock markets. But not everyone's Yahoo. And not every local business is AliBaba!! Valuations are driven entirely by the picture the company manages to draw in its investor presentations, but anyone with common sense can see that its all virtual - hope entirely! If Tata Steel has to shut shop, there are real assets that they have - land, factories, machinery, a brand, its distributor network, past dues, which will account for some of the investment to be recovered. If an e-com company folds, there's Poof! So many instances of throwing good money after bad!!

In the early 2000s, Silicon Valley startups were offered insane prices by rich fools. Some of them cashed out early. But most got stuck and when the bubble burst, millions of investors went bankrupt. And yet we're doing it all over again. Crazy terms like 'brand value', intangibles' and 'forward guidances' will be bantered over jazzy presentations in business rooms of large hotels. Fund managers of angel investing companies will be treated like royalty. Deals will be struck, and the bubble will keep growing bigger.

It isn't wrong to build castles in the air. Like someone said, that is where castles should be. But then we also need to work towards a foundation that'll hold the castle there. In this classic case of Other People's money, the castles are becoming larger, the shine is all glossy, but small investors will get slaughtered. Atleast that's how its appearing as of now. And I pray I'm proven wrong.

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