Internet Commerce Valuations: Pay for strong fundamentals, not for hype – Deepak Srinath

(This blog was first published on the VC Circle blog on 29 July 2011)

There is a raging debate in the US tech and financial media about the ‘tech bubble’ we apparently are in the midst of. Every journalist, blogger, VC and academic is either painting doomsday scenarios or vehemently denying there is a bubble. Either way, we’re seeing unprecedented valuations for social media and social commerce startup’s, both from VC’s and public markets.

US tech valuations seem to have had their affect on the Indian startup scene too. A few days ago The Economic Times carried an article on Snapdeal’s next round of funding – ‘sources close to the deal’ are quoted as saying that the deals site is raising INR 200 cr at a valuation of INR 1000 cr. Rumors are doing the rounds that Flipkart is raising its next round at a billion dollar valuation. If these valuations are halfway close to the truth, we’re talking multiples of 10 to 15 times their annualized run rate or Gross Merchandize Value-GMV (i.e., their current monthly sales multiplied by twelve). Are investors justified in paying such valuations? What about margins and net income, have they become irrelevant?

This debate about VC’s over paying for e-commerce startup’s is particularly important in the Indian startup context. VC funds in India, barring a handful, are still going through their first or second investment cycles and very few of them have seen big exits yet. Most early stage funds have significant exposure to e-commerce and need to show good exits in order to raise future funds. It may not be an exaggeration to say that the early stage ecosystem will suffer if VC’s have overpriced these investments and don’t make good returns.

I actually don’t think these valuations are as crazy as they are made out to be.

E-Commerce companies take a long time to become profitable. Amazon took seven years to turn in its first profitable quarter. Even today Amazon’s net income is small compared to Google or other tech giants. The market values Amazon (P/E of 82) for the kind of profitability it will deliver in future. If you take a closer look at investments in the internet commerce space in India, it is only the category leaders who command such valuation premiums. E-commerce worldwide is all about becoming the no. 1 or no. 2 player in a category and dominating it. So investors are essentially taking bets of firms who have demonstrated early traction and paying in anticipation of what they hope these companies will grow into in two or three years.

However, investors must be wary of paying valuation premiums based on GMV alone. GMV spikes can be achieved by deep discounts or cashback schemes and these will ultimately prove unsustainable unless you build loyalty and repeat purchases. Critical success factors in the long term are low Customer Acquisition Costs and high Customer Lifetime Value (CLV). Profitability will ensue if these two metrics are under control. Investors should be very careful not to pay for hype. As long as premiums are being paid for real fundamentals, all of us will be fine in the long run.

Mentoring the Mentor – Deepak Srinath

A couple of years ago, when Viedea was a relatively new start up, I was approached by somebody who offered to become our mentor. I remember being surprised, because the person neither had experience of entrepreneurship nor of leadership in a corporate set up.  Needless to say, we politely declined the offer.

As the number of entrepreneurs and startup’s grow in India, it is but natural that various elements of the support ecosystem also develop.  Organizations like TiE and NEN, angel Networks like IAN and Mumbai angels are all doing a phenomenal job of supporting entrepreneurs. So too are numerous individuals and private organizations like Mentorsquare, Morpheus, etc. who have created innovative models which hopefully will create the sort of support ecosystem Indian entrepreneurs need.

However, the trend that has left me partly amused and partly concerned is the rapidly growing breed of entrepreneurs who are in the “business of mentoring and incubation”.  I have interacted with many such “mentors” over the last few months and barring a few exceptions most have left me with the feeling that they do not have adequate experience or skills to mentor a startup. Some of them are barely out of college themselves and many of them claim to be serial entrepreneur s (on closer inspection, it’s more like ‘serial company starters’, none of which have managed to last beyond a year).  It’s extremely worrisome that young entrepreneurs with smart ideas could be signing up such mentors, giving them equity and wasting a lot of time in the bargain.

A good mentor is a critical part of an entrepreneur’s journey. A few tips for entrepreneurs from my own experience –

  1. Choose your mentors wisely. Sometimes, finding and pitching to the right mentor is as difficult  and as important as finding the right investor,
  2. You may need multiple mentors on your entrepreneurial journey, for different stages of your venture or for different domain skills. It is likely that you will outgrow a mentor as your business evolves and takes different shapes. Make sure your relationship with the mentor is flexible and not joined at the hip.
  3. Decision making should never be delegated to the mentor. The mentor’s role should be to give you perspective and advice, not to make decisions on your behalf.

A few months ago I was approached by a leading incubator to empanel myself as a mentor. However, I did not feel I was qualified to be a mentor just yet.  As an entrepreneur I continue to learn immensely  from my mentors. Only when we have achieved the goals we have set out for Viedea will I believe that I have the right to mentor other entrepreneur’s and share my experiences.

Testing the waters: Our experiences as customers of start-ups – By Uday Disley

Being in the start-up ecosystem has its advantages, for one gets a firsthand view of new products and services which are at either a concept stage or at a beta stage. Now that the people in this ecosystem are most likely to evaluate start-ups from a business viability point of view, we at Viedea more often than not try out these products/ services as consumers. So has the experience been good? Well it’s been interesting to say the least, let’s see what we have here:

Enterprise Software company: Building an enterprise product is the holy grail for most in the IT products space, and there are plenty of them out there, trying permutations and combinations of various ‘features’, which unfortunately end up remaining just that, a bundle of features and not a wholesome product. We have used a software product of a start-up in the past, which had obvious issues of not understanding its users and their workflow well, and to top it had really bad UI. Whilst you may have the intention of building a great product, but one needs to understand that a hundred features, may not solve the core problem, which the product was to built to address in the first place. Verdict: Use this logic – Simple product = address core need = great user experience = happy customer

Printing services company: If somebody needs to build a great service platform, here is a case study. This printing services company came up about the same time we started off and we have been loyal customers since then (though not a volumes customer). What we like about the place is its clean approach to addressing a customer need and delivering the same with reasonably high service standards. Well let’s see what works for them – they have demystified printing for the consumer with a fairly interactive and easy to approach delivery mechanism, in other words the first time user is as comfortable as a regular user. Verdict: Consistency in service = happy returning customer

Consumer electronics company: Ok we have not been early adapters when it comes to consumer electronics, but that is set to change, as we took a big leap of faith and pre-ordered a tablet pc from one of the most talked about start-ups in the tech space. Well we have been tracking this company for the last six-eight months and if not anything else this is a superb study of how a product can be built, evangelized, supported and maybe even funded, by a community. For the community of supporters it has been an interesting and frustrating journey, for it has stood by this company through its development stage to product delivery stage, going through the teething problems of a start-up. Anyway the company has delivered the product in its first round of pre-order, where most of the users have been very happy, meanwhile the second set of pre-orders though much delayed, is eagerly awaited. Verdict: Hype and good response needs to be followed up with good customer support.

Apart from the ones mentioned above, we have tried various start-up food services, salons, online stores, bought bus tickets, books, with varying degrees of ‘customer’ satisfaction (or dissatisfaction). It’s a classic dilemma for somebody who follows the start-up ecosystem, while you want to support it to the hilt by buying and endorsing the product/ services, at the same time you as a consumer can’t stop yourself from criticizing a mediocre product/ service. Instinctly you feel for the start-up team and are able to relate to the teething issues that they might be facing, but at the same time you want them to succeed by pushing their limits. The start-up ecosystem needs supporters and critics to be consumers as well and in all fairness guess it just completes the loop.

Where’s the action going to be: The Viedea guide to deals in 2011 – Compiled by Deepak Srinath with contributions from Uday Disley, Aravind G.R and Alap Bharadwaj

As we take stock of the year that went by and take our collective deep breaths for the year ahead, we’re pondering on the big question- what do we focus on in 2011? As part of our business planning process we asked each team member to send in their predictions for the year…and predictably got some interesting comments.  Uday felt this was akin to predicting whether the Indian team will win the world cup at home and Aravind opined that we should just ask that big brother VC fund (Wily Wonka’s chocolate factory is Aravind’s precise metaphor) with an army of ex-consulting associates to tell us what sectors they’re investing in and pick up mandates from all companies in those sector….The logic being that all other funds will follow big brother and we’ll be sitting pretty. Finally after much persuasion, the team sent in their vision for the year ahead, and we present to you an edited summary of our guideline for 2011:

(Please note- This is limited to VC/PE and M&A activity in the sectors we focus on in the early, growth and mid market space)

1. Internet /E-Commerce – Unanimously elected as a high action sector for the year. Frantic VC  and angel activity will continue for the first two quarters of CY2011, fuelled by the makemytrip inspired billion dollar IPO vision. The Indian consumer finally seems to be buying online and we expect all sub sectors in the ecommerce space to see funding activity. The internet investment frenzy will ease off by the second half. However, we expect strong M&A action, both inbound and domestic consolidation through the year.  The second half will also see Series B and C investments in internet firms that have managed to reach some scale.

2. Education – Last year’s darling, still has some fizz left for this year. Aravind, our in-house education expert believes that funding action will mostly be for mid to large size firms. Lot’s of small M&A deals are expected as PE funded players mop up strong regional brands to consolidate, especially in the tutorial and test prep space.  M&A deals of the size of Tutorvista-Pearson will be more of an exception than the norm. Valuations will remain unrealistic though, and we may actually see a lot of long drawn out deals that take a long time to close. (Note to Aravind – Patience and Stamina, your mantra for the year!J)

3. Mobile/3G/Connectivity – This year’s big focus in the mobile space will be around 3G plays- Video, Optimization, Software products, Cloud, Data Security and Recovery, Gaming (enabling not developing). We expect VC investments in all these areas and the likes of Apalya have already demonstrated this emerging trend.

4. IT/Tech services – Unanimously voted as the ‘not cool’ sector of the year.  As Alap says,”Mid cap IT will see another year of stagnation on the deal front.” There may be some outbound M&A  traction with Indian mid cap companies acquiring in geographies like Australia and South America.  Alap is betting on Infy making a big acquisition this year but the office betting syndicate is not giving it favorable odds yet.       

5. Hardware devices/Tablets – The gadget geeks in the office (everyone except me) want to believe this will be the year of the Indian tablet. Notion Ink has swayed them all, and we’re hoping this is one rock star to emerge from India. However, hardware plays from India remain hugely challenging and we don’t expect much funding activity here. Even the low cost mobile handset plays seem to have peaked and we expected that raising PE funding will be a challenge for new players.

6. Healthcare – Will continue to attract investor attention, both hospitals and services/technologies that enhance healthcare delivery. Rural healthcare providers will attract VC investment. Consolidation will be seen with bigger hospital chains acquiring smaller or regional hospitals.

7. Financial Services – Financial inclusion, the big investment theme in India over the last few years will continue to drive investments this year also. The MFI party will be muted this year, but areas like housing loans to lower income segments will attract PE investment. Mobile banking platforms, combining technology and brick and mortar may attract some investment.

8. Agri and Food – Farm to fork seems to be the theme for this year with supply chains and agri warehouses continuing to attract some serious investments.  Aravind is of the opinion that food processing companies that emerge from the food processing parks set up by the government will attract some investment.

We hope our analysis is useful as you plan your year. Thank you.

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