As I am writing this post, the only thing I know is that people in India are all talking about one thing that has captured their minds- Flipkart/ Snapdeal/Amazon. Different people have different reasons to speak about it- Ladies speak of discounts & sales online- Men wonder about how much weight will reduce from their pockets due to this. Nevertheless, in midst of this chaos, the promoters of these companies are making moolah like it's no tomorrow. So lets try n understand the ecommerce space.
First of all, ecommerce refers to any activity/thing which provides an option to make payments via online portals whether it is internet banking, credit cards, debit cards & finally the medium most important to India- Cash on Delivery. So, summed up, makemytrip is as much ecommerce as is snapdeal, though both are as different in their offerings as chalk & cheese. Makemytrip operates in travel & tourism, whereas snapdeal operates in retail sector.
The reason why this is the hottest sector as on date is because apparently, India has huge potential for online services/products sale because internet penetration is low, Modi's promise of acche dinn(good days) which includes providing internet to each & every corner of India (which I don't see happening anytime soon) & underdeveloped banking system- by this I mean banking transactions, as most of the transactions in India are still done in cash.
So many wonder about the truthfulness of the articles they read in newspapers of the humongous valuations the companies get. Let me first assure you (even though I have not been paid by any newspaper) that the articles are completely true in all aspects. This would make people wonder about how can such valuations be true for a less than decade old company when Reliance should get such a valuation? Let's try & analyze the rationale behind such crazy valuations.
In this article, I will focus only on retail ecommerce companies valuations, but the rationale remains more or less similar for other tech companies as well. For the purpose of better understanding valuations, we will divide the valuations into two parts:Investors perspective and Traders perspective.
From this classification only most would've understood that it's the traders perspective that is ruling in valuations. However, I won't recommend having a traders perspective in valuations. Let's try & understand both perspectives.
1. Investors perspective: An investor in this case is one who would think invest in a company for long term & not just speculate for short term/medium term. An investor will always look for value companies, he will look at companies performance from its balance sheet rather than its performance from the stock price movement. For him Profit After Tax(PAT) will matter more, he will make a financial model incorporating various scenarios & project revenues, profits, reserves etc. & then decide on an investment. This is apt for a long term investment because one can sell a company only on its future rather than its past laurels. These are players who will gain in long term because a company having good fundamentals will gain no matter what the situation. In the long term such valuations will yield comparatively better results than short term speculations when held for long term. Short term & temporary losses will not matter for a long term investor.
2. Traders perspective: A trader here means one who invests for a very short period-earns profits-divests from the company/shares. A traders perspective is driven mostly by narrative going on in the market. Even the wildest estimates by investors, sometimes cannot justify a traders valuations. A narrative driven valuation is very high & out of understanding of normal people like u & me. Nevertheless, there are some traders still remaining who invest on a company's balance sheet(which is keeping the market from becoming complete wilderness).
Valuations today are being driven by some solid narratives going on around ecommerce companies- whether it be the David(Flipkart) v/s Goliath(Amazon) story or the daily funding done by various Private Equity(PE)/Venture Capital(VC) Firms. But mind you these firms buy only a minority stake in these companies & this minority stake is what is driving up valuations enormously. Still, I would say I wouldn't agree more with the valuations these companies(ironies are a part of life) I base my argument on 2 phases of company life cycle:
1. Initial growth phase: Every company when started is a start-up, till it grows up that is. During this phase, customer acquisition is the key because customers are what help you sustain a business. This is exactly what Flipkart & Snapdeal doing, during this phase profits don't matter as much as customer acquisition. Take for example people like us- when we find a price lower than Flipkart on Snapdeal or we get the same product for cheap offline, we wouldn't buy it online, this volatility of customers is what companies want to overcome- hence the huge marketing expenses or the huge discounts on products.
2. Consolidation phase: This is a phase where a company need not spend on customer acquisition, rather focus on its core & improve the service being provided. Continuing the example above, we the consumers will gradually still buy online despite having not much incentive in terms of discounts or company spending huge on marketing, this will be because of the convenience online shopping offers- home delivery.
Phase 2 is the point where companies will start making profits- case in point segmented Ecommerce startups like Zivame.com/Pepperfry/Babyoye are already reporting profits. This is because they spent less on customer acquisition, the customer base was available for many of the niche segmented/vertical businesses, only cost was to bring people online. Whereas, for Flipkart the challenge was to bring people online + keep them with flipkart due to competition & also due to it being a horizontal player. Many products which flipkart offers would be available with other vertical players also i.e. on specialized websites.
If anyone was to look at even companies like say L&T or Infosys which are goliaths in their own spaces in India & overseas, even these companies burned cash in their initial days to acquire buyers for their products. But nevertheless, even they had competition from others who didn't survive & finally these both emerged victorious in their said sectors. This is true for every business, it's a risk which PE/VC players take. Few of these majors are going to go down sooner or later as not many can survive in a sector, the only case when many companies survive will be when all of them have differentiated services or products- case in point during the dot com boom Microsoft & Apple both of them had OS on computers but both survived because of product differentiation. But since in this battle all are horizontal players, product differentiation is a long shot, so the key will be service differentiation. Flipkart has started working towards its back-end logistics by forming a new company by the name E-kart & recently Amazon tied up with Indian postal services to get access to all the pin codes in the country. These are just baby steps to a next level of differentiation, which will determine the final survivors. In this phase however, valuations tend to come down as compared to the previous phase. It is seen that young tech companies usually outperform other companies in any country- be it US or India. This is the similar phase as all companies are technology driven & are showing many signs of strong growth.
I wrote this post just to express my views on the valuations. Hence, these are my views & forum is open for different views & thoughts which anyone might consider as to impact the valuations of these companies.
Special Thanks to Mr. Aswath Damodaran for my understanding of this sector.
Cheers!
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