E-commerce valuations: To invest or not to invest?

By Natashaa Shroff, Shardul Amarchand Mangaldas & Co

In recent years, India has seen startups mushroom in the e-commerce sector. Boosted by cheaper data and penetration of smartphones to more households, mobile users today have greater access to e-commerce portals. The rapid adoption of e-tailing has seen the rise of Indian e-commerce players that are looking to be the next Amazon or Alibaba. “Unicorns” such as Flipkart, Snapdeal, Zomato, Quikr, Paytm and Ola have received billions of dollars of funding in the past five years.

However, the recent markdown on Flipkart’s valuation by Morgan Stanley, T Rowe Price, Valic Company 1 and Fidelity Rutland Square Trust II, coupled with international stars such as Twitter, Fitbit and Alibaba seeing a drop in valuation after going public, have sparked questions as to whether there is a bubble in e-commerce.

Natashaa Shroff, Partner, Shardul Amarchand Mangaldas & Co
Natashaa Shroff
Shardul Amarchand
Mangaldas & Co

India’s e-commerce sector is an attractive investment proposition due to five key factors. First, the percentage of Indians shopping online, albeit fast growing, is still a small fraction of the organized retail segment. The potential for the market to grow remains immense (Morgan Stanley estimates the Indian e-commerce sector will be worth upwards of US$119 billion by 2020). Second, more than 60% of the Indian population is in the 18 to 40 age group, which has a high disposable income and is comfortable with transacting online. This demographic dividend has a huge role to play. Third, while broadband outreach in India is still poor compared to Western Europe or North America, the availability of 3G and 4G telecom networks and smartphones has helped make the internet accessible. Fourth, the government’s policy in relation to e-commerce has undergone a shift. Since March of this year, 100% foreign investment under the automatic route has been permitted in e-commerce marketplaces. Lastly, e-tailing has the added bonus of reducing the grey or black economy in India, which has knock-on effects for bringing more transactions within the banking system and widening the tax net.

At the same time, e-commerce companies have several challenges to overcome. The ecosystem supporting the e-commerce sector (logistics, last mile delivery, warehousing, etc.) requires significant investment and improvement to build efficiencies. A large section of society is not in the banking system, limiting the use of internet banking. Recent tax issues faced by Flipkart and Amazon in Karnataka also highlight challenges faced by the e-tailing segment. However, all macro-economic indicators show that e-commerce itself is not a bubble and the economic opportunity remains.

With the unicorns losing their sheen, private equity (PE) funds are re-examining the economics of e-tailing players. Are the funds themselves to blame for this valuation mismatch?

While being asset-light companies, e-tailers have received valuations significantly higher than their brick-and-mortar cousins. Most investors have valued e-tailers based on multiples of gross merchandise value, which does not factor in losses and deep discounts offered by such portals. Despite the large valuations, most e-tailers are operating at huge losses.

PE funds need to examine the kind of exit rights they secure when they invest. Most investment documents provide for an exit through IPO. Given the current volatility of stock markets and track record for exits through IPO, this option is unrealistic. As yet, no e-commerce marketplace has been listed in India. The most common exit method is a secondary sale to another PE fund and it seems PE funds subscribe to the “greater fool” theory, that there is always someone to buy you out at a higher price.

Globally we are seeing more control or platform deals being done by PE funds. The e-tailing sector may be ripe for such transactions. A wave of consolidations has already been seen with investors matchmaking their portfolio companies. Acquisitions such as Zo by OYO Rooms and Myntra and Jabong by Flipkart may soon become the norm.

E-commerce companies with large operating losses are undertaking lay-offs and some of the smaller startups are going under. The e-commerce players looking to survive in the long term are aiming to become profitable and are focusing on improving the customer experience to maintain customer loyalty, diversification of income streams, strategic acquisitions in the value chain and resizing operations.

Companies that did a fund-raising round in 2015 and have capital may ride the storm better than those looking to fund-raise this year. Raising funds has become more difficult as investors are looking for a shorter path to profitability – a “cockroach” which can survive through the troubled times.

Natashaa Shroff is a partner at Shardul Amarchand Mangaldas & Co. The views expressed in this article are those of the author and do not reflect the position of the firm.


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