This article is written by Minhaz Merchant and the original article is here.
Got a great new idea? Are you from IIT? Here’s a $5 million cheque.
That’s the dream conversation every 20-year-old has with a fantasy venture capital (VC) or private equity (PE) firm. And there are lots of people living out that fantasy. Flipkart’s valuation is now over $15 billion (Rs 100,000 crore). In comparison, the stock market values the venerable Tata Motors at a mere Rs 95,000 crore.
Hindalco, India’s largest aluminium company, has a market valuation of Rs 16,000 crore. Snapdeal, which began trading just five years ago, is valued at Rs 35,000 crore. India’s biggest airline, Jet Airways, with large assets, is valued at Rs 3,800 crore. In stark contrast, asset-light Ola Cabs, the app-based taxi-hailing startup, is worth Rs 30,000 crore.
So what gives? In short: the internet and mobile phones.
App-based firms (Ola, Snapdeal, Flipkart, Grofers, Foodpanda) are essentially brokers and couriers. They connect service providers with consumers. The web cuts through the infrastructure clutter. Small town buyers who don’t have a physical store to pick up a pair of branded jeans or a set of bluetooth speakers can do so through an e-commerce site. And they can be assured of delivery the next day.
But are these startups worth the money VCs and PEs are paying for them? Conventional wisdom suggests they are not. Dig deeper and a more complex, nuanced story emerges.
But first let’s dispel some myths. Myth number one has to do with revenue. Most e-commerce sites like Flipkart and Snapdeal focus on gross merchandise value (GMV) to pitch their stories.
Now GMV is misleading for two reasons. First, it reflects the total value of goods and services transacted through the site, not the actual revenue earned by it. Second, the huge discounts offered are not excluded from GMV.
The real revenue of e-commerce sites is broadly around five per cent of their GMV. It’s like a stock broker who buys shares worth Rs 1,000 crore for clients and whose actual brokerage revenue is one per cent (Rs 10 crore) but claims Rs 1,000 crore as revenue.
GMV is pass-through revenue. Real e-commerce revenue is the commission the site charges the brands it sells through its app. That’s rarely over five per cent of the discounted retail price.
When VCs and PEs do valuations of startups, they use GMV as the primary metric. No startup is listed; so scrutiny by financial analysts is limited. Their balance sheets, though, are available on the Registrar of Companies (RoC) website and it’s clear that actual annual revenues are a fraction of the GMVs.
Does that mean e-commerce startups are over-valued? Not necessarily. The Indian retail market is huge and growing rapidly amidst an aspirational middle-class. Mobile internet is exploding. VCs and PEs are betting that sheer volumes will eventually make even five per cent of GMV a big number. Flipkart, for example, has “real” annual revenue of just over Rs 3,000 crore on a GMV of Rs 40,000 crore. That’s a ratio of around 7.5 per cent. Its audited annual loss on account of discounts in 2013-14 was a staggering Rs 719.50 crore.
That had got investors worried. Questions are now being asked: is the hype overcooked? In a recent piece in Mint, Shrutika Verma and Mihar Dalal searched for an answer: “Investors have started to step back, take stock and ask questions about how consumer internet startups plan to make money before writing cheques, according to investors, analysts and entrepreneurs.
“About time, some analysts say, pointing to the mushrooming of such internet startups, some of which have questionable business models. For instance, more than 25 startups in food and grocery delivery and home services market places – startups that deliver food, groceries and services – have received venture capital (VC) money. ‘There’s a definite slowdown in terms of the pace at which deals are being struck since the last seven-eight weeks,’ said Avinish Bajaj, managing director at VC firm Matrix Partners. ‘Investors are starting to ask questions about long-term sustainability. The number of $50 million deals has gone down. Deals are taking longer. This is a soft landing and it’s a good sign. The time correction is likely to be followed by a price correction.’”
The US offers a glimpse of the future for e-commerce startups. Amazon, only recently, announced a quarterly profit after 21 years of being in business, but commands a market value of $260 billion (Rs 17 lakh crore), which is more than that of America’s largest retail chain Walmart (market value: $230 billion). Uber, the taxi cab aggregator, founded in 2009, is valued at $50 billion (Rs 3.30 lakh crore), higher than auto giant General Motors ($44 billion), which was founded in 1908.
In a recent article in The New York Times, Katie Benner sounded a warning from the Silicon Valley: “Startups that cannot adapt to a world that prizes profit over growth may ultimately be forced to raise money at the same or lower valuation than in the past, something referred to as a ‘down round’. Those can be debilitating: employee stock options usually become less valuable when a firm’s valuation falls, making it harder to retain people.
“If a firm has raised many rounds of capital, later investors often have protections that guarantee a specific cash payout or return on investment. In a down round, those protections are paid for out of the returns that would have gone to earlier investors and employees.”
And yet, there’s little doubt that technology will change the rules of business.
E-commerce, mobile wallets, payment banks, driverless cars – these disruptive technologies will transform the way we work, consume, travel and pay. It is this transformation that VCs and PEs are betting on.
The future of private/public transportation, for example, is Uber and Ola. With tech companies developing driverless, sensor-laden cars, the General Motors, Fords and Toyotas of the next decade could be Google, Apple and Tesla. All three are in advanced stages of testing sensor-driven autonomous vehicles or selling battery-powered electric cars. Tesla has already sold over 21,000 Model S electric cars this year to rave reviews. Apple has quietly begun testing a driverless prototype in San Francisco, dubbed by geeks as the iCar. Google too is testing advanced models of driverless cars with sensors to detect and avoid the smallest object on the road.
Meanwhile, startups are surviving on VC/PE/angel money, not earned profits. When that source eventually dries up, some will go belly-up. Only those with business models that generate real cash profits will survive and a few thrive.
But when six-year-old Uber is valued higher than 107-year-old General Motors, we know that a brave new world is already upon us.
This article is written by Radhika P. Nair from Your Story. The link to the original article is here.
E-commerce companies usually have a longer gestation period and this results in investors focusing more on the topline in the immediate term
says Aviral. However, this changes as the companies mature and growth stabilises. Profitability then becomes the critical metric to reach the valuation.
The Indian e-commerce industry maybe young but is growing rapidly. At the start of the current decade online retail was a billion-dollar-industry. A Goldman Sachs report released this year pegs the industry size at $7 billion at present, with an expectation of reaching $220 billion in FY 2030.
Companies are registering triple to four-digit growth in sales annually. “Flipkart’s GMV has increased about 50 times in the last three years. Hence, this becomes an important parameter in evaluating the company’s performance and the resulting next-round valuation,” says Aviral.
Flipkart’s valuation over the last three years has grown at a combined annual growth rate of 150%. In the same period, the eight-year-old company’s GMV has grown at 250%. Flipkart, according to reports, is targeting $8 billionin sales by end of 2015.
Snapdeal too has a similar trajectory in its valuation and GMV growth. Its valuation over the past four years has grown 145%, while GMV has grown 566%. The GMV growth of Snapdeal has been more dramatic, compared to its larger competitor, as it pivoted from a low-turnover group-buying model to the high sales e-commerce marketplace model in late-2011. At its current rate of sales, the company will reach $3.5 billion in GMV this fiscal. Since we do not have reliable information on the latest valuation of Snapdeal, we have not included the latest fund-raise details ($500 million raised in August) in the graphic below.
For online marketplaces, GMV is almost the only yardstick of performance right now, as these companies are not profitable. “Investors usually track the current level of Net GMV and the growth in Net GMVs to understand the sustainable commission income and the profit potential in future,” says Aviral. “This helps in determining an appropriate EV/GMV multiple…”
This is where the correlation between valuation and GMV becomes clear. When we look at the early years of fund raising, Flipkart’s and Snapdeal’s valuations might seem small. But when we compare their valuation with their GMV we see that it is now, at the higher absolute valuation, that the two numbers are trending close to each other. For instance, Flipkart’s implied valuation in 2011 was $164 million and GMV $11 million. So the valuation was almost 15 times GMV. Flipkart’s valuation in May was about $15 billion and GMV was $4.5 billion. That means the valuation is now only a little over three times the GMV. With GMV projected to grow to $8 billion this multiple is set to get lower.
Similarly, Snapdeal’s GMV multiple has come down from nearly 20 in 2012 to under two in FY2015.
In the early days, the expectation of growth was high, hence the higher GMV multiple. If we look at the GMV chart and look at the triple-digit-percentage growth the two registered, it is clear why investors feel the valuations were justified. As the two become mature companies and growth has begun to stabilise that multiple has come down.
Amazon vs Alibaba
At this point in our analysis it is fitting to look at the two international benchmarks when it comes to e-commerce—Amazon and Alibaba. The enterprise value-and-GMV multiple of these two giants have been trending in the 0.5x to 1x range since FY 2011, says Aviral of American Appraisals. This is the range that Flipkart’s and Snapdeal’s GMV multiple is trending towards.
But why is Alibaba’s enterprise value-GMV multiple lower than that of Amazon, especially when Alibaba’s GMV is much higher than that of its American competitor? Alibaba’s GMV was almost $400 billion in FY 2015, as compared to Amazon’s GMV of $165 billion for calendar year 2014 (US companies follow calendar year and not financial year). Amazon’s GMV has been estimated by dividing fulfilment cost by the fulfilment cost as a percentage of estimated GMV. Aviral says:
Alibaba’s EV/GMV multiple (~0.5x) has been trading at a discount to Amazon’s multiple (~1x) due to lower profitability. Alibaba’s EBITDA margins (on GMV) is about 1.5% whereas Amazon’s margins are much higher at about 2.5%. This results in higher EV (enterprise value) for Amazon vis-à-vis Alibaba, resulting in higher EV/GMV multiple too.
The upward trend in Amazon’s profitability is due to operating margins increasing from 3% in 2014 to about 5% in 2015. The North America region contributes more than 50% of its total global revenues. Another area where Amazon is seeing high growth and margin improvement is the Web services business. “Higher margins typically result in analysts pricing the stock at a premium sales multiple vis-à-vis industry,” says Aviral.
The analysis of enterprise value-to-Ebitda of the two majors shows that they are trending close to each other. This enterprise value-to-Ebitda comparison is important, says Aviral, “For listed companies, analysts typically track the trading profitability multiples of listed companies to understand a stock’s potential for any over- or under-performance vis-à-vis market.”
Coming back to Flipkart and Snapdeal, it will be interesting to see how much more risk capital funding Flipkart and Snapdeal will raise when the GMV multiple is not as attractive. The analysis shows that the growth these two are seeing is stabilising and, as we see with Amazon and Alibaba, finally it all comes down to profits. With both companies getting closer to the stage when a public listing becomes inevitable, profitability and margins will become imperative. So will the two Indian e-commerce biggies finally talk profits?
This is an article written by FirstPost on payment banks in India, a crucial game changing initiative. The original article is here.
The Butterfly Effect holds that a butterfly flapping its wings in some place can, in theory, cause a hurricane somewhere else weeks down the line. The term, coined by Edward Lorenz, came into vogue as weather forecasters saw that a small variation in initial atmospheric conditions can lead to completely unanticipated weather outcomes elsewhere.
Yesterday (19 August), Reserve Bank Governor Raghuram Rajan flapped his wings and set off what could turn out to be a revolutionary storm in the Indian banking system – a storm bigger than the one created when private banks were first given licences in the 1990s.
Eleven private parties were given licences to set up “payment banks” – banks which can do everything a regular bank can do – take deposits, pay bills, issue cheques and drafts, et al. The only thing they can’t do is lend to you and me. Payment banks can only lend to the government and almost anybody with Rs 100 crore in his pocket can, in future, set up a payment bank, assuming they pass the RBI’s “fit and proper” norm (which basically means if you are not a crook, or someone who has cocked a snook at the regulator, you can get a licence). This means payment banks will theoretically be the safest of banks since they have only the government as borrower – and governments don’t default. In future, payment bank licences may be available on tap, and we could see even 50-100 such banks being set up. India will be fully banked over the next decade.
That payment banking is a big deal is evident from who’s got the initial set of licences – the big boys and billionaires are there. Among them: the Aditya Birla Group, Reliance Industries (majority owner of Network 18, which publishesFirstpost), the big telcos (Airtel, Vodafone), the National Securities Depository (which holds almost all of India’s stocks in demat form, and provides the backbone for a tax information network), PayTM (India’s biggest mobile wallet company), Tech Mahindra (one of the Top Five IT companies in India), and Sun Pharma’s Dilip Shanghvi. Billionaires wouldn’t be filling in forms at the RBI’s window if they didn’t think payment banking was the in thing, though they might prefer to become regular banks, if that were possible. Since the RBI does not want corporates in banking, they are going for the next big thing that’s available – payment bank licences.
The reasons why payment banking will revolutionise money movement are many. Consider the areas they will touch, and how their mere presence will impact everyone.
First, and foremost, payment banks will bridge the last mile (or last 10-20 miles) between bank branches and the remote customer living in a rural hamlet. Payment banks will essentially rely on technology to reach payment services to all customers, using mobiles as the vehicle of banking. Mobiles go even where humans don’t. Physical bank branches (or bankers or ATMs) will still be needed for some functions – opening an account, depositing cash, etc – but all day-to-day payments, including peer-to-peer payments) can be done remotely. The mobile phone will become the virtual ATM and small-payments cheque-book. In less than 10 years, every Indian will have a bank account. Payment banks are the key enablers.
Second, banking costs will come down due to intense competition driven by the expected proliferation of payment banks. Currently, we pay through our noses for banking services, whether it is above-limit ATM transactions, additional cheque-books, big money transfers, maintenance of minimum balances, or draft issuance fees. These costs will come down as payment banks start offering zero-balance accounts and low-cost services. Currently, efficient private banks like HDFC Bank, ICICI Bank and Axis Bank make huge profits from their low-cost current and savings bank accounts, but a big chunk of this will move to payment banks, who may offer higher savings bank rates of 5-7 percent. The HDFCs mint money since they only have to compete with slothful public sector banks. Now, they will have nimbler rivals to worry about. The customer will finally be Queen.
Third, the public sector banks are sitting ducks for bankruptcy and taxpayer bailouts if they do not change. Between then, efficient payment and private sector banks will take away their lucrative businesses and prized customers, as they will be both well capitalised and efficient. The government should privatise the weaker banks quickly if it is not to be stuck with feeding white elephants permanently. It can’t cope with one Air India; if it does not privatise, it will have several Air Indias on its hands. The weaker public sector banks are dead ducks.
Fourth, the arrival of payment banks – including India Post – will transform social welfare and subsidy schemes. Even if the Modi government does no other reform but this one, government subsidy payments to the poor – whether for LPG, kerosene or even food and fertiliser – can now be routed through regular and payment banks. India Post is already there in places where banks aren’t there (with over 1.5 lakh post offices), and tomorrow Airtel and Vodafone and Idea (and Reliance Jio, when it enters mobile telephony later this year) will reach customers through mobile-enabled payment systems. The holy triad of Jan Dhan no-frills bank accounts, Aadhaar IDs and mobile banking will enable direct payments to the poor, eliminating fake recipients, ensuring cash in zero-balance accounts, etc. Inclusive banking and subsidy reforms are simply the biggest things to happen during the Modi government, even though the seeds for this were planted by earlier governments. The difference between State Bank and Airtel is simply this: both have over 200 million customers, but Airtel can go where State Bank cannot with a branch.
Fifth, mobile banking will create the conditions for cash-less banking. This means, over time, the mobile will perform the same role as credit and debit cards, obviating the need for too many cash payments. Even ATM expansion can now be slowed down in cities, and focused on distant villages or towns.
Sixth, we now have one additional tool to eliminate black money in large parts of the financial system. A government that wants to eliminate black money – which the Modi government says it wants to – can effectively ban cash transactions once a 95 percent mobile and Jan Dhan penetration rate is achieved. India is close to reaching a mobile user base of one billion, and Jan Dhan is said to have reached all households. The next target for Jan Dhan should be universal adult coverage through mobile, payment banking. It is achievable in five to 10 years, with some public and private investment in financial literacy education and empowerment of rural citizens, especially women.
Seventh, the government will be one of the biggest beneficiaries of payment banking, as payment banks will expand its access to cheap funds. Currently, banks are the major investors in government bonds. While this will remain so even with the entry of payment banks, the sheer impact of additional money coming into payment bank accounts which can only invest in short-term government bills of up to one year’s maturity means short-term rates will come down, and the government can borrow more cheaply.
Eighth, bank depositors can expect to earn higher short-terms deposit rates from payment banks, and the old 4 percent savings bank norm will probably fade away.
After payment banks, the RBI will license “small banks”, which have to focus loans on small borrowers and not big corporates. Once this happens, non-bank finance companies will become “small banks” and make financial inclusion more complete from the small borrower’s point of view.
Between them, payments banks and small banks will make Indian banking more competitive and more inclusive on both the assets and liabilities sides – that is, for both depositors and borrowers. The era of the consumer is finally at hand.