Buying into the online hype

The e-commerce industry might be at a nascent stage in India but the sector has strong potential. If chosen carefully, such companies can reward investors.
Tanvi Varma/Money Today        Print Edition: December 2014
Buying into the online hype
Photo: Reuters

A quick question for you. Which was the first online company to be listed in India? Before you Google, here's the answer-Info Edge, an internet classifieds company, which got listed in November 2006. Those who bought into the initial public offering (IPO) would remember that it was offered at Rs 320 per share, which translated into a 12-month price to earnings (P/E) multiple of 52.6 times earnings. Despite the high valuation, the issue was subscribed 54.79 times and listed at Rs 480 while closing at Rs 593, a gain of about 85% over the issue price.

Info Edge owns one of the leading job portals naukri.com as well as websites related to matrimonial (jeevansaathi.com), real estate (99acres.com) and education classifieds (shiksha.com). The company's income has grown from Rs 84 crore in 2006 to Rs 549 crore in 2014.

Following in the footsteps of Info Edge was Justdial, which offered its IPO to Indian retail investors at Rs 477 per share and listed on the bourses in June 2013 at Rs 590 per share, a premium of 22% over its issue price. Although the company was valued at 60 times 2011-12 earnings, investors rushed to buy the stock.

According to Rahul Shah, vice president, Motilal Oswal Securities, Justdial is a strong brand with first-mover advantage complemented by a strong database. "The company is in a high growth phase and is aided by an asset-light business model, virtual monopoly in the voice search segment, negative working capital cycle, strong free cash flow, good dividend payout and healthy return ratios. Hence, its premium valuation is justified," he adds.

Soaring high
Both Justdial & Info Edge have done well after listing
Both examples prove that online companies offer a unique value proposition. Initially, it may be difficult to understand how a company that does not have a tangible business model can command such premium valuations. However, these two companies have rewarded investors handsomely.

BUSINESS MODEL AND VALUATION

The valuations of internet-based (online) companies are essentially based on whether they can survive on advertisement revenue, which contributes a major chunk to their bottom lines. According to Shah, ideally internet-based companies should not be valued differently from brick-and-mortar companies-by predicting future cash flows through an understanding of the business and market dynamics. However, online companies are still relatively new and there is often little robust data for valuations.

Sandip Agarwal
Sandip Agarwal VP, Wholesale Capital Markets, Edelweiss Financial Services
"There could be a difference in valuations of online companies on the basis of the product or services being offered," says Sandip Agarwal, VP, wholesale capital markets, Edelweiss Financial Services. For instance, job and real estate portals will be valued on the number of paid listings, while a travel portal will be valued on the basis of transactions handled (both volume and value). To understand valuations of these companies, one can look at the two companies which are listed on Indian bourses. Info Edge, for instance, is valued at 43 times its 2015-16 earnings estimate by ICICI Direct while a recent report by Motilal Oswal Securities put a 'buy' call on Justdial with a target price of Rs 1,750, valuing the stock at 60 times the 2015-16 earnings estimate.

THE NEXT BIG THING

Unless you have been living under a rock, you would have seen that newspapers have been abuzz about Flipkart and its massive sale offers. The company also hit the headlines in July 2014 when it received a funding of $1 billion, which according to industry sources values it at about $5 billion (Rs 30,000 crore). This made Flipkart nearly 10 times more valuable than the biggest retailer in India, Future Retail, which had a market cap of Rs 2,665 crore as on October 27, 2014.

But are such astounding valuations justified? According to Shah, the logic behind Flipkart's value is straightforward. In March this year, the company declared sales of about Rs 500 crore for February, which led it to project annual revenue of Rs 6,000 crore or $1 billion, valuing the company at five times its revenue. When it comes to online companies, revenue may not be the defining number for valuation. Skype was acquired by eBay in 2005 for $2.6 billion even though the company generated only $7 million in revenue that year from its 53 million subscribers in 225 countries-a multiple of 371 times annual turnover. The valuation was clearly in anticipation of future annual growth.

The other factor that astonishes many is the fact that Flipkart is still a loss-making company. Although comparing it with Amazon, which has a market cap of $150 billion seems far off, Agarwal adds that Amazon too made losses at the operating level for seven years. Flipkart, with a similar model, is also making losses, and hence, should not be viewed only from the angle of profitability in the initial years.

IS THIS A BUBBLE LIKE 2000?

It is only fair for investors to question if the current hype will lead to results like the bubble for internet companies in 2000. According to Agarwal, the current situation is different from that witnessed in 2000. At that time, the ecosystem was not developed for an internet revolution. Personal computers were expensive, laptops were nearly out of reach for most people and the smartphone was still a pipe dream. Add to that, internet was expensive in those days. But now, with the huge size of our young population, proliferation of social media sites and instant messaging services, falling prices of smart and feature phones, the enablers are in place to drive internet penetration, unlike in 2000. "One key lesson to be learnt is that only the top two-three companies in any segment grow big and, hence, the competition for top will be fought aggressively in India," adds Agarwal.

WHAT NEXT?

In September, China's Alibaba Group Holdings, an internet-based e-commerce company, raised $25 billion in the biggest IPO for a technology company. With an IPO price of $68 a share, Alibaba was valued at 29 times expected earnings for the year till March. Going forward, you will see lot of internet-based companies raise money through IPO. Hence, before investing, take time to understand how strong the business model is-how it makes money, what is the customer value proposition it offers and how does it differentiate itself from its peers.

Today, India offers great opportunities primarily because the industry in India is still taking baby steps. But the sector has grown at 35% a year between 2009 and 2013. Japanese brokerage house Nomura says India's e-commerce industry has the potential to quadruple from $10 billion in 2013 to $43 billion over the next five years, largely driven by online retail, which is estimated to grow from $2 billion in 2013 to $23 billion by 2018.

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