E-commerce treads shaky ground

Investors more cautious on evaluations, base decisions on performance, not future predictions

The Indian e-commerce fairytale is in for a reality check. The first jolt, which came when the daily deal site Taggle shut shop in November, has translated to a lull in investment.

According to data of research consultancy firm VCC Edge, in November private equity players invested $57 million in 12 deals. However, in December, this came down to $16 million and remained low at $24 million in January.

According to an Avendus report, in the first 10 months of 2011, $829 million were pumped in to the sector.

Things are going to get worse, said Mahesh Murthy, founder of Seedfund, a level-1 funding private equity player. “The crazy valuations, which had no justification in bottom lines, are a thing of the past,” he said. “In the next month, three players — one each in the deals space, slash sales and e-commerce — will shut down or sell out. LetsBuy merging with Flipkart was only the beginning.”

Industry insiders agree that several valuations were overhyped in 2011. Some of the valuations that made news, and have since been questioned include Flipkart, which is also the market leader. It was estimated to be worth $1 billion (Rs 4,900 crore).

Snapdeal, which is the leader in the deals segment, was valued at $100 million (Rs 490 crore), and Fashion and You, the current leader in the lifestyle space was valued at $200 million (Rs 980 crore).

“These valuations were made not on performance indices but on future potential that someone else would want to pay for the company,” said Murthy.

This has changed. According to Kanwal Singh, founding partner at Helion Ventures, while interest in e-commerce as a sector has persisted among investors, investments have slowed because people are looking at a different set of factors for evaluation.

“There is significantly increased caution on evaluations, and investors are basing decisions on performance as opposed to future predictions,” Singh said.

Helion Venture Partners, an early-to-mid-stage venture capital company has invested in companies such as LetsBuy.com (which has recently been acquired by Flipkart), Hoopos.com (baby and mother care products), YepMe.com (fashion brand), Exclusively.in (fashion retailer) and RedBus.in (bus ticketing).

According to some of the players in the segment, money is currently hard to come by. Manu Agarwal, founder and CEO of Naaptol.com said the questions being asked now are different when one is trying to raise money.

“All of a sudden, issues like growth in top lines, margins, unit economics and road to profitability have become relevant. Because of this, many who had started businesses with no business plan are now in trouble,” Agarwal said.

Murthy, who has been talking about the “greater fools theory” in explaining the valuations, is now quoting doomsday. “Eighty per cent of all players who raised money last year are now in trouble,” he said.

According to Prashanth Prakash, partner at Accel Partners, the current lull is symptomatic of an investment cyclic, since investors are in wait and watch mode.

“People do not want to invest in the same kinds of businesses. In any sector, there is a cycle. I think investors are more prudent now,” Prakash said. He admitted the trend would mean many would sell out or close shop. “You can expect consolidation later this year,” he said.

According to another private equity player, requesting anonymity, the problem is that small companies which had raised the first round will find it difficult to raise the second round, leading to a large scale shake-up in the next few months.

“Clear category leaders who have already emerged will now be the ones to survive, because no investor will put money in the third or fourth company,” said Harish Bahl, CEO, Smile Group, which owns Fashion and You, and Deals and You.

The other problem is that the cost of customer acquisition is on the rise. The business is in itself a discount-driven model. This has meant the road to profitability looks further away than anticipated.

Cost of consumer acquisition range from Rs 500 to Rs 2,000 depending on whether a company is in the horizontal or the vertical play. Incidentally, Snapdeal earlier claimed its cost of consumer acquisition was lower than the industry.

“Problems have been magnified because most players are investing marketing on costly mediums including the television, which drives up cost of acquiring customers. Since no one is making profits, it is imperative the industry is able to raise money,” said Gaurav Kachru, CEO Deals and You.