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The billion-dollar gift

Doubts over Flipkart's valuation will persist

Business Standard Editorial Comment  |  New Delhi 

Flipkart, India's largest e-commerce company, has gone back to its private-equity investors and raised yet more money from them - another $1 billion (about Rs 6,000 crore). The company has now been valued by its investors at between $5 billion and $7 billion - a hefty sum indeed, if still far behind the $100-billion-and-over club dominated by Amazon and Alibaba, which Flipkart's founders aspire to. There is little doubt that e-commerce in India can only grow; already 19 million Indians buy goods and services online and many more are getting used to the idea as internet penetration rises and the use of smartphones becomes more widespread. Flipkart certainly has high recall value in this segment. But is it worth $7 billion? In general, is India-focused information technology (IT) subject to some of the bubble-like conditions that IT, in particular, should be careful about?

The logic behind Flipkart's value is straightforward. In March this year, the company declared that it had sold about Rs 500 crore worth of goods in February, which led it to project annual revenue of Rs 6,000 crore or $1 billion. From these numbers, it is a short step to deploying a "revenue multiple" of between five and seven - high, but not unheard-of, given that MakeMyTrip, for example, benefits from a revenue multiple of between seven and eight; and by some estimates, the average revenue multiple that private-equity investors estimate for the tech companies they buy is three. In any case, a "reasonable" revenue multiple could lead one to estimate a real value for Flipkart pretty close to what its investors have sunk into it. There are, of course, several problems with this idea. The first is the use of revenue rather than earnings - the very substitution that has caused most IT bubbles. The logic is that tech companies are different - they have a higher "burn rate" when young, going through vast sums of money to build a network that they will monetise later, when the profits come rolling in. The logic is fine; it's the practice that's the problem. Few technology companies, and fewer e-commerce websites, manage to justify this logic a few years down the line. Remember, even Amazon barely breaks even one quarter in four, and has years of losses to make up for. It's hard to argue that the e-commerce market it is targeting in the West is not yet mature.

The oft-cited exception to this rule, about e-commerce companies struggling to make money even after they mature, is China's Alibaba. Alibaba is generally considered to be worth $100 billion, and makes tonnes of money, too. In June, Alibaba trebled its profits from the previous year; it makes over $1 billion a year. But even Alibaba may be overvalued - after all, it has 85 per cent of China's market already, and that market's growth is slowing. A price-earnings multiple of 100 is tough to pull off under such circumstances. The difference between Flipkart and Alibaba, however, is that Alibaba is hard to replace for its users - the positive network effect it has built up is considerable. Competitors to Flipkart, also offering cash-on-delivery and, thus, security, are a Google search away; its size is not protection. And it may sell Rs 6,000 crore a year - but it doesn't dominate the e-commerce market. It can hardly command similar multiples. Its relatively small early lead is no guarantee of future success; and, thus, no guarantee of profits. That point was just underlined by the $2-billion investment Amazon announced in its India subsidiary, the day after Flipkart's own announcement. In any case, as and when foreign investment rules are liberalised, the market's entire dynamics will change. Still, for Indian shoppers, this is all good news. High valuations should not upset them.

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First Published: Thu, July 31 2014. 21:40 IST