Flipkart, Rediff, MakeMyTrip — American market myopia has inflated Indian internet company valuations once more. Our bubble could burst in another six months, warns MAHESH MURTHY

I’M SUPPOSED to be the risk-taking investor, throwing caution to the wind, picking good teams with great ideas and zero revenues — then backing them against all odds in the hope of a high multiple. While the stock market and private equity (PE) guys are supposed to be the cool pros, weighing decisions based on established revenues, profits, multiples and such, making safer bets.

But this is identity crisis time — have I suddenly become a namby-pamby? Is the world speeding by and have I missed the shinkansen?

I hear that Flipkart, a loss making company with FY11 topline revenues in the sub- 100 crore range, is raising a round at a $1 billion (that’s 4,500 crore) valuation. And then I hear that its main rival, the similarly-sized Infibeam is doing exactly the same.

I’ve seen this movie before. In 2000. And 2007. A price-to-sales ratio of 50 times? A PE ratio of infinity? What could the logic be to value firms at these numbers?

Have we not learnt our lessons from our earlier wounds? Are there any comparables here? MakeMyTrip (MMT) just announced gross revenues for the year of 550 crore, net revenues — if you take out the cost of hotel rooms they count as sales — of 270 crore and a profit of 23 crore. That’s about 8 percent on net.

A travel agency with 270 crore in revenues and 23 crore in profit is not likely to raise a bead of sweat on Dalal Street. But it’s raising thunderstorms on Wall Street. The stock goes up to a 4,000 crore market cap. That’s enough to buy two Kingfisher Airlines and have enough left over to buy a few Mallya-type yachts. Two hundred times profits? Fifteen times sales? What’s up with the Yanks? Do they know something I don’t?

Past experience says it must be the US myopia on India (“Let’s just buy the Indian expedia!” says a man in a suit in a glass-walled Manhattan office. “Sure, boss,” the underling goes. “And the Indian Google”. “Brilliant, boss”. Little do they know the Indian Google is… Google and the Indian Yahoo is… Yahoo. But I digress.)

US market myopia is perhaps the single cause of survival for our other bellwether Internet firm, Rediff.com. This 15-year-old company announces its third straight year of losses and would be slaughtered if it was listed in India. Once India’s no. 1 site, it’s now barely in the top 10. Four years ago, when the Indian ad market was around 650 crore, Rediff did one-fifth of it with 130 crore. Today, in a digital ad market of almost 2,000 crore, Rediff does less than 100 crore. Some idiot stock analyst in New York calls it “the Google of the Ganges” and clueless punters take the stock price up to a market cap of 1,300 crore.

I never knew calls with analysts would be so easy. Three years ago, Rediff told them: “Wait for broadband, then see.” We did, and nothing happened. Now they say “Wait for 3G and see”. In all this time, Yahoo has grown past it — and Google is now almost 10 times as big as either. My prediction? After 3G is passe and the others have grown even bigger, they’ll say, “Wait for 4G and see”. And some fool on Long Island will take the stock even higher.

Market cap to me reflects two things — either the value of the earnings or cash flow discounted into the future — or a proxy for the cost of replacing the company if one were to rebuild it from scratch. With no earnings, no growth and just losses to speak for, discounted cash flow (DCF) is not the issue with Rediff. And would it really take 1,300 crore to build out a portal like this with 100 crore in flat-lined revenues? Not a chance. Most of us venture capitalists (VCs) wouldn’t offer even 1/25th as much if someone approached us with such a plan. So why is the “safe” public market offering much more than what us “risk-taking” VCs are? Maybe it’s tulip time again.

Applying this same logic to MMT and Flipkart brings the same conclusion. Does either have such a lock on the market that it’ll take 4,000 crore or more to dislodge them? Nah. They are barely ekeing out a living — neither shows much customer loyalty, both compete every day on price. Each has stiff competition. So what’s with the valuation insanity?

Is it some big Internet boom? Well, I think the boom’s already happened. We’re at a 100 million plus users now. And will be at 150 million in a year or two. And most of that growth will come through mobile devices, not landline-driven computers. So do I see an incredible jump in air ticket sales only through MMT only through phones and tablets to justify a 15x multiple? No Sir, I don’t.

Public markets have their own hysteria and I’ve learnt over time to stay away from the madness. But private markets?

If a private equity firm is valuing Flipkart at $1 billion now, this must mean they see it worth $3 billion sometime soon — either to an acquirer or to the public markets when they flip it. Who would pay 13,500 crore for a loss-making e-commerce portal? Amazon.com? Unlikely — from what I hear, they are already well underway setting up in India.

(But I will take this aside and talk of nonsense accounting practices at some of these e-commerce firms. Here’s how it works: a book has an internal cost price of 100. Offer it at 120. But at the same time, offer a coupon or such for 30, so you finally realise only 90. But show the selling price as 120, count the 20 as net positive income and show the 30 coupon as “long-term amortisable marketing expenses”. One day, some big four accounting firm partner will go to jail and then this loophole will be plugged.)

Coming back to why private equity chaps are going bananas. Perhaps they think they can pull off an MMT or Rediff by listing it overseas. Where Joe Schmoe will be told “it’s the Amazon of India” and hence in a frenzy mortgage his home and plunk out big greenbacks for it, in the hope that a greater fool will take it off him at a higher price.

Yes, there’s money to be made in this madness — but not by me. I’m not a speculator.

It is ironic that we say the Indian stock market is full of speculators and overseas markets are far more rational than us. I see exactly the reverse happening.

The men in Manhattan are chasing unicorns, while Mr Patel in Surat is asking in puzzlement where the rokda is.

Stay calm, Mr Patel. This world will fall apart soon enough. My guess? Another six to 12 months till valuations come crashing down again. And till investing bargains come by your way and mine.

So till then, don’t buy these stocks or stories. Instead, buy a book or a high-fashion bauble at a ridiculous discount from any of these firms.

That’s where the real bargain is — and that isn’t going to last much longer.

Murthy is the co-founder of Seedfund, a venture capital firm and founder of Pinstorm, a digital brand management firm. Follow @maheshmurthy on Twitter

Irina: You invest not only in technology companies but in companies in other sectors, right?

Pravin: Yes. India has many opportunities and challenges; technology adoption is not the best here. There are enough opportunities in different business models on how to do things better and more efficiently. We have done a bunch of hospitals in class B and class C cities. 

It is not that there are no hospitals in this country. There are many hospitals here, but there are no hospitals that are run efficiently and provide value for money to the people who need and pay for these health services.

Irina: What type of investment you usually do?

Pravin: They are all common shares. There is not a big concept of preferred shares here, but in the shareholder’s agreement, like any typical investor we will have some veto rights, some need for approval on capex, and some liquidation preferences. They are pretty standard rights.

Irina: What are your challenges as an angel investor?

Pravin: One challenge from the supply point of view is the quality of entrepreneurs. I have the money to invest, but the entrepreneurs are not mature enough. That is a challenge and sometimes we spend a lot of time nurturing them.

Second is the country itself. There are challenges of technology adoption and [understanding of] how business is done, so the market can be inefficient. To that extent, growth is not always as spectacular or “hockey stick shaped” as you would like it to be.

The ecosystem for early stage investment here is so poor, there isn’t enough money available in any case, and there are not enough mentors. It is not yet clear to me whether there are not enough entrepreneurs because there is not enough money or if there is not enough money because there are not enough entrepreneurs.

We haven’t seen much success for a country of a billion people. Israel can probably show much larger success ratio than India can. The ecosystem is still weak and that needs strengthening. Government interventions and some incentives are needed, but I think that there are bigger issues to solve.

The problem with incubators is real estate. For example, at any point we can incubate only three companies. One challenge in India is that lot of entrepreneurial work is not about developing an IP sitting at home or two guys in a garage. Many of these are execution plays, which means that at the very start you may have 10 to 12 people, which make it very difficult to execute out of homes.

People in India, for example, don’t buy off the Internet as easily as they might in the U.S. Which means you must have a sales team or at least a salesperson who physically has to go and do stuff, and then [you need] someplace for a team to develop software. Very quickly it become three to four people.

In a typical U,S. entrepreneurial model, the teams are small, basically it is around IP development. This works very easily. Here, it may not be a common occurrence.

Irina: Could Flipkart be is a good role model for Indian entrepreneurs?  They started from home, right?

Pravin: Do you know how many people Flipkart has today? Two hundred. It did start from home to the point that they built a website, but the minute you talk about warehousing, logistics, staff grows quickly.

CarWale also start from home in that sense. Generally,  if you want to be in the market quickly, that is perhaps in two to three months, it is no longer a home-based business.

 Irina: Thanks, Pravin. This has been a really interesting discussion. Thanks for your time.

Seedfund’s unique experiment is spurring early stage investing in India

CLUB SEED: (From top left) Shreyas Srinivas of Level 10 with Seedfund’s Pravin Gandhi, Mahesh Murthy and Anand Lunia (BW Pics By Satheesh Nair)

Most people redefine themselves in one way or the other when they make a comeback. This holds true for the Indian venture capital industry, where former adventurers got tamer after the 2000-01 Internet boom-and-bust. Pravin Gandhi and Mahesh Murthy, however, have remained exactly the same. And, yet staged one of the industry’s most successful comebacks with Seedfund.

Tuesday afternoons are usually a good time to visit the Seedfund office, tucked away in a by lane off the Mahalaxmi racecourse in mid-town Mumbai. Gandhi, Murthy and team members Anand Lunia and Paula Mariwala can be found poring over monthly reviews of portfolio companies or talking deals. Sometimes Bharati Jacob, the firm’s Bangalore-based managing partner, joins. Tuesday is also when the team catches up with each other’s lives. They mostly work from home or are in the field the rest of the week. It is a throwback to the informal way many VC firms worked when ‘dotcom’ was not a bad word. “It was a good experience for this country as it chastened a lot of people. The true entrepreneur — driven by passion and willing to make sacrifices — began to emerge after that,” says Gandhi, referring to the excesses that marked the era.

Yet, it did not change the way Gandhi and Murthy saw VC investing. In 2006, when they raised Seedfund’s $15-million maiden fund, they had no doubt that they would back only pre-revenue startups. “There was enough money above us. So we picked the seed stage as our sweet spot,” he says. This is where firms need that critical $50,000 (up to $1 million) to build a prototype and test their idea in the market. The strategy was validated last November when German media company Axel Springer bought majority control in automobiles classifieds portal CarWale. Seedfund had picked up 25 per cent in the firm for $690,000 in 2006 and made a profit of $25 million on exit. When the firm invested in CarWale, it had not even raised its first fund. “They wrote us a personal cheque of Rs 30-odd lakhs,” recalls Mohit Dubey, founder and CEO of CarWale.

Teething Time: MyDentist, founded by Vikram Vora, is incubated by Seedfund. It offers affordable dental care

Firms such as CarWale fitted nicely in Gandhi’s own sweet spot. Gandhi has never enjoyed investing in mature firms with proven business models. An active angel investor since 1996 and an early-stage investor with Delhi’s Infinity Ventures, he continued to back ground-up startups well after the crash. In Murthy, who earlier ran early stage fund Passion Fund, he found a kindred soul. While Murthy used the void left by the dotcom crash to start digital advertising firm Pinstorm, he continued to engage with startups as a mentor. “At one point, we were practically running every business plan contest in India,” he jokes.

The exposure to startups of different hues had a big role in firming up the belief that there was a clear need for a specialist seed-stage fund. This unique approach, which mirrors the classical VC style of investing in the US Silicon Valley, has led to 16 deals so far. The first 12 have come from Fund I, which is now fully invested and already in exit mode. Another four have come from Fund II, which the firm raised with a $55-million corpus this February. “We will announce three more deals,” says Lunia, executive director at Seedfund. While a larger fund will allow the firm to put more money to work, the investment thesis will remain the same. “We try to invest in ideas we think will become sector leaders, often creating new sectors,” says Lunia.

So far, this thesis has been borne out by most of the firm’s investments. Vaatsalya, founded by doctors Ashwin Naik and Veerendra Hiremath, is now the acknowledged pioneer of affordable hospitals for smaller towns. It has just raised a $10 million round of funding from Singapore’s Aquarius Capital and is surging towards 20 hospitals by end 2011. Online bus ticketing portal redBus has notched up Rs 120 crore revenues and 3.6 million users. Education solutions startup ThinkLABS Technosolutions now has a presence in 25 schools and 10 colleges. It expects to reach Rs 10 crore revenues by March. “When we met Seedfund in 2007, we did not even know what VC was. It played a big role in helping us become a full-fledged business,” says Gagan Goyal, founder and CEO of ThinkLABS.

Seedfund has had a few other exits, too. It sold its 54.5 per cent stake in online financial services startup Rupeetalk to Delhi-based NetAmbit. It had invested $940,000 in the company in November 2007. It has also partially exited personal health records portal Healthizen and sold off its stakes in SaaS startup Uhuroo and social networking startup Lifeblob (bought by Printo). Not all the exits have been successful, though the investment in each has been under $1 million. “We realised early that some would not make it, and it made sense to cut losses,” says Lunia.

The experience with some of the early exits also drove home the point that a larger fund may have enabled the firm to stay invested in some firms longer. Fund II gives it the ability to do that now. It will invest in companies in e-commerce, mobile value-added services, media, healthcare, education and SME-focused IT products. The ticket size will be $2-3 million to begin with.

All For Cubs
Even as it embarks on investments from the new fund, the founders are on to their second experimental initiative: Seedfarm. This is an incubator for young entrepreneurs who have an idea, but not resources, both in terms of money and office to build the business prototype. The ‘farm’ has already signed up two. Shreyas Srinivas, who founded comic book startup Level 10, is relocating himself and his team from Bangalore to take up residence at the incubator.

The second incubatee is Mumbai’s MyDentist, founded by Vikram Vora, which will operate as a remote incubatee. MyDentist offers affordable dental care at self-branded clinics and already has four such clinics up and running. The uniqueness of the business, apart from being affordable, is that it makes the process of going to a dentist transparent. “When a patient comes in, we first analyse his problem and then offer him a standardised price list. Show me one dentist who would do that!” says Vora.

Seedfund will invest up to Rs 1 crore (about $222,000) per incubatee, which it thinks should be adequate for the first 12 months. If the firm stabilises within the year, it will bring a $2 million round as follow-on funding. Incubatees will also have access to Seedfund’s network of mentors — industry experts and successful entrepreneurs — who will work alongside the startup.

In setting up an incubator, the Seedfund team is addressing the same funding gap they sought to plug in 2006. While they have been partially successful with their first fund, it is clearly not enough. Fortunately, and in further validation of their investment thesis, the need to invest in younger entrepreneurs and businesses is finding some resonance in the VC industry.

New Delhi-based SAIF Partners, which manages over $3.5 billion in funds, is now incubating an apparel e-commerce startup in Bangalore. “We now see a better climate for early stage deals and will ramp up activities in that area,” says Mukul Singhal, vice-president at SAIF. The incubation project, ongoing since January, was born out of an idea that the SAIF team liked. “This kind of a project requires a lot of bandwidth and we may do one more in the next three years,” says Singhal. The firm intends to invest a minimum of $2-3 million in such firms over a period of time.

In Mumbai, Nexus Venture Partners recently unveiled Nexus Seed, which aims to invest in technology, retail and ecommerce startups. The ticket size of funds will range between $50,000 and $500,000. “A lot of high quality entrepreneurs are building capital-efficient businesses using tools such as cloud computing, crowdsourcing and viral marketing. There are not enough sources of capital for them,” says Sandeep Singhal, managing director of Nexus.

To be fair, most VC firms active in India today do not abhor funding pre-revenue startups. For instance, Bangalore-based IDG Ventures India was among the first to incubate one, Aujas Networks, under its entrepreneur-in-residence (EIR) programme. It spun Aujas as a separate firm in 2008. Helion Venture Partners had backed young firms such as Ngpay and R&R Salons. In Delhi, Canaan Partners runs an EIR programme and brought on board former Yahoo India R&D head Sharad Sharma in 2009. Mumbai’s Norwest Venture Partners teamed up with Reliance Venture and TV18 to inclubate travel portal Yatra.

That said, most VC funds that started investing in 2004-05, prefer stable firms. Seedfund shows Silicon Valley style investing can work in India and with reasonably good results. It is time for others to get on to the bandwagon.

-Snigdha Sengupta

(This story was published in Businessworld Issue Dated 04-07-2011)