Category Archives: private equity

FLIPKART NEEDS SOME PATIENT, PERMANENT CAPITAL

The markdowns are flowing thick and fast for Flipkart. There’s a lot of noise out there painting a picture of doom and gloom. But should valuations cause so much consternation? Isn’t there a larger story waiting to be told? In the last few days I trawled through old reports, news stories and information available in the public domain to make sense of the proceedings. I also had the good fortune of catching up with Haresh Chawla, Partner at India Value Fund Advisors, and a keen observer of and commentator on the Indian e-commerce sector.

The nuance that most media reports seem to have missed out is that it is not a simple question of whether Flipkart will get future funding or not. We need to dig deeper, because Flipkart will get funded – there aren’t too many Indian e-commerce players at that scale. The real issues are: (1) the kind of investor that Flipkart needs and (2) how soon that can happen.

But first things first: what is a markdown?

There can be both a markup and a markdown. It is only a way of denoting the fair value of an asset or liability on your balance sheet. In other words, because market conditions change all the time, your books should present the truest picture possible. But it’s subjective and is further complicated by incomplete information or over-optimistic/over-pessimistic expectations.

Should we be bothered?

If you are wondering why, simply look at the markdown exercises and the implied valuation after that.

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Do you note that essentially none of them are in real agreement as to what the valuation of Flipkart should be? There is a huge deviation.

Now here is where a lot of people are running around either screaming doomsday or smirking on Twitter. In fact, some unnamed experts have been quoted as saying that if the valuation isn’t marked up soon, then Flipkart may have to accept a significantly lower valuation than its “preferred” $15 billion.

Let’s set the record straight. The figure $15 billion is obviously bigger than $5.5 billion, but to say that that is the “preferred” valuation would be wrong. It was what the market and investors expected based on the $10 billion of GMV projected by the company itself in June 2015. Mukesh Bansal, Head of Commerce, Flipkart, had told The Economic Times, “Flipkart will sell goods worth $10 billion during fiscal 2016, and nobody will be even half of that… There is not a shred of doubt based on all the market numbers we have today.” (You can read it here: https://goo.gl/FQKGy4 and here: https://goo.gl/a9UArZ)

According to Haresh, “It was expected and I have been saying it for some time. Flipkart announced that they would deliver a GMV of $10 billion and, clearly, on that expectation investors gave it a 1.5x multiple and valued it at $15 billion. But the company fell drastically short of its GMV target. The actual figure was only about $4 billion.”

In fact, it wasn’t only Flipkart that went wrong with its projection. Even the fund houses overestimated Flipkart’s GMV clout. To jog your memory – This Morgan Stanley report from early 2016 (Read that here: https://goo.gl/WWXLaa) said that in 2015 Flipkart, Snapdeal and Amazon together accounted for $13.8 billion in GMV or 83 percent of the market. That implied a market size of $16.6 billion. The report further said that Flipkart’s market share was 45 percent. That implied Flipkart’s GMV to be $7.5 billion – a gross overestimation, versus the $4 billion that Flipkart actually is said to have delivered.

Haresh pointed out one of his earlier peeves on the same issue, which he wrote about on Medium (Read it here: https://goo.gl/b1k7JW). At that time, he had noted, “Imagine when you extrapolate this error to the future. This has ended up muddying the waters, and misreporting the market share numbers.”

So, what happens next?

Let’s face it, valuations are a mix of many things – market environment, risk appetite, a fund manager’s own biases, the hot new trend, the fear of missing out, the multiples comparable companies are commanding, and of course, expected cash flows and margins. Of these, the last two are the most important and the most difficult to wrap your head around in an environment where you have to constantly burn money to stay in the game. So if an investor needs to justify why he/she is jumping onto the bandwagon he/she will constantly look at data that confirms his/her biases. Therefore, valuation is only a large headline figure; it’s not what decides your success.

Haresh concurred, “Currently, the world over, most of these companies are valued at 0.8-1.2x of GMV. Even with the markdown, Flipkart is still valued at the higher end of this range. But these valuation figures don’t reveal much. What matters is sustaining the business. The battle with Amazon will be fierce, but valuation has no relevance to Flipkart being among the top two in India.”

That’s the trick. Sustaining the business – according to data available in the public domain, while FY15-16 revenue grew 143 percent to about Rs 1,950 crore, expenses grew at an equally rapid clip of 128 percent from a much higher base. Expenses for FY15-16 were a little more than Rs 4,250 crore and losses more than doubled, to a shade over Rs 2,300 crore.

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An analyst at a VC fund that I spoke to, on condition of anonymity, pointed out that for every incremental Rs 100 of revenue, Flipkart spends Rs 200. He was also quick to point out that the losses seen in the public domain don’t add up to the “ostensibly” $2.5 billion (Rs 15,000 crore) that Flipkart is said to have lost or sunk into its business so far. Therefore, it would be safe to say that we don’t know what lies waiting in Flipkart’s balance sheet, which most people wouldn’t have seen.

But, enough said, ladies and gentlemen! This business is burning Rs 6.3 crore a day.

The management has been trying its best to cut its burn, focus on the right categories and rationalise headcount – though there have been many versions of exactly how many were let go during July 2016. (Read it here: https://goo.gl/XMXgJZ)

Haresh has a slightly different take. He feels Flipkart is doing a good job of it, given the tightrope it needs to walk. “Any drastic decisions to cut burn could result in a spiral down in marketshare making it even more vulnerable… The only option is to become lean and hold your fort at the same time – that would be the investors’ mandate and they seem to be doing a good job of it,” he said.

But, hey, existing investors have nothing to be worried about

It is unlikely that investors will lose money. The sum total of money that has been invested in Flipkart till date is about $3.4 billion. To that extent, as long as the valuation doesn’t drop below that level there is no reason to be concerned, because early investors would be protected by special rights like liquidity preference.

Haresh noted, “As far as the VCs go, they are unlikely to ‘lose’ money. Liquidation preferences protect them from any value destruction that may arise. But the wait for exits will be long. However, this protection may not be available to investors who may have entered secondary deals with founders or very early-stage investors at the higher valuations.”

Tying back to that magic $15-billion figure

So, here goes: The ‘$15 billion’ figure that people are talking about is not written in stone. It means that investors are taking a call that if Flipkart does exactly as well as they expect it to the maximum valuation they would give is $15 billion. It also means that they expect the future to be brighter than that $15-billion figure (because if someone were to invest at $15 billion valuation, they would expect much more than that in return, right?).

But, in the same breath, if the call on future valuation is not as bullish, there is nothing to stop a potential investor from adjusting it downward.

For example, if Flipkart’s GMV is $4 billion and one were to attribute a generous 1.5x multiple, then the valuation would be $6 billion. Sure, it would find buyers at that valuation, but it is unlikely that any of the previous investors would take any hit depending on the rights agreed upon during earlier funding rounds.

Therefore, it really is a question of what Flipkart needs right now

1) A control on costs – this is a given, so let’s park this for now.

2) The right kind of investor – strategic and very long term – someone whose investment horizon is a multiple of the 5-7-year typical VC horizon. That’s because Flipkart needs to take on the strategic money that Amazon has. Consider this: Amazon generated free cash flow (Amazon Annual Report: https://goo.gl/sYUIoz) of $7.3 billion for the year ended 2015 (that in itself is a multiple of Flipkart’s GMV). It can just dig in its heels in India, a market it can’t afford to lose.

Haresh said, “While they have taken steps to cut the burn, the biggest issue for Flipkart is who will buy? The company needs permanent capital on its balance sheet to take on Amazon, which has deep pockets and possibly infinite patience to win in India. When will this happen, on what terms and who it will be remains to be seen, because any investor with permanent capital, the likes of Walmart, Alibaba or JD.com, will not be interested in a minority shareholding – they will seek a path to control.”

But will Flipkart’s existing investors be willing to leave a clear path to control? They just might, because there’s definitely more to gain that way.

In a way Tiger bringing back Kalyan Krishnamurthy in a key role at Flipkart is evidence that the investors had a crisis of confidence in the team and hence are seeking to put the house in order. This allows them an opportunity to seek strategic sale with transfer of control. Remember, no VC, Tiger included, will be in it forever – they all have to provide their investors with an exit. (Also read: Saving Private Flipkart https://goo.gl/AIzsm6)

In the end, this series of markdowns has and will continue to cause a few flutters in the market, and may also affect the fundraising plans of smaller players. But the big boys may get by because there are enough strategic global investors interested in doing deals; and if they can get in after a series of markdowns, why not?

There’s huge merit in the space Flipkart occupies. We have barely scratched the surface of e-commerce in India. Flipkart is definitely India’s biggest calling card in the sector; it has inspired thousands of entrepreneurs and brought to the forefront a new way of doing business. But, Flipkart, on its part, will have to find ways to make its way deep inside customers’ wallets by constantly cross-selling and up-selling, while at the same time tightening its own belt.

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Investing in Media? Junk Traditional Models

The business of media, especially news media, is a curious one. You wield a lot of power, but often the economics of running the business is tricky. It is a business that delivers above-normal returns to the top 2-3 players, and practically nothing to the rest.

The reason is that success is dependent on the quality/quantity of content and the TG reached – each feeding off the other to form a positive feedback loop – something that lesser players will not be able to replicate. But, on both ends, you need to pump in a lot of money and keep at it.

Unlike a content aggregation and curation business, which may be more of a play on content marketing and tech, core content creation is extremely human-skill-intensive.  Therefore, typical success parameters like revenue, efficiency ratios, margins, active users, returns, exit opportunities, etc. will all come to naught if one doesn’t add Editorial Talent & Patience to the mixture – These two require investment and conviction.

A content-heavy media business is not amenable to the regular cookie cutter method of investing/business modelling. There are three essential components – content creation (input), content discovery & engagement (output).

Creation

Let’s face it quality news/informative content is inherently not exponentially scalable, regardless of the technology that you might deploy. This is because one requires human skills that can identify trends, smell out stories, contextualize them and produce compelling content (text, videos, pictures, infographics, etc.). This means you need to seriously invest in good talent and then give them time. Every time you wish to ramp up quantity of content, you need invest in more talent, and so on and so forth.

Yes, there’s user generated content & citizen journalism, but if you are a serious player you would mandate serious fact-checking and editing. That implies equally dedicated editorial process/teams. Curation is an option but there’s no long term benefit, as you would want to own the content and the associated value chain.

Discovery/Distribution

The next leg, discovery of content, is perhaps where one could apply a traditional business prism of marketing and audience building. Discovery is dominated by platforms like Facebook, WhatsApp, YouTube, Twitter, Snapchat, etc. and stories are being discovered by contextual shares.

Therefore, you need to be (1) creative; (2) iterative; (3) able to crunch data; (4) repurpose content; and (5) most importantly, prepared to spend money. Given constant algorithmic tweaks by discovery platforms like Facebook, pumping up organic reach is not easy and paid reach is getting expensive. Hence, one needs adequate funding and a healthy disregard for instant gratification.

Moreover, you need to focus on where the trend is, where your TG hangs out, how the content fits in that spectrum, and what is it that will drive discovery into engagement. Once again, it boils down to investing in talent that can straddle content creation and community building, and empowering that talent to do so every day.

Engagement

Home pages are no longer the entry point, which means that you need to figure out more meaningful UI/UX across your entire product. It also means being able to create an affinity with your content in the time it takes to scroll from one time to the other on the feed of any of the discovery platforms.

Need I mention it again that it boils down to the right talent? Content businesses need leaders & teams that can integrate tech and content in a way that they are able to tell a story and distribute it across several channels for maximum impact. And the talent that can do that is scarce.

Ultimately, it all boils down to a founder’s/investor’s commitment to the cause and her stamina to run the course every day of her life. The shelf life of news/informative content is low and one cannot afford to take their eyes off the meter even for a day.

The question is how does one sustain such a business? Constant fund raising is not the solution. It calls for looking for revenue sources outside of regular advertising & branded content. Can we put the bad genie of free content back in the bottle? Can our wish for patient capital be fulfilled?

Not Too Stale, Is It?

About nine months ago, July 2014, within the span of a week, both Amazon India and Flipkart got in billion-dollar-plus commitments.

Strategically, they would both have the same agenda… In the interest of scale and repeat clientele, both would have to spread their wings beyond discretionary purchases and into the most habit-forming & repeat purchase zone of shoppers a.k.a. groceries (see my write-up on how online-groceries are changing consumer behavior HERE )

Both Amazon and Flipkart would also have to follow suit, and it seemed that Flipkart would perhaps be the more aggressive one given its need to ringfence itself against a much bigger giant.

Hence, looking at that situation and trying to extrapolate how it would pan out, I had made a key suggestion on July 30th, 2014, to sell / partially sell one of our portfolio companies to Flipkart. The portfolio company was at the time vying for leadership in Mumbai’s online groceries space (now it has expanded much more).

It could have been a strategic opportunity, where the acquirer would have been an established e-commerce player buying into an online grocery start-up that had refined its act. It would have given Flipkart immediate entry into the grocery market.

But then, one can never time these things to perfection. It’s a trade-off between waiting & nurturing an investment in hope of higher value or taking an exit route when it comes. Maybe it’s still not too late. Consolidation is key in an industry where large scale sourcing, large scale operations & large scope of customer choice are big competitive advantages. Who knows?