Some Thoughts on Crazy-Stupid Valuations - The 5 Minute WrapUp by Equitymaster
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Some Thoughts on Crazy-Stupid Valuations

Nov 5, 2016

In this issue:
» CV sales in October bring hopes of revival
» A quick round up of global markets
» ....and more!
Sarvajeet Bodas, Research analyst

Let me ask you a simple question: How would you value a company making a net loss almost double its net sales?

You probably wouldn't touch that company unless the bottomline were in the green. That's fundamental, right? You would want to see how the business model evolves. How the company progresses with its products and services. More importantly, you would want to see if the company is earning a profit and able to generate free cash flow.

But sometimes, things get crazy, especially in the ecommerce space.

I am talking about the recent acquisition of Ibibo by MakeMyTrip (MMT). As per Mint, the deal is pegged at US$720 million. That's nearly eight times Ibibo's FY16 sales. Crazy, right? Then consider this: Ibibo has been making losses the past three years.

But gets crazier.

MMT itself is bleeding. In FY16, the company posted a net loss of US$89 million. The latest 1QFY17 results showed a loss of US$14 million. What the hell is going on here? A bleeding company acquires a loss-making company. A match made in heaven, I guess.

So the rational person asks: How will MMT fund this acquisition? Here, the company has two options. Either through debt (cash-based acquisition) or through equity dilution (stock-based acquisition where the shareholders of the target company get stock of the acquiring company). Ibibo and MMT are going with the second option.

What does equity dilution mean? It means treating shares as a currency note and issuing more of it so as to buy the target entity (although it is a different thing that MMT is not making any profit).

Are we saying that this acquisition will end in tears? What if the consolidated entity turns around and starts making profits? This possibility can certainly not be denied.

However, here, one has to consider the base rate. The base rate is the probability of future success based on past success. What is the success rate of a new start-up? According to Bloomberg, eight out of ten new businesses fail within the first eighteen months. In other words, a pretty low base rate of success. Therefore, based on base rate, the chance that the consolidated entity will survive is pretty poor to say the least.

In fact, we are worried about this dangerous trend where people are focusing on new fads, new ventures and new information, but ignoring the base rate or prior probabilities.

Just look at some more recent examples. What happened to Askme, the consumer internet search platform that shut down a couple months back? Or what about Tinyowl, the now-defunct restaurant delivery service that had raised more than US$27 million? Or Localbanya, the online grocery store that shut down last year?

We've come to think these insane valuations are only possible in the ecommerce space. But crazy-stupid valuations are all over the stock market. Take some of the recent IPOs for example. IPOs are flocking to the market at insane valuations.

As an analyst, when I see the valuations of stocks such as Teamlease Services, Quess Corp, and Infibeam - all listed this year and now trading at PEs between 70-500 times their FY16 earnings - it's beyond my understanding.

Maybe the ecommerce start-up bubble and the IPO bubble will burst soon. Or maybe they will continue to inflate. Or perhaps they'll go bankrupt the way Mike Campbell in The Sun Also Rises did: 'Gradually, then suddenly.'

One place where you will never find insanity with respect to valuations is our Hidden Treasure service. Richa and her team have done an excellent job over the years in identifying the best quality small cap stocks and recommending them only when they felt that the price was right. This discipline has paid off handsomely. The median CAGR returns on each recommendation since inception is an impressive 26%. You can learn more about Hidden Treasure here.


One of the most widely tracked indicators of economic activity has some good news to share. We are referring to the sales of Medium and Heavy Commercial Vehicles (M&HCVs) in the month of October. If a leading daily is to be believed, M&HCV sales seems to have grown more than 12% over the same month last year.

While the positive number is in itself comforting, the fact that it has come after three straight months of decline in sales, makes it even more noteworthy. Industry sources are pointing to a variety of factors that has led to this revival. Key amongst them include stability in freight rates, increased load availability, increased activity in the agriculture sector and better availability of finance and lower interest rates.

Will the momentum continue? The manufacturers seem cautiously optimistic. Irrespective, we think that the industry is poised to do well over medium to long term with the growth likely to be in the region of high single to low double digits. And with road infrastructure only getting better, the historical growth rates could well be exceeded.

Commercial Vehicles: Revival around the corner?


Barring China, major global markets ended the week on a negative note. The uncertainty over the outcome of US elections has kept the global markets on its toes. Dow Jones Industrial Average (DSIJ)- the benchmark index of US was down by 1.5% during the week. Further, the US central bank in its meeting on 2 November kept the interest rates unchanged. Experts believe that there is a high likelihood of interest rates being hiked in the month of December.

Asian markets too ended on a weak note with benchmark indices in Japan and Hong Kong down by 3.1% and 1.4% during the week. However, stock markets in China were up by 0.7% during the week mainly on the back of good numbers pertaining to their Purchasing Managers Index (PMI) data. An official gauge of the nation's factory activity rose to the highest level in more than two years in October. China's official manufacturing PMI increased to 51.2 from September's 50.4, indicating a third straight month of expansion.

Back home, Indian markets too fared badly. BSE Sensex was down by 2.4% during the week. Worse affected was the BSE Small Cap index, which went down by 4.3% during the week.

The outcome of US elections will play an important role in determining the trajectory of the global markets in the short run. The markets are expecting Mrs. Hillary Clinton to win the presidential elections. However, if this does not happen, fickle minded Foreign Institutional Investors (FII) may flee from emerging markets to safe heavens like US Treasuries and Gold.

Performance During the Week Ended 4th November, 2016

04:57Weekend investment mantra

"Price is what you pay. Value is what you get" - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Sarvajeet Bodas (Research Analyst).

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