»The Daily Reckoning by Bill Borner

Do these billion dollar firms really put bluechips to shame?
1 JULY 2015

- By Tanushree Banerjee

Dear Readers,

In this special edition of The Daily Reckoning we have Tanushree Banerjee writing for us. Tanushree as you would know is the co-head of research at Equitymaster and writes the The India Letter.

I recently wrote a series of columns on the Indian e-commerce companies. The basic point that I tried to make in these columns is that most Indian e-commerce companies are bleeding and are managing to run because of the era of easy money unleased by the Western central banks. This has allowed VCs and private equity firm access to a lot of money, which they have been pumping into these firms.

In the days to come many of these companies will try and get listed on the stock exchanges to help the VCs and private equity firms make a profitable exit.

In this column Tanushree tries to answer the question as to whether you should be investing in these initial public offerings (IPOs) as and when they hit the market. And quite correctly she comes to the conclusion that: "Investors should resist the temptation to invest in over hyped IPOs."

This isn't surprising given the rather dismal numbers of these companies.

Happy reading!
Vivek Kaul


Flipkart, Snapdeal, Myntra, Jabong and Makemytrip. They did not even exist a decade back. Most are the first entrepreneurial ventures of their young technocrat CEOs. Nearly all cater to a business segment that the previous generation never heard of. Yet they are reporting several billions of dollars in sales Their year on year growth numbers go into triple digits. And the valuations that PE funds are falling over each other to offer them can put blue chips to shame! It's therefore without doubt that the idea of allowing startups (largely ecommerce ventures) to list is something that not just large but even retail investors are finding extremely appealing.

So should you be readying funds to apply to every startup IPO that seeks listing on the exchanges? More importantly, can you evaluate these IPOs like any other?

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Google or Facebook in the making?

The easiest way to evaluate if a business idea is feasible and can create value for shareholders is to look at similar entities listed elsewhere globally. Now, here you would be making a cardinal mistake if you expect the ecommerce ventures to have Google or Facebook like success in the stock markets. Not just is their business model very different from ecommerce entities. But both have income and profitability patterns that are starkly different from ecommerce ventures. Instead a company like Amazon would be a comparable benchmark. And Amazon itself, despite being the largest and one of the most successful ecommerce companies globally, has created little wealth for shareholders so long. With thin profit margins the company hardly enjoys the kind of investing appetite that Google and Facebook do.

Scarcity premium - How much is too much to pay?

Newly listed ventures with unique business models often attract what is called 'scarcity premium' in valuations. This is because investors hoping to cash in on the exponential growth in the one-of- its -kind business get greedy. And in the absence of competition do not find sufficient benchmarks for the valuation.

So it was not without reason that companies like Facebook and Twitter, amongst the first social media companies to get listed, saw valuations soar to unreasonable levels during their IPO itself.

The first pure play ecommerce firms to get listed in India could also see a similar rush of investor appetite. Ones that have had private equity (PE) firms pay astronomical valuations will have all the more reason to justify the premium. However, as a retail investor, you do not have the kind of risk appetite that PE firms do. Hence there is a need to rationalize the valuations that you would want to pay.

What is in it for you - the shareholder?

The way to figure out how much to pay for a stock is to take a look at what is in it for you, the shareholder. Not just new companies but even ones that have been around for decades, like ones in aviation sector, sometime fail to create shareholder wealth. The billion dollars in sales is therefore not a good yardstick for shareholder returns. Instead the profit margins and return ratios (like return on capital employed) will give a better sense of what is in it for you. Companies like Amazon and even Flipkart back home have yet to prove their investment worthiness with a healthy bottomline.

When to invest?

The initial public offerings of most ecommerce firms are likely to be the first exit route for the PE firms that have so far supplied them billions in funding. Therefore notwithstanding their fundamental strength, the ecommerce IPOs are likely to be priced at significant premium to sweeten the deal for PE investors. Hence for you, the retail investor, the IPOs may be a good starting point to start tracking the performance of ecommerce companies. But do resist the temptation to invest in over hyped IPOs.

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and has not been authenticated by any statutory authority. The author and Equitymaster, do not claim it to be accurate nor accept any responsibility for the same. Please read the detailed Terms of Use of the web site.
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