A financial poser

Basic principles of finance have not changed that much in the last century: Businesses exist to make profits and generating positive cash flows is important.

Given the recent developments in the e-commerce space, several ‘old school’ finance professionals are unsure whether the ‘universal’ and ‘time-tested’ principles will ever hold good in the future. Valuations of most e-commerce deals in the recent past have been at astronomical levels, most often expressed as several multiples of sales. It’s common knowledge that virtually every e-commerce company in India is losing money today. So, why are investors paying a sales linked multiple (and a premium at that!) for buying into a loss making company.

The reasons are not far to seek. Like the dot com story in the past and the examples of mobile telephony, offline retail, real estate and food and beverage franchising businesses, investors are paying a premium today to take a bet on an anticipated strong growth story in the future. When these assumptions turn true, investors have a ‘multi bagger’ on their hands and everyone is happy with their investment returns or variable bonuses. A good example would be Warburg Pincus’ investment in Bharti Airtel, Prof Mankekar in Pantaloons or Carlyle in Repco Housing.

However, while success stories get good press, several spectacular failures go unreported. Both retail and institutional investors have lost money in dot com bubbles and in poor quality real estate plays.

So, are investors overpaying for investments in e-commerce companies? That’s a tough one to answer. The answer will depend on what your expectations of growth are in the Indian online retail market. This simple parameter has several component parts: rate of internet penetration in the country, smartphone penetration, site visitors to paying customer conversion ratio, average revenue size per transaction, customer loyalty (repeat sales), average time spent by a customer on the site, ability of delivery systems to service orders, etc.

Given that the industry is so new, an estimate on each of these factors including an extrapolation into the future can be ‘guesstimates’. Only time will tell who got their assumptions right and who got them wrong.

As one of the ‘old school’ finance folks, what I find somewhat worrying is the end use of the funds. When funding is used to expand market reach, build scaleable IT systems, improve customer experience, strengthening delivery mechanisms, it is good and desirable. Recent ‘big bang’ one day sale experiments however point to a competitive situation where all serious e-commerce players are focused on market share expansion, even at the cost of selling below purchase price. Using funds raising from ‘capital account’ to pay for ‘operating expense’ is not a new concept.

But how long can the enterprise sustain this activity?

As a customer, I love the price war. As a concept, I like what discount selling is doing to expansion of the online market size. But, as a finance person, I am worried about using price as a tool to attract a customer. Will a customer who comes to you for low price be really loyal to you or will he or she continue to be loyal to himself or herself by looking for the best deal, everytime?

Bubbles burst when cautious optimism morphs to bullish behaviour to greed and finally to ‘herd mania’. At what stage of this morphing is e-commerce today? That, to borrow from Flipkart’s recent campaign, is really the Big Billion Dollar question!

The writer is co-founder MyCFO

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