Troubled times ahead for India's e-commerce start-ups

Morgan Stanley writing down its investment in the e-commerce leader by 27 per cent does not augur well for the sector.

InMobi, a fledgling mobile ad network back in 2011, was out in the market to raise $25 million when Japanese investor Softbank decided to sink $200 million for a 35 per cent stake in the company.

The firm jumped at the opportunity, took the money, and expanded rapidly.

Three years later, in 2014, Softbank wrote down a majority of its investment.

It was a classic case of a business that was trying to build its fundamentals being given cash to do so.

InMobi quickly burnt the cash in the next two to three years and while it's now valued at $2.5 billion, talk is that the promoters are looking for an exit through acquisition, which the company has denied.

This scenario echoes in India's e-commerce industry which took a massive hit when Morgan Stanley marked down the value of its investment in leader Flipkart by 27 per cent to $58.9 million between June and December.

Experts say the move will affect the overall value of the company.

"The writing has been on the wall for some time. The write-down brings the travails of the metro-consumer-facing start-ups to the public eye," says Sharad Sharma, co-founder and governing council member of iSPIRT, the think tank. 

Similarly, Gurgaon-based budget hotel room aggregator Oyo Rooms, which planned to raise $400 million, is struggling to justify its valuation to investors.

The company could settle for just a fourth of the amount it planned to raise at a valuation below its benchmark of $600 million, which in turn could hurt its plans to acquire rival ZO Rooms for a stock swap of 7 per cent.

With these market leaders facing trouble, the interest of investors in e-commerce start-ups is waning.

According to a survey of private equity and venture capital funds done by VCCircle, 92 per cent of VCs believe that valuations of start-ups going in for Series B, C or D rounds of funding will drop, which will make exits more difficult.

Moreover, a majority of the investors surveyed believe that the exits that do happen will be through sale of stake to strategic investors.

Over-valued start-ups aren't just an Indian phenomenon.

The US public markets have failed to recognise private valuations of companies such as GoPro and Box, whose stocks have failed to hold on to their IPO prices.

Start-up investors are slowly recognising this and correcting the valuations. Morgan Stanley, while marking down its investments in Flipkart, also brought down the valuation of Palantir, a Silicon Valley-based data crunching company, by 32 per cent.

Amazon's growing clout

Besides investor concern on valuation, the Indian e-commerce space, especially Flipkart, is feeling the pressure from Amazon.

Up until 2014, investors assumed that Flipkart would be the undisputed leader in India's e-commerce space, but that surety isn't there anymore.

The US online retailer has in a short span of time cornered a piece of the ecommerce pie and that is hurting Flipkart.

To be fair, another Morgan Stanley research report last month said Flipkart continues to dominate the e-commerce market with 45 per cent share compared to Amazon's 12 per cent.

Amazon, with an open cheque, wants to conquer India after it lost out in China to local behemoth Alibaba.

Amazon's bullishness on Indian e-commerce is matched by Softbank which has pledged to invest $10 billion in the sector over the next few years.

It has backed ventures such as Paytm and Snapdeal, which it hoped would take on Flipkart and more importantly Amazon.

This bullishness comes from the fact that Amazon doesn't rule the Japanese or the Chinese e-commerce markets, making them assume that the 'Amazon of India' will once again not be Amazon itself.

Other investors came in witnessing the rapid growth of China, thinking that India would go the same way.

Some experts find their enthusiasm misplaced. "These large investors have been compromised by their lenses that don't apply in India," says Sharma. 

While Flipkart claims it has 50 million active monthly users on its platform, industry sources say the number of actual transacting users is far smaller.

The problem stems from overestimating the buying power of India's middle class.

While the National Council of Applied Economic Research caps India's middle class population at 264 million, others say it is closer to 100 million.

Investment banking firm Credit Suisse puts that number at just 24 million.

Accel Partners, an early backer of Flipkart, in a March 2014 report estimated that "online shopping of goods in India will grow to $8.5 billion in 2016. The number of online shoppers will more than double to 40 million."

While in terms of gross merchandise value (GMV), India's ecommerce market crossed the $12 billion mark in 2015, the number of online transacting users remains far less than 40 million.

It's a combination of these issues that has led to the onset of a financial bubble and hurt the valuation of Flipkart and a few other start-ups in India.

The million-dollar question which no one has the answer to is whether the turmoil in the e-retail, FoodTech, hyperlocal, online classifieds and online real estate spaces will lead to drying up of funds in other sectors?

"I don't think that's the case. I mean SaaS (Software as a Service) start-up valuations are not linked to e-commerce start-up valuations. Different sectors, such as FoodTech, have gone through a period of consolidation. Going forward, what you're going to see is segment-specific dynamics," says Rajan Anandan, Google's managing director for Southeast Asia and India.

Several other investors and industry watchers are of the opinion that the downturn in India's start-up funding space is cyclical and that the market will recover post correction.

Sanjay Nath, managing partner of Blume ventures, says there was no doubt that Indian B2C firms were overvalued. "What you're seeing today, it's more in terms of rightsizing or to be fairly valued."

"This new environment is actually good for us because it reduces all the clutter. I don't think the large guys are going to go anywhere. I think they will find a way to survive, and down the road there will be consolidation. Recession is when good companies are built," says Shashank ND, founder and CEO of Practo.