Caris Analyst Sandeep Aggarwal On Me-Too Internet Models, Group Buying

The successful listing of online travel company Makemytrip (MMT) on NASDAQ has reaffirmed the faith of many venture capitalists in Indian internet businesses. While there is an overall optimism on the future of internet growth and emerging business models, there are a few unanswered questions which still worry the investors like whether this growth is hype or for real or whether this indeed is the right time to be an internet entrepreneur in India.

In an interview with VCCircle, Sandeep Aggarwal, senior internet & software analyst, Caris & Company, a San Francisco-based research-driven boutique investment bank, who recently authored a detailed report on the Indian internet, shares insights on internet growth in India, the business models at work and other unique trends in this space. Aggarwal, who had famously said that India has hit the tipping point for Internet, was in India for a short visit to meet a dozen internet companies including the MakeMyTrip and InfoEdge. Excerpts:

What is exciting about the Indian internet market? Internet penetration of 7% that can reach 20% in next five years, increasing time spent on the Internet, adoption of connecting devices (smartphones, tablets etc) and above all, people are more ready to engage in transactions online. So the entire ecosystem is evolving very fast, albeit after 8-10 years of disappointments.

What are some on-the-ground shifts that you see? People have started embracing Internet beyond email, IM, search and news. This will create all sorts of new opportunities for start-ups in content, commerce, communication, gaming, and social media.

You have said Indian internet companies are me-too in nature. How can they strive to be unique and different? Are these challenges in near term? To some extent, "me too" is working in India for now until the market starts to gravitate towards global standards and best practices. However, innovation is always good and I did not see much of localization by Indian Internet companies other than Cash on Delivery and a Call Center for pre-sales and post-sales support.

What are the types of businesses that you are bullish about in India and why? Given the total addressable opportunities, we think transactional businesses will likely do better in the next 2-3 years followed by Internet advertising and content play. Retail is a $400-billion market in India and advertising is under $10 billion, hence online travel, E-Commerce and B2B businesses will likely do well just because of the sheer size of the industry.

Can you shed light on trends in developed internet markets which India can emulate? India is 10 years behind US and perhaps six years behind China. China has two large portals, one large search engine, nearly half dozen online travel sites, a dozen plus online gaming sites, multiple social media sites, and 1,000+ E-commerce sites. So, to some extent, India can emulate everything what has happened in China from 2003 to 2006 to be on a big growth trajectory.

Is it safe to say that time has arrived to become an internet entrepreneur in India? Yes, of course. The kind of reception MakeMyTrip has seen after getting listed on NASDAQ is hard to find. In our view, global institutional investors are willing to pay premium valuation multiple for growth stories riding on multiple secular themes. India Internet offers the rise of India, rapidly growing middle-class, and under penetrated Internet economy -- these are too compelling themes to ignore by global institutional investors.

How safe is internet as a bet for VCs in India as compared to other sectors which have a more visible liquidiy horizon? In my view, VC investments in India are starting to deliver fruits. In the past, VCs tend to make late stage investments to buy more insurance against risk and to a large extent, they were right in doing that because the pace of market development was disappointing. Now there are many sub-sectors of the Internet that are growing in excess of 100% Y/Y, of course with a small base.

What are the M&A options available here? How willing are foreign corporates to look at Indian companies? India has still not reached a critical mass to be attractive for global Internet companies. For example, Expedia and Priceline do not care about India as much right now as they would in next 2-3 years when India will double the installed base of hotels. In my view, by 2012-13, US-based large Internet companies will likely get more active for Indian market and will use its balance sheet to acquire local companies and expand its geographical base.

There is a general fear that we are revisiting the dotcom boom-bust era with the kind of valuations that companies like Facebook or Groupon are getting. Is this growth for real? Yes, the old Internet promise that one day shares of eyeballs will translate into revenue has not started to happen in a big way. Companies like Facebook and Groupon are bringing real innovations and disrupting the older way of doing things. In the last 15 years of Internet, a lot has been said about local advertising and local merchants online but nobody cracked the code for local merchants online, the way Groupon has done. As far as Facebook is concerned, it is almost becoming a "start" button for the Internet and right from chat, photo share and news consumptions to social media games and E-Commerce, Facebook is delivering everything and the way it has not been done before.

How important is India as a market for facebook? Well if you look at the rise of the Internet in US, it primarily centered around Google-led ecosystem of search from 2000 to 2008. That allowed content providers to come up with content and Google would deliver them audiences. That allowed E-Commerce companies to come up with hundreds of millions of listings and Google would drive traffic to the right listings/pages. All of Google innovations for search were centered around page rank, which of course work and work really effectively. Because it works, it is also expensive. Search is very effective way to acquire new customers online but it is expensive. Facebook's innovations are centered around "people rank" vs "page rank". They are harnessing human knowledge and people preference and sort of giving a substitute of search. In my view, India Internet is not going to spend next eight years on Google-led search ecosystem and will likely embrace Facebook much sooner and much deeper.

Is group buying overhyped? What do you think of group buying sites in India? Group buying is not over hyped in the US but in India perhaps yes. In the US, local advertising alone acount for $65 billion annual market and, in India, it is less than $3 billion. Also, US market is full of spas, restaurants, hotels, resorts, bars etc that are not sold out and always have excess capacity. I do not think India is quite there yet.

How can companies like Naukri, Makemytrip gain competetive modes? How do they grow from here? Becoming category leader, maintaining category leadership and participating as good corporate citizen to let the overall pie grow and then fight for marketshare would be key for these companies to continue to experience massive secular adoption of the Internet and eventually decent enough profit margins.

What are the business models within Indian internet which VCs should stay away from? In our view, Internet has hit the tipping point in India, so it will be hard to stay away from compelling opportunities but I would still argue that herd instinct will not translate into market outperformance for VCs. I see too much money chasing too little ideas/innovations.

Any other key takeaways from the Indian internet market? Well, I would say that market development for the Internet is finally looking very encouraging but just be careful about market consolidation. It will be perhaps 2012-13 before see market consoldiation. So many companies will not see timely exits.

What are the kind of trends that you see in the Indian internet market? What do you think about online advertising in India? The Internet trends in India are fairly nascent in nature. There is no doubt that Indian Internet population is coming online for more than email, IM, news, social media etc. but still the amount of activities a typical Internet user is engaging in US or Western Europe is unmatchable vs. India. In my view, rising Internet penetration, increasing time spend online, rapid adoption of social media, mobile Internet, and people's readiness to engage in transactions are some of the noteworthy trends. As far as online advertising in India is concerned, in my view, this will likely remain a small segment of the Internet for next 2 years. We expect Internet advertising to grow at 35% (perhaps 2x faser than US) but because the overall advertising industry is small and TV/Newspaper/Magazines have very good reach, it will be a while before Internet advertising takes off.

In my view, paid search, email marketing, lead generation, and social media marketing will likely pick up as online travel and e-commerce become more ubiquitous in India. As far as online banner advertising is concerned, I think it will likely remain small and fragmented industry in India.