E-com Hype Is Driven By Cash-rich VC Funds, Not Wise Investors: Mahesh Murthy

According to popular view, it is a second coming for e-commerce in India. This is clearly visible as more than half-a-dozen e-com businesses have procured funds during the first half of this calendar year while VC funds are literally competing with each other to get a large chunk of the pie. However, some investors like to think differently. They feel that investors are going bananas and e-commerce investing is now akin to topi investing – a balance sheet game where one investor sells the futuristic valuations of its portfolio to another, without any real visibility on revenues or cash flows. In an exclusive video interview, Mahesh Murthy, a founding partner at Seedfund, talks candidly about the current e-commerce frenzy in India. Murthy holds the contrarian view and feels that this surge is certainly not for real. Excerpts from the interview:

What do you think of the valuations of e-commerce businesses? This is not the first time we have seen such rush to invest in that sector. It had also happened a decade ago when a lot of marquee funds lost a lot of money. Do you think this surge is for real and also bigger this time?

I don't think this is for real. This is just a bubble. In fact, we have seen totally ridiculous valuations at times. These are driven by funds which have more money than the sense to invest wisely. They are all in a hurry to invest. And they are sprinkling it all over the place, hoping that it will go up and also hoping that two years from now, people with even less business sense than them will buy those at higher valuations. These things happen because it always goes in cycles. Also, you are right about those earlier losses. Ten years ago, some funds lost money big time and this time around, there will also be funds that will lose money. These are momentum funds, to be precise.

But right now, investments should be done based on the fundamentals and we should judge the companies more by their standards. For instance, one can pick those companies that can go public in India or those with an India base. I do think that many of these current investments are based on the frothy US-NASDAQ valuations. They just say, "Oh! Let's invest in Expedia of India, let's invest in Google of India, let's invest in Amazon of India…" and drive such companies to ridiculous valuations.

But one knows that you want to build something for the future here, for an Indian stock market, which is far less forgiving and far more knowledgeable than the US markets. So you will see that solid companies built for an Indian market will succeed in the long term.

All others are topi companies, where an investor buys a company at a certain valuation and sells it to another investor who then puts the topi to someone else. So there is a business in doing topi. However, we are not in that business.

But what's wrong with investing in Expedia or Amazon of India? Isn't there a theory that what happens in the USA comes to China after five years and eventually to India, after 10 years?

If that is so, there is something really very wrong with that theory. For example, Google of India is Google, Yahoo! of India is Yahoo! and the Amazon of India will be Amazon in actuality. And unlike China, the Indian market will follow the US market directly. Therefore, we will do things differently and specifically on our own.

Also, some guy in New York has actually said that Rediff as the Google of the Ganges. But we all know that Rediff has been losing money for three odd years. It has not made money for several quarters now and its revenues have not gone up. I am sure nobody in the Indian market will invest there. You got to be ignorant and deluded to buy those stocks there.

So one must find companies that understand India and not just the Indian arms of multinationals. For instance, Naukri.com in India is not an equivalent of anyone else out there. Likewise, you need not find the equivalent of a US company. Investing doesn't work in copy-paste mode.

What we need are companies which are built for an Indian condition, an Indian market. These are the companies that have a longer future than the topi companies.

VCs often compare the Indian venture market with China. Is that a valid comparison?

I think it's completely wrong. Unlike China, 99 per cent of our Internet usage is in English. But in China, nobody uses English. Also, we don't face any restriction here but in China, you have to have deep political connections to succeed. Even Google couldn't get along and had to move out.

The Indian market is more like the US market and that's why US companies are already doing well in India. Even today, the traffic that Amazon gets from India is four times more than the Flipkart traffic. But it's quite possible that Amazon India will be just like Amazon. So you have to find an Indian company that is solving problems that no foreign company has resolved.

Are you suggesting that a host of VCs and those like Tiger Global Capital are also getting their bets wrong?

They have their own thinking and I can't pretend to think for them. But I wouldn't have taken those decisions as we think differently.

Obviously, we know that there is enormous scope for e-commerce here in India. We understand it well, having made investments in Printo (personal printing company) and RedBus (online bus-ticketing portal). But that's because we know what makes tickets sell. We also know that it's not crazy marketing expenses. Till this year, RedBus had a zero marketing budget and it still sells enormous number of tickets. So it is all about creating a remarkable value and consumers will flock to you.

We see enormous opportunity – not just in travel but in luxury goods, education, retail, apparel and other consumer goods. There is an enormous market for potential start-ups. But I request entrepreneurs not to copy what happens in the USA; it doesn't work here.

What's the kind of deal flow you are seeing now? Are there enough companies built purely on domestic innovations?

The current deal flow is quite promising. Of course, we are a little unhappy with the frothy valuations but those will come and go. We always have a choice not to invest and hold back. In fact, we become extremely suspicious when a company says: I am just building a copy of this US company. Because we know not a single clone of any US company has worked in India. Rediff was supposed to be the Yahoo! of India but in reality, Yahoo! India is far bigger than Rediff. So you can't copy-paste companies here in India; you can't copy-paste start-ups; you can't copy-paste investments. If you are doing that, you are not doing enough research or you don't know enough about the Indian market. We need to pick companies that are right for this market and capable of solving the problems here.

What do you prefer – an Indian listing or a US one?

I would prefer companies to get listed in India because you can stay here for a longer period. In the USA, you can go out of fashion very easily. There, it all depends on who is pulling what stock and whose buy-and-sell recommendations you are following. In fact, at one point, the company was listed below its cash value. If you want to be here for a long time, the preferable route is India listing. If you are a strong Indian consumer brand, consumers will buy your stock. There is nothing wrong with the Indian market. It may not be a perfect place but it is a growing, healthy market. I think you should have a strong, fundamental base in your market where people know you the best.

But don't you think when Internet companies list in India, they require a longer gestation period to scale up and get analyst coverage?

If you look at it, you will find Naukri has reasonable analyst coverage. I think we have only two listed Internet companies here – Naukri and 123Greetings. 123Greetings doesn't have analyst coverage as it hasn't worked hard enough. You have to work hard and fight for it to get that.

But it's not just the analyst coverage that matters. India also represents a large retail stock market. As long as you conduct trade shows, go around or may be do what Reliance did to promote its stock, people will buy you. You don't necessarily have to go to New York where investors say, let us buy an Indian exposure, instead of saying – let us buy a solid Indian company. Right now, information is asymmetric. This is the reason why people there (USA) priced the Rediff stock so ridiculously. But in India, people do know a lot more. And eventually, information will be more and more symmetrical. Once information becomes symmetrical, people will value it stock by stock – at least, that's my belief.

What should be the listing bar for Internet companies here?

It depends on which business sector you are in. Naukri.com listed at Rs 80 crore, I think. For an Internet company, Rs 40-50 crore is a good baseline to start with. I have even listed a company at Rs 4 crore of revenues. As long as you have a good story, you can build upon it. If you are a market leader, you can list at small revenue. If you are the No. 1 car portal, top bus ticketing site or No. 1 in your business area and have market leadership, you can do it. Incidentally, we are a small fund called Seedfund. And we want a big fish in a small pond because we don't really have the might or the muscle to create small fish in big ponds.

In your opinion, what should be the key focus area of e-commerce companies?

There is no brain surgery here. The key thing is to figure out what consumers really want when they come online. If I already have an offline store, do I really need to build an online channel? However, nine out of 10 top e-tailers in the USA are offline companies. So there is great room for the TATAs or the Croma to expand their models online.

Eventually, the hybrid model will work in the majority of cases. Consumers have a lot more confidence seeing something on the ground. Even today, Yatra and MakeMyTrip have their stores all over the country – 100 each to be precise – not so much for sales but for building the confidence that they are 'real' companies.

As long as you find the fundamental gap where you can provide consumers with some value that they haven't experienced before – be it lower price, higher convenience or something that has eluded them till now "there is business to be made.

However, what makes businesses investible is altogether different. As long as you can become big enough to be acquired or go public, you are investible. Therefore, as venture capitalists, we tend to look at various factors and also the exit options before investing. After all, at the end of the day, we are investing our investors' money. So not all e-commerce companies will get funded; only a small number of them will and only some of those will exit successfully.

So what are the grey areas that should be looked into?

Interestingly, I have seen enough balance sheets to say that there is some crazy accounting going on. It's the same kind of accounting that Groupon was doing till it restated its numbers. All these guys are giving deep discounts on their products. And these discounts are actually lower than those given by manufacturers. For instance, the internal cost of a product is Rs 100 and the regular selling price is Rs 120. But if you give a special discount and sell it for Rs 90, you are making a loss of Rs 10. But the accounting is done very differently. It goes like this "the selling price is Rs 120 and Rs 30 is the marketing cost. It is being shown as customer acquisition cost and this Rs 30 is capitalised and expensed for seven years, which means one only shows Rs 4 as a loss this year.

So even though my actual sale is worth Rs 90, I show Rs 120 as my selling price and Rs 4 as loss. And this kind of accounting doesn't make any sense. None of our portfolio companies would do this. We are also very cagey about people who come up with such business plans and show things like this. Because we know that eventually, it will be found out. Till recently, Groupon was very profitable and suddenly they come and say, "Oh, you want us to expense our marketing costs this year. But we forgot to tell you that we are a loss-making company." So you can't hide your expenses away like this. It's wise to let people know the actual state of your business. We want to move away from such fancy accounting things because they are fooling investors. Yet, at the end of the day, you can't fool investors. Run a decent company and don't hide behind such fiduciary stuff.

You sound exceedingly cautious. But isn't there the fear of missing the bus with so many early-stage investors betting on e-commerce businesses?

I don't know about missing the bus, but you can't ignore a few things. For instance, why does MakeMyTrip include the charges of hotel rooms and report it as revenue? In contrast, it only specifies a margin on airline tickets. So apparently, it is allowed.

But if you take that out, MakeMyTrip is no longer a company worth Rs 500 crore. It's a company worth only Rs 250 crore. Then you sit back and think – should I value the Rs 250 crore company at Rs 3000 crore and do I give it 15x multiple on sales? You want to sit and think about that.

Eventually, people will come back and ask: So you are a travel agent and what are your margins? Tell us your margins. In fact, there is a famous joke: If you ask me what 2+2 is for me, I will say 4; but ask an accountant and he will say how much do you want me to make it? That was the thought process from the beginning. But I have no idea where it grows. We are a strong, profitable company; let us see where it goes from here.

You have had a successful fundraising as well. What do Local Partners think about the early-stage venture capital market in India?

One thing that they have really understood is that it's not about doing a large PIPE deal in India or backing a large private equity fund in India. There is a market for truly early-stage venture capital where the investment ticket size is not $5million, $10 million or $ 20 million, but one that ranges between $1 million and $5 million. We have managed to fit in the box of developing economies, early stage. It is the riskiest box, of course. But we are happy to be with them.

(Transcribed by Bhawna Gupta)