The world watched as Indian startups hit astonishing valuations over the last few years. Eight Indian startups had become unicorns, with valuations exceeding $1 billion. However, two recent events i.e. the IPO of Infibeam & markdown of Flipkart has brought in doubts about the valuation of Indian e-commerce startups. While people claim that corrections are nothing new in valuations, the unicorn club has steadily drawn flak because of over-hyped figures. Let’s try to understand the valuation process & connect the dots in the Indian context:
Indian Unicorn Club Valuations History:
Flipkart has raised over $3.5 billion in 10 rounds of funding and is backed by multiple investors like GIC, DST Global, Qatar Investment Authority, Tiger Global, Steadview Capital. When it raised funding of $700 million in July 2015, its valuation stood at over $15 billion, which is slightly over IOCL’s market cap. In a similar story, Snapdeal raised $1.7 Bn in funding and reached $ 5Bn valuation comparable to Yes Bank.
What is the approach & methodology followed for valuation of startups?
The predicament faced by most VC/PE firms is how does one forecast ROIC for an early stage startup when it has meagre revenue, next to nil physical assets & limited customers. Typically, before the final valuation is done, startups go through multiple financing rounds (Seed, First, Second, Third, Mezzanine*), Pre-money valuations & then final IPO is raised. For all such rounds, the commonly used valuations techniques are:
How often are the valuations revised? Is it general practice for a company to be devalued?
Flipkart’s valuation took a hit from $15bn to $11Bn as Morgan Stanley MF valued its stake at $59 Mn v/s $80 Mn in a recent SEC Filing in December 2015. But, devaluations are not merely an Indian phenomenon. In the past, several major US Mutual Funds like T Rowe Price, Fidelity have devalued their stake in DropBox (Online File-sharing), Palantir Tech (Analytics), SnapChat (Social Media), Zenefits (cloud-based HR software) etc. Public listed companies like LinkedIn and Twitter have also seen a 25% drop in their stock prices in recent times
A markdown happens after a private market portfolio is put through a valuation exercise based on the techniques described in the table. Typically, markdowns are common for startups as fund houses routinely re-evaluate their equity positions e.g. large MF houses publish their results on a quarterly basis.
What factors govern the devaluation of a startup ?
As highlighted earlier, the predicament is that most of valuation techniques are archaic and designed for run-of-the-mill brick & mortar companies. It is difficult to get accurate results if we apply the same framework for online startups that have a starkly different operating model.
Also, markdowns have very little to do with external factors like market or even the existing business model; it is a function of the valuation method applied. As stated in the table, all the steps are fraught with subjectivity: both in choices of comparable companies or of the final value reported across a large range of possible valuations.
Based on the subjectivity highlighted above, you can end up at a significantly lower valuation of a private company even if nothing materially changed at the company. Markdowns may even happen because conservatism has lowered the fund manager’s estimate!
How does Flipkart’s 25% devaluation reflect in the Indian e-commerce industry?
In terms of valuations, many of the Indian unicorns are valued between 4 and 10 times its GMV, while global majors like Amazon and Alibaba are valued at just 2.2 times and 1.2 times its GMV respectively. Often, investors have over-valued these firms simply on the fear of losing out. High valuations of mid-sized companies also make them pricey targets for larger rivals, potentially closing another exit option for investors.
Skeptics believe that this devaluation is simply the tip of the iceberg. All large Indian online startups have enjoyed soaring valuations despite being loss-making and entirely dependant on discount-driven model for customer acquisition. However, if they decide to forgo this model, they will have to contend with the elephant in the room, Amazon, which has effortlessly outpaced the others in fund infusion. Fund infusion has remained the crux of these unicorn startups for retaining market share against global players.
The question remains that devaluation might merely be the starting point for the valuation bubble bursting in india. There could be a cascading effect on other smaller over-hyped players which are yet not profitable
Will the markdown help other e-commerce firms in any manner?
Many industry veterans argue that the huge valuations that took place in the past few years were ahead of its time by one or two financing rounds for many of the current Indian unicorns. Perhaps, a few markdowns in the near future will help the unicorns raise funding as currently they grapple with raising capital post-stage III (Series C Funding). Also, Alibaba is looking to expand its ambit beyond Snapdeal & PayTm and invest heavily in Flipkart. The devaluation simply makes his life much simpler.
Perhaps, the Flipkart setback could help Indian ecommerce startups to shift focus from discount-driven customer acquisition model to exploring new ways of sustainable growth.
Maybe Markdowns aren’t such a bad thing after all.
*Mezzanine is the final round of financing before IPO. The company has been valued over hundred dollars, operates in multiple countries, employing 100+ people