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Indian Internet Startups – Comparative Analysis of Unicorns Afzal Anwar and Himadri Das Great Lakes Institute of Management, Gurgaon, India

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Indian Internet Startups – Comparative Analysis of Unicorns Afzal Anwar and Himadri Das Great Lakes Institute of Management, Gurgaon, India Indian Internet Startups – Comparative Analysis of Unicorns Afzal Anwar and Himadri Das Great Lakes Institute of Management, Gurgaon, India Abstract The Indian Internet space is growing at a very fast rate. Companies are attracting high investment and fetching even higher valuation from the investors. Many companies have attained the so-called Unicorn status of valuation over USD 1 Billion in a very short time. This paper examines these unicorns focused on the consumer space from a valuation model perspective. Traditional valuation methods are ineffective in case of these companies as they fail to capture high future growth potential, high uncertainty and heavy losses in spite of growing revenues, some typical characteristics of such companies. This paper focuses on carrying out a comparative analysis across Indian unicorns in an attempt to find a relationship to explain the high valuation with respect to their customers and other growth drivers, which depend on the space the business operates in. Keywords: India, Internet, Unicorn, Valuation, E-commerce Introduction We are living in times of cheap and easily accessible capital, where entrepreneurs have succeeded in quickly converting their business ideas into billion dollar valuations that defy common perceptions about earnings, profits, multiples and the short terms focus of capital markets (Driek Desmet et al, 2000). Valuing these companies as per traditional models has become a challenge, especially when these are coupled with high uncertainty and heavy losses. Most practitioners are left wondering why these Indian internet unicorns merit such high valuations. Do they have higher return on assets and lower marginal costs? Do they see faster growth? Are they more profitable? So, who are these Indian Internet Unicorns? (Libert et al, 2014) According to a Harvard research on trends in valuation that have evolved over a period of time across different business models, there are four business models (Libert et al, 2014) : 1. Asset Builders – They create and develop assets to produce and sell other physical things. Eg. Volkswagen, Coca Cola, Nike. 2. Service Providers – They provide services to their customers through their employees. Eg. Verizon, Accenture, Goldman Sachs. 3. Technology Creators – They develop proprietary products. Eg. Microsoft, Oracle, Apple. 4. Network Orchestrators- They create peer network in which participants collaborate in value creation. Eg. Airbnb, Uber, Alibaba, Trip Advisor. Based on reports quoted in international and national publications, private equity investments into some of the largest names in the Indian internet market, India is now home to at least 7 unicorns in consumer facing internet businesses (USD 1bn+ companies) such as three of India’s biggest ecommerce players: Flipkart, Snapdeal and ShopClues; taxi hailing app: Ola cabs; wallet/mobile commerce company: Paytm; online classifieds company: Quikr; online restaurant and food delivery platform: Zomato; and mobile advertising network: Inmobi. All of these Indian Internet Unicorn are network orchestrators. They build a network in which the participants interact and share in the value creation. They may sell products or services, build relationships, share advice, give reviews, collaborate, co-create and more. The existence of these businesses and the revenues they generate depend significantly on the use of the Internet. Libert et al, 2014) These type of companies have achieved rapid growth in a short period of time (<10 years) by creating a unique value for their customers. The traditional valuation techniques are not able to quantify the value of these internet businesses (Gupta & Chevalier, 2002). Traditional valuation techniques are based on metrics such as profit after tax (PAT), earnings before interest (EBIT), EBITDA, or free cash flows. These methods, however, cannot be employed for internet companies as they generate massive losses. A need, therefore, exists to come up with newer and more meaningful metrics using which fair assessment of these companies can be done. These Internet unicorns are here to stay as the convenience of shopping online, home delivery, availability of service 24X7, ease of access and low prices are the real benefits that traditional business models can’t offer. Most of these companies are, however, not even close to profitability at their current scale of operations but investors are nevertheless giving them high valuations based on the expectation of strong future profitability as the scale of operations increases. Literature Review Characteristics and Specifics of Valuing Internet Companies Internet firms are very different from other firms in terms of much longer time taken to turn profitable. Internet companies typically generate heavy losses for the first several years, which results from high marketing costs and network growth costs that dramatically decrease their earnings in spite of high revenues. Internet companies grow at a very fast rate from a revenue perspective, with the most successful ones increase their revenues many fold in the early phase of development. Valuing internet companies is a great challenge given the lack of validated data, heavy losses and many uncertain factors about the future. Based on the overview of recent academic research on the valuation of internet firms Jansen and Perotti (2002) draw the following conclusions: 1. Traditional accounting data remains important for valuing internet companies, however, the link between accounting numbers and Internet valuation is very weak. 2. Web traffic is not a major value driver for valuing internet companies 3. Financial Analysts stimulated the overvaluation of internet stock 4. New valuation factors are unsustainable Financial Value Drivers The following is a look at valuation factors, both financial and non-financial, which have great impact on companies’ earnings and value. Price to Sales Ratio Demers and Lev (2000) examine the value relevance of two categories of Internet companies’ expenditures related to the acquisition of intangible assets: (i) marketing expenses and (ii) product development and R&D expenses. They state that the market will positively value both of these variables as long as it views them as positive investments. They also examine the value relevance of the income statement components cost of goods or services sold. With the exception of cost of goods sold, the income statement components were significantly value relevant in 1999. Cash-Burn Ratio Demers and Lev (2000), construct a proxy for internet companies’ ability to sustain their current rate of cash burn. Their proxy for cash burn is cash on hand divided by current period’s cash flows from operations. They find that this proxy is a significant value-driver through 1999- 2000. Their proxy is defined as (cash on hand)/(current period’s cash flows from operations). Kozberg (2001), Hand (2000a), Hand (2000b) used non-financial data from the Nielsen called “Internet Audience” database which carried detailed information on the web browsing habits of approximately 57,000 Internet companies. However, this database is no longer freely available. Gross Merchandise Value (GMV) GMV indicates total sales value of merchandise sold through their market place over a period. For a consumer facing internet unicorn, it means the listed (not discounted) price charged to the customer multiplied by the number of items sold. Companies in India are currently burning cash at an average rate of 1.35X the GMV sold, through heavy discounting, marketing, free shipping and handling, cash incentives and various other incentives that e-tailers give to attract consumers. Characteristics: • Does not account for the deep discounts most consumer facing internet companies offer. • Nor does it factor in product returns. So, if a firm says its annualized GMV is $100 million, it can actually be booking discounted sales of anywhere between $20 million and $70 million. Valuation at about 2-2.5 times a firm’s GMV is considered a reasonable number, while market leaders fetch valuations of up to four times their GMV. (Livemint Report,2015) Non - Financial Drivers The non-financial drivers which have significant effect on valuation for internet companies are those factors that cannot be found in accounting and financial statements, though they have huge impact on the future growth potential of internet companies, especially when most companies are generating very low revenue. Demers & Lev (2001) examined and suggested that all of these performance measures are relevant to the valuation of Internet companies. 1. Web Traffic – a ranking of the website traffic. 2. Reach – the percentage of Internet users that visit a particular web property. 3. Views – the number of pages that are viewed. 4. Hold – how long visitors stay on the site 5. Loyalty – driven primarily by the average number of visits to the site per unique visitor per period a. Number of Register Customers b. Daily Active Users 6. Strategic Alliances with other brands Most researches assume that the future gross profits to be positively and linearly related to a current period’s gross profit, operating expenses and web site usage. It is based on the assumption that current period Website usage reflects potential future demand for the company’s products and affects the rates a firm can charge for advertising on the company’s Websites. Valuation Methods Many researchers and industry practitioners have mentioned merits and demerits of various valuation methods in their papers. Two of
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