16 December 2015 Asia Pacific/India Equity Research Consumer Internet

India Internet Sector Research Analysts COMPANY VISIT Anantha Narayan 91 22 6777 3730 [email protected] Rationality setting in? Nitin Jain 91 22 6777 3851 [email protected] Figure 1: Key takeaways from our meetings 100 mn to 400 mn users in just five years but only 40 mn have ever shopped online. Internet ecosystem >> Focus is on 'lite' and vernacular. Two-third of internet traffic from mobile, but app-only strategy does not work. Mobile first >> R-Jio's progress is keenly watched. Payments >> Rapid growth: 255 mn transactions on wallets, but a crowded space. Winners >> Space for 2-3 large players in most segments, consolidation below that is inevitable. Hyperlocal/O2O >> Can become big; key areas are taxis, classifieds, grocery, and restaurants. Rationality >> Funding has dried up in some segments, discounting ebbs and flows, taxis remain very competitive. Amazon >> Progress seems to be good in India, according to the peers in the internet ecosystem. Logistics >> Significant investments in logistics and customer experience, COD remains high. Regulations >> The GST will help due to faster delivery periods; regulations can adversely impact taxi aggregators. Public listings >> No major ones likely in the next couple of years, companies are still in investment mode. Source: Credit Suisse

■ Possibility of some rationality setting in. We met 20 leading e- commerce/internet companies across key segments last week. After the aggressive pricing behaviour of the last couple of years, there seems to be some rationality returning to the market with a focus on cash flows. Funding seems to have dried up somewhat, especially for smaller companies—this is also causing companies to regulate their cash-burn. ■ Rapidly growing and evolving market, although there is some sense of realism coming in as well. Growth rates continue to be strong at 100-300% (annual) for most companies. India's internet users have also increased from approximately 100 mn five years back to ~400 mn, implying internet penetration of over 30% by the end of 2015. However, our conversations with industry experts during the trip suggest that of this 400 mn, only about 300 mn access the internet at least once in 30 days and only about 40 mn have ever been engaged in online shopping. Access speeds and logistics infrastructure are key challenges. ■ No major listings likely in the next couple of years. While the market opportunity is sizeable, most of the e-commerce segments have severe competitive dynamics. The current strategy of the firms seems to be to build a moat around themselves by scaling up and outsizing their competitors and in this process, most of these companies are incurring heavy losses. The general thought process among the larger e-commerce firms appears to be that a public listing could restrict their ability to aggressively invest in the business and that public investors may want to see at least a concrete path to profitability, if not actual profitability itself. DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, AND THE STATUS OF NON-US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

CREDIT SUISSE SECURITIES RESEARCH & ANALYTICS BEYOND INFORMATION® Client-Driven Solutions, Insights, and Access

16 December 2015 Focus charts and table

Figure 2: India's internet penetration has been increasing Figure 3: …but only a fraction of that is transacting online rapidly… 400 30.0% 25.0% 300 Total population: 20.0% 1.28 bn 200 15.0% Online shoppers: ~40 mn 10.0% Active internet 100 Total internet users (atleast 5.0% users: ~400 once in 30 mn days): ~300 mn 0 0.0% 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Internet users (mn) Internet penetration [RHS]

Source: Internet Live Stats, IAMAI, Credit Suisse research Source: IAMAI, TRAI, Google, Credit Suisse estimates

Figure 4: Mobile is big for Indian e-commerce players Figure 5: Although small, there is some traction in mobile banking and prepaid instruments (PPI)

120% 100% 20 India - Payments statistics 100% 70-75% 75% 75% 80% 60-70% 60-65% 70%* 15 60% 40% 10 20% bn US$ 5 0% 0 FY12 FY13 FY14 FY15

% traffic from mobile devices PPI Mobile banking

Source: Company data Source: RBI, Credit Suisse research

Figure 6: Overall, the VC funding activity remains robust Figure 7: …but some companies are facing greater for Indian start-ups… investor caution; instances of operation rationalisation 3,000 150 Vizury Dazo 2,000 100 LocalBanya Pickingo 1,000 50 HelpChat Tinyowl 0 0 Zomato 3QCY14 4QCY14 1QCY15 2QCY15 3QCY15 Housing Total VC investments (US$ mn) 0 200 400 600 800 1000 Number of VC backed companies [RHS] Recent employee lay-offs

Source: CBInsights Source: VCCircle

Figure 8: Amazon was the most visited e-commerce Figure 9: Companies we met during the trip website in October, ahead of the larger e-commerce peers

Source: Company data Source: Credit Suisse

India Internet Sector 2 16 December 2015 Rationality setting in? We met 20 leading e-commerce/internet companies across the main segments last week. After the aggressive pricing behaviour of the last couple of years, there seems to be some Funding has dried up rationality returning to the market. Most companies feel that the level of pricing/discounting somewhat, especially for in India has been unique and perhaps no other market has witnessed a similar kind of smaller companies cash-burn. Funding has dried up somewhat, especially for smaller companies, which is also causing companies to regulate their cash-burn. As far as different segments are concerned, the e-commerce ecosystem is evolving very E-tailing is scaling up rapidly in the country, as expected, and the companies are scaling up quickly. The rapidly; payment is growing payments ecosystem is also evolving but the market has started to get crowded with but is getting crowded multiple players. Wallet companies are focusing on increasing their use-cases. O2O continues to gain traction with several aggregators emerging in the market with attempts by even the e-commerce companies to enter some of these areas. For example, some e- commerce firms are trying to enter the grocery market on their own. With a large addressable market opportunity in many of the segments, there would be opportunity for multiple players to co-exist. There are a few businesses, however, where the network effect is very high—such as search, social media and local search. We believe market leaders here can have disproportionate advantage. While the companies we met were excited about the market opportunities, key challenges Internet access and logistics highlighted were on the logistics and internet infrastructure. The internet broadband are key challenges infrastructure still remains fragile and mobile is the key medium of growth for companies. The proposed GST and upcoming R-Jio rollout will be key developments for the sector. While exploring key takeaways from these meetings, we have used the same ten themes from our India Internet Primer #2 of 5 August 2015: Ten lessons from China.

Figure 10: Takeaways from our meetings

E-commerce eco-system No major public listings likely in Some regulatory next 2 years challenges

Plenty of activity in Many of the the payments categories are not space "leaders take all" 10 key takeaways from our Lot more focus meetings on logistics and Some signs of customer sanity experience

O2O becoming For Amazon, the next big India ≠ China thing Mobile first market has its own complexities

Source: Credit Suisse

India Internet Sector 3 16 December 2015 #1. Only a small proportion has active internet usage; infrastructure cost and quality are key constraints India's internet users have been increasing at a fast pace from approximately 100 mn 100 mn to 400 mn internet internet users five years back to ~400 mn (by the end of December 2015), according to users in five years… the estimates of India's internet association (IAMAI). This implies an internet penetration of over 30% by the end of 2015. However, this penetration number by itself is not a true indicator of the internet usage in …but only 40 mn have India. Our conversations with the industry experts during the trip suggest that of the 400 shopped online mn internet subscribers (or users) only about 300 mn would be accessing the internet at least once in 30 days. Even of these 300 mn internet users, only about 40 mn have been engaged in online shopping. Many of the first-time internet users restrict their usage to basic services such as WhatsApp, which are low in data consumption and have high frequency usage.

Figure 11: India's internet penetration has been Figure 12: …but still significantly low compared to the increasing rapidly… other emerging countries

400 30.0% 700 100%

350 90% 25.0% 600 80% 300 500 70% 20.0% 250 60% 400 200 15.0% 50% 300 150 40% 10.0% 200 30% 100 20% 5.0% 100 50 10% 0 0.0% 0 0% 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 China US India Japan Brazil Russia

Internet users (mn) Internet penetration [RHS] Internet users (mn) Internet penetration [RHS]

Source: Internet Live Stats, IAMAI, Credit Suisse. Note: The data as of 1 Source: Internet Live Stats July of each year. 2015 is estimated based on IAMAI estimates

Figure 13: A large chunk of population accesses internet Figure 14: Only a small percentage of the population has through mobile been using internet for e-commerce

% of people using internet on Internet mobile penetration (75%) (Over 30%)

Source: IAMAI, Credit Suisse Source: IAMAI, TRAI, Google, Credit Suisse estimates

India Internet Sector 4 16 December 2015

Cost and quality of the internet infrastructure are the key constraints One of the most significant hindrances that e-commerce companies highlighted during the Development of 'lite' sites to trip was the weak internet infrastructure in the country. With limited broadband penetration, address this issue the population largely relies on the mobile internet. However, mobile connectivity is very unreliable and the average mobile connection speed is very low in India. This leads to significant incidences of transaction drop-outs on mobile (i.e., transactions initiated on the mobile but not finished due to connectivity problems). Also, higher cost of mobile internet also leads to lower usage and hence lesser monetisation opportunities for the e-commerce firms. Consequently, many companies have created 'lite' mobile websites to overcome this problem. Language is the next barrier to cross India has wide language diversity and there is significant share of population with Given a large non-English knowledge of just one language. English is much more commonly used in India compared speaking population, there to China and hence the e-commerce companies started with English language, initially is focus on local languages targeting the relatively more affluent population that uses English. According to several for websites, apps estimates, only 10-12% of the population use English in India (~130-140 mn people) and most of these people are already internet users. Given a significant part of the incremental traffic for the e-commerce companies is coming from smaller cities and from remote areas within India the English literacy is even lower than the national average, local languages will become important. Six to seven key local languages such as Hindi, Tamil, Kannada, Gujarati and Marathi can cover a wide proportion of the population that is not comfortable with English. Most companies agree that vernacular language capabilities is important and several ones that we met have been working on developing vernacular language capabilities on their web portals/apps.

India Internet Sector 5 16 December 2015 #2. India is a 'mobile first' market and that has its own complexities Nearly two-thirds of the internet traffic in India originates from mobile devices. With Two-thirds of internet traffic reducing average price of smartphones (likely to decrease from US$135 in 2014 to originates from mobile US$102 by 2018), smartphone penetration in India is likely to increase from 14-15% devices currently to over 25% by 2018. This will make mobile all the more important.

Figure 15: India is largely a 'mobile first' market (% of Figure 16: With increasing smartphone penetration, this is internet traffic from mobiles) likely to increase even more 300 30% Nigeria India 250 25% UK

China 200 20% Japan US 150 15% Brazil Germany 100 10% France 50 5% Russia

0% 20% 40% 60% 80% 100% 0 0% FY13 FY14 FY15 FY16 FY17 FY18 Russia France Germany Brazil US Japan China UK India Nigeria Smartphone Penetration [RHS]

Source: Statscounter, Credit Suisse Source: eMarketer, Credit Suisse estimates Apps are important but 'app only' is not the right strategy A user at any point can access an e-commerce platform from three sources—desktop 'App only' does not work website, mobile website, or mobile app. While the desktop website gives better visual due to lack of 'real estate' on experience, the mobile website and app offer greater convenience (on-the-go usage). phones for many apps Additionally, the app also helps the e-commerce companies own the user (price comparison with other portals is a more tedious process when the user uses an app as compared to a website) and to have better engagement with the user. However, an app-only strategy has its own challenges. Many of the lower-end smartphones can support only 4-5 apps—this leaves very limited space for the not-so- frequently-used apps. Many of these will be apps such as WhatsApp, Facebook, and Gmail. This leaves little space on the mobile for other apps. Given that a large chunk of new online shoppers is likely to be from the mid- to lower-end of the consumer pyramid with lower-end smartphones, the storage space availability is a big constraint. Considering these shortcomings, the app-only strategy does not seem very effective. The two companies—Flipkart and Myntra—that were the proponents of this strategy seem to have changed their mind and have relaunched their mobile websites.

India Internet Sector 6 16 December 2015

Figure 17: Mobile is big for Indian e-commerce players % traffic from mobile devices 120%

100% 100%

80% 75% 75% 70-75% 70% 60-70% 60-65% 60%

40%

20%

0%

Note 1: Hotel bookings for MakeMyTrip. Note 2: Trademarked icons used. Source: Company data, Credit Suisse Mobile has its own challenges With over 95% of telecom subscribers still being prepaid, most of them have a limited data Speeds and storage are usage plan (and once the data usage crosses the plan limit, the charges are typically very challenges high). This makes Indian mobile users very particular about their data usage. Further, only ~10% of the internet users in India have 3G connections as compared to ~40% in China. Besides the smaller screen size of mobile phones, data consciousness and low quality and unreliable internet connection pose challenges before the e-commerce firms. The e- commerce companies have taken a few initiatives. For example, Flipkart and Snapdeal have launched the 'lite' version of their mobile websites that consume lesser data and work better with weaker mobile networks. Flipkart has worked with Google's Chrome team to roll out an app-like mobile website, that supports push notifications, location-based data and access to phone features such as cameras. High expectations from the R-Jio launch The e-commerce industry has high expectations from the upcoming rollout of R-Jio. Better data quality at cheaper price can make the mobile experience better and increase the data usage, providing higher monetisation opportunities to the e-commerce firms.

India Internet Sector 7 16 December 2015 #3. Plenty of activity in the payments space…and plenty of players India is largely a cash-based economy. It has a large payments market (US$2 tn) and most of it is done in cash. Credit card penetration is low at about 1.5% of population and debit cards (35% penetration) are used to a large extent for cash withdrawal. Even within the financial sector, a large chunk of transactions happens in cash. For example, about 90% of the business of Microfinance Institutions (MFIs) happens in cash in India. In categories such as recharge, there has been some traction with platforms such as PayTM, Freecharge, Mobikwik making decent headway. However, the other areas still remain wide open and cash continues to dominate. Other areas in online finance such as loan and policy distribution, lending (including P2P lending), crowd funding, fund distribution and online deposits are yet to see any significant traction. There are several regulatory constraints in these segments.

Figure 18: A large proportion of consumer transactions in Figure 19: Although small, there is some traction in India are in cash mobile banking and prepaid instruments (PPI) 18 100.0 % cash consumer transactions volume India - Payments statistics 16 90.0 80.0 14 70.0 12 60.0 10 50.0 US$ bn US$ 8

40.0 6 30.0 4 20.0 2 10.0 0 0.0 FY12 FY13 FY14 FY15

PPI Mobile banking

Source: Mastercard Advisors' Cashless Journey report 2013 Source: RBI, Credit Suisse Several companies, besides the traditional banks, have been trying to build a business in the payments segment in India with an online proposition. Our conversations suggest that four models are emerging:

■ Remittance led: This includes companies such as ItzCash, mRUPEE and Oxigen.

■ B2C led: This includes companies such as PayTM, Freecharge (owned by Snapdeal), and Olamoney (Ola cab's wallet).

■ B2B2C led: This includes offerings for the insurance, microfinance companies. mRUPEE, ItzCash and Vodafone M-Pesa operate in this space.

■ Payments bank and small bank: These include entities such as Airtel Money, Vodafone M-Pesa, and Idea Money.

India Internet Sector 8 16 December 2015

The wallet market is scaling up fast The wallet market has been scaling up fast. Two categories of players have emerged in US$1.3 bn of wallet the segment: (1) online-loaded wallets and (2) offline-loaded wallets. PayTM and Mobikwik transactions now versus are online-loaded wallets, targeting the existing internet banking using population. The US$150 mn two years ago offline wallet market is much more fragmented and includes players such as mRupee, ItzCash, Oxygen, Airtel Money, and Vodafone M-Pesa. According to RBI (Reserve Bank of India) data, there were 255 mn transactions on mobile wallets, aggregating over US$1.3 bn in value (from less than US$150 mn a couple of years back). Although this is a small part of the payment ecosystem, it has been growing at a very rapid pace. While the current regulations do not allow wallet companies to pay any interest on the float in the wallet, the companies with Payments Bank licences will have an advantage as they would be now able to offer interest to the wallet customers. PayTM should benefit from this. The firm already seems to have a lead in this space. With a couple of strong use cases (exclusive Uber tie-up, PayTM marketplace, and recharge/bill), PayTM's total number of wallets has crossed the 100 mn mark. Non-banking players taking the lead in bringing under-banked population online So far, the traditional banks seem to be focused on the more affluent internet using population for mobile/internet banking. On the other hand, non-banking players such as mRUPEE and ItzCash have been taking the lead in bringing the under-banked population online. These companies have built large store presence across the country, covering most of the towns/villages with access to internet. For example, mRUPEE uses the Tata Docomo outlets for loading the wallets/remittance and ItzCash has a tie-up with over 75,000 retail outlets. ItzCash has also tied-up with Flipkart—people can visit ItzCash stores, pay cash and buy products online with the help of store persons. Banks building digital business as a tool for retaining customers' wallet share Traditional banks are also taking several initiatives on the digital side as a strategy to retain the customers' wallet share and owning the customers. Non-banking players in the payments space have been causing some disruption and with the Payments Bank licence, could cause some shift of funds from banks' deposits to their wallets in terms of float. Also, the fee income from financial product distribution could be impacted by the online financial product marketplaces such as Policybazaar.com and others.

India Internet Sector 9 16 December 2015 #4. India is not necessarily a winner-takes-all market Large addressable market; except for a few segments, there is no clear leader by huge margins India's e-commerce market is highly fragmented. There are only a few segments (such as There are only a few search, online job search, social media and online video) where one can identify a clear segments (search, online market leader. Our conversations with the leading e-commerce companies indicate that job search, social and video) there is space for 2-3 large players to exist in most of the categories, unless the where one can identify a addressable market size is very small or the network effect is very high. clear market leader For example, in the horizontal e-commerce, there is a large addressable market and the No. 1 player (Flipkart) does not have a big lead like Alibaba in China and the No. 2 and No. 3 players (Snapdeal and Amazon) are broadly similar in size. Similarly in the travel vertical, MakeMyTrip and Goibibo seem to be well settled on the top-two positions and the players below them will need to have a clear value proposition.

Figure 20: India's e-commerce market is very fragmented in many segments

Note: Trademarked icons used. Source: Company data, Credit Suisse

India Internet Sector 10 16 December 2015

Consolidation looks inevitable in some segments The Indian e-commerce market is still very underpenetrated in many categories and there is ample scope for multiple players to co-exist. However, given that the current growth phase is driven by aggressive pricing, the ability to scale up depends on the availability of funding. The smaller players are in a Catch-22 situation, as investors want to see relative growth before providing funding and growth, in turn, depends on the availability of funding. In such a situation, there is scope for market consolidation, with larger players acquiring some of the smaller ones. Markets such as real estate, food delivery/food tech, travel and grocery have become hyper competitive and may be among the first to see some consolidation. Many of the vertical categories have three to four players. The smaller players could be acquired by the horizontal or the larger vertical players. For example, in the real estate classifieds vertical, there are 5-6 reasonably large players and a list of small players. There has already been some consolidation in this segment with Proptiger acquiring Makaan and there have been reports of the likely acquisition of Commonfloor by Quikr (as reported in Business Standard). Other segments such as fashion e-commerce has also become crowded and some of the firms have very similar value proposition.

India Internet Sector 11 16 December 2015 #5. Hyperlocal and O2O can become the next big thing Hyperlocal e-commerce has been witnessing increasing adoption in India. The Taxi, classifieds, grocery, addressable markets for these hyperlocal services typically includes cities and towns with restaurants are some of the population above 1 mn. On the services side, similar to China, there has been decent key segments adoption of e-commerce channels in taxi, real estate and restaurant search and food ordering. While online taxi has a transaction enabling business model, real estate portals and the online food platforms to a large extent are currently used as classifieds platforms. There has also been some traction on the O2O physical store e-commerce segment. India has a large local trader base that is offline and not yet on the e-commerce platforms. These hyperlocal e-commerce platforms are trying to bring the offline stores online, positioning themselves as pro-offline stores vs. the anti-offline stores positioning of the e- commerce platforms. Several players such as Justdial and Zopper (mainly in electronics) have been active in this space. Grocery is a large market with some players preferring an inventory-led approach (such as BigBasket) while others prefer a pure marketplace approach by listing the local "kirana" stores (traditional grocery stores) on their platform (e.g., PepperTap, ZopNow). Grofers now has a hybrid model versus its earlier sole-marketplace one.

Figure 21: Local lifestyle O2O has become a large market in China and the penetration is still low relative to overall e- commerce penetration

80 GMV and penetration of local lifestyle O2O market 7%

70 6%

60 5%

50 4% 40 3% 30

2% 20

10 1%

0 0% 2010 2011 2012 2013 2014 2015 2016 2017

GMV (US$ bn) % penetration [RHS]

Note: Includes segments such as catering, entertainment, beauty and hairdressing, hotel, wedding service and parent-child related services. Source: iResearch, Credit Suisse estimates The 'aggregation' space has become quite popular Aggregation model has become quite popular with several new online aggregation platforms emerging for a broad range of products/services. This ranges from grocery, laundry, courier, home services, medicines to categories as diverse as auto parts and repairs. While there are several vertical specific start-ups in this space, Justdial (through its "SearchPlus" offering), LocalOye and TaskBob are building their businesses as horizontal aggregators. Given Justdial's scale (business listings as well as the user base), it can potentially have an edge at the moment.

India Internet Sector 12 16 December 2015

Horizontal e-commerce platforms expanding into grocery Given the large untapped opportunities in O2O, larger horizontal e-commerce firms have Flipkart, Snapdeal, Amazon, also taken some initiatives in this segment. Amazon has recently launched Kirana Now (an PayTM are all making some on-demand delivery service which sources from local 'mom-and-pop' stores and moves in this segment guarantees deliveries within two to four hours) on a small scale. Snapdeal is approaching the hyperlocal segment through acquisitions and financial investments (following a strategy similar to its investor Alibaba). It is also piloting with 'Snapdeal Instant' in a few cities. Flipkart is also working on hyperlocal offerings, particularly in groceries and plans to scale up this business over the next six months. PayTM is also running pilots in grocery in Bengaluru and has also made some acquisitions in this area (it recently acquired Near.in for hyperlocal home services). It also has a reasonably large offering in online ticketing (particularly bus ticketing). Justdial eyeing overall O2O opportunity Justdial already has a large reach on both ends—businesses as well as the users. It launched an upgraded version of its app recently with significantly better user interface. It aims to increase user engagement and create a platform that offers all local services under one roof. The company plans to provide services ranging from online shopping (hyperlocal), doctor's appointment, table reservation, ticket booking, food ordering, grocery ordering, bill/payment recharge, etc. The company is still in the process of fixing the backend and tying up with the merchants/logistics service providers. Monetisation of these services will likely take time. Given the merchants' back-end systems are not yet integrated with Justdial's platform, there could be execution challenges. Justdial will launch JD Omni—an ERP solution for the merchants. Justdial thinks this can solve the back-end integration problem.

India Internet Sector 13 16 December 2015 #6. Signs of rationality; funding has dried-up in some segments Pricing has always been an integral part of the e-commerce strategy in China as well as in Segments such as real the more mature US market. Besides inherent cost advantages, the internet also leads to estate and food tech have more transparent pricing as price discovery is more efficient. Switching costs are low for seen significant moderation shoppers, which further reduces the pricing power of the e-commerce companies. Hence, in competitive activity pricing has extensively been used as a tool to survive in a competitive environment and to acquire new clients or retain existing clients. Indian e-commerce firms' pricing strategy includes cashbacks and merchant incentives besides the normal discounts. Even the marketplaces have been funding some of the discounts on the products sold on their platforms. Besides pricing, Indian e-commerce firms have also been very aggressive in marketing to attract user traffic on their platform. From our conversation with various companies, we understand that some rationality is returning in the market. Some of the segments that were intensely competitive until the last few months have witnessed some moderation in competitive intensity. Real estate and food delivery/food-tech are two such examples. Although the investment activity remains high, investors are more cautious Although the VC investment activity in the start-ups continues to remain robust in India, we understand that there has been more caution among the e-commerce investors for successive rounds of funding. The focus seems to be shifting from just traffic share and user base statistics to revenue and a path towards profitability. The companies are now talking about reducing the cash-burn. The larger e-commerce firms do not seem to be feeling the pressure as much from their investors at the moment. However, several smaller ones (more particularly in O2O and Hyperlocal) are now finding it relatively difficult to raise funds. The companies are trying to realign business strategies accordingly. There has been a lot of news flow on companies rationalising their operations. For example, leading vertical players such as Zomato, TinyOwl, Housing.com and hyperlocal grocery marketplace LocalOye have been reported to have laid-off a chunk of their employees.

Figure 22: Overall, the VC funding activity remains robust Figure 23: …but some companies are facing greater for Indian start-ups… investor caution; instances of operation rationalisation 3,000 160 Vizury 140 2,500 Dazo 120 2,000 LocalBanya 100

1,500 80 Pickingo

60 HelpChat 1,000 40 Tinyowl 500 20 Zomato

0 0 Housing 3QCY14 4QCY14 1QCY15 2QCY15 3QCY15 0 200 400 600 800 1000 Total VC investments (US$ mn) Number of VC backed companies [RHS] Recent employee lay-offs

Source: CBInsights Source: VCCircle

India Internet Sector 14 16 December 2015

Discounting activity intensified again somewhat after the festive season; companies expect it to moderate in coming months The e-commerce firms have rationalised the discounts to some extent since the beginning of FY16. However, during the festive season (starting October 2015), like last year, all the e-commerce companies came up with festival offers at the same time, with a focus on increasing user traffic and GMV. For example, Flipkart sold goods with a GMV of about US$300 mn during its 'Big Billion Days' sale (from 13 October to 17 October 2015), nearly 3x the GMV of last year. Snapdeal and Amazon too witnessed a significant increase in their GMV, although they did not quantify it. During our conversation with these e-commerce companies, there seemed to be greater focus on profitability and management seems to be thinking about breaking even in the medium term. Aggressive pricing behaviour continues in the online taxi space, however At a time when several segments of the e-commerce market are starting to think about revenue and profitability, the online taxi segment remains hyper-competitive. Our conversations with the industry participants indicate that the rate of cash-burn probably continues to remain high for both Ola and Uber. Also, it seems to remain as one of the favourite e-commerce segments for investors and funding does not seem to be challenged at the moment.

India Internet Sector 15 16 December 2015 #7. For Amazon, India ≠ China Amazon entered the China market with the acquisition of Joyo.com in 2004, later dropping Amazon was the most this name in favour of Amazon China and shortened its local website URL to 'www.z.cn'. visited e-commerce website Despite a relatively early move and technological superiority over Alibaba during the early in India in October days (due to its investments in the US), Amazon has struggled to capture a significant share of the Chinese e-commerce market. With its poor show in China, there has been a lot of focus from the company on the Indian market. The progress of Amazon in India has so far been impressive and we heard positive things about the company during our trip. Indeed, the recent comScore traffic share data indicates that Amazon was the most visited e-commerce website in October, ahead of the larger e-commerce peers Flipkart and Snapdeal. Also, its traffic has been more or less similar to Flipkart over the last six months. While this data may not include the app traffic, it does reflect the growing acceptance of Amazon in India. Figure 24: Amazon was the most visited e-commerce website in October, ahead of the larger e-commerce peers Flipkart and Snapdeal

Source: comScore, Company data Amazon seems to have learnt lessons from China; following a flexible and localised strategy in India Unlike in the case of China, we believe that Amazon should be able to compete efficiently with home-grown e-commerce leaders such as Flipkart and Snapdeal. There are structural market-specific reasons as well as company-specific initiatives for this belief. Structural factors

■ Relatively more fragmented market in India: There is a structural difference between India and China's e-commerce markets. Unlike China, where Alibaba soon obtained a dominant market share, India's e-commerce market is much more fragmented. This reduces the ability of one firm to control the market.

■ Better familiarity with India: Amazon has had some familiarity with the Indian market Amazon has been in India and people here, given its presence in India for several years even before operating the for many years through its online marketplace. It has had a technology centre (the Indian operating centre is development centres Amazon's largest centre outside the US) for many years. The company thus had familiarity with local laws and in dealing with local entities. Furthermore, Amazon was also a reasonably well-known brand and a few buyers in India were actually using Amazon's US website for buying books and movies that were not easily available in India.

India Internet Sector 16 16 December 2015

Several other company-specific initiatives Besides the above structural factors that increase Amazon's probability of success in India, Amazon is also applying its learnings from the China experience, with a significant focus on localisation.

■ Localised approach: Amazon is following a more localised approach in India. Its recent 'Aur dikhao' (show more) campaign targeting the traditional Indian population and its sponsorship of the Indian Premier League or IPL (one of the most popular events across India attracting significant eyeballs) have been impressive strategies to engage more users and position the company as a localised player. Amazon has also been introducing new product categories. Localised approach, together with among the best user experiences, has helped business gain traction.

■ Support to merchants: Similar to other e-commerce marketplaces in India, Amazon is also focused on engaging, onboarding and supporting merchants. It has also opened an exclusive call centre for merchants (it will be managed by a third-party outsourcing firm).

■ Greater management focus after missing out the China opportunity: Given the fact that Amazon has not been able to capitalise on the China opportunity to the extent it had expected, management seems to be very keen on establishing itself in India. Within a year of its operations, India has become Amazon's fastest market to have crossed US$1 bn GMV so far. Amazon's founder and CEO, Jeff Bezos had visited India in September 2014 and announced US$2 bn investments in Amazon India and there are media articles (Firstpost) on the company's plans to make further investments in India. India has been a frequently discussed topic in Amazon's recent quarterly earnings calls as well.

India Internet Sector 17 16 December 2015 #8. A lot more focus on logistics and customer experience among the e-commerce companies Logistics includes back-end (packaging, warehousing, seller management) and front-end (last mile delivery, payment, returns and customer services) functions. After marketing, this is one of the biggest cost items for the Indian e-commerce firms. While pricing still remains a priority, customer fulfilment is also becoming an important factor for consumers. E-commerce firms are trying to differentiate and more effectively compete against offline players with initiatives around faster and more predictable delivery. This has also raised the level of customer expectations. However, the standard of infrastructure is still not supportive of this.

Figure 25: Logistics value chain for an e-commerce transaction

Source: Dion research and analysis, Credit Suisse Significant investments in logistics Indian e-commerce firms are making significant investments in logistics. These companies 80%-plus of logistics for are building the warehousing network (through their own and leased warehouses) and many large e-tailers ate trying to have as much control over the goods movement as possible. For example, through own logistics Snapdeal claims to have 80% of deliveries from its controlled warehouses. Amazon claims that 90% of the sellers on its platform use Amazon's logistics and warehouse and its fulfilment capacity has increased by nearly 3x over the past year. Flipkart does ~85% of its deliveries through its in-house logistics arm eKart, and claims that about 70% of the deliveries are within three days of placing the order. Flipkart has plans to spend US$3-4 bn in logistics infrastructure over the next five years. PayTM, on the other hand, is trying to build a logistic cloud (network of warehouses not owned by it), similar to Alibaba. For last-mile delivery, the e-commerce firms are using a combination of in-house delivery network as well as third-party last-mile delivery partners (such as Delhivery, Ecom Express, Blue Dart, and Gati).

India Internet Sector 18 16 December 2015

Besides customer services, e-commerce platforms have also been offering several seller assistance services including fulfilment, delivery assistance, call centre assistance and assisted financing (through financing institutions). Cash on delivery (COD) remains (and may remain) the primary mode of payment With a large cash economy, low penetration of electronic banking and credit cards and a COD is more than 50% of trust deficit among customers (particularly in smaller cities), a large proportion of e-tailing total transactions transactions still happens through cash on delivery, which is an inefficient way of payment. This increases the instances of returns of goods sold and increases the working capital requirement. However, given the structural challenges, the Indian e-commerce firms have learnt to live with it. Companies have come up with options such as cards on delivery but it has had limited adoption so far. Our conversations suggest that COD still accounts for 50-55% of the online shopping transactions (excluding travel booking) for many companies and that this number has not materially changed over the past couple of years. Companies such as Paytm and PayU have their wallets, and banks have been aggressively promoting the usage of their own wallets besides debit/credit cards and net banking. E-commerce portals such as Flipkart also have their own wallets but the usage is still limited.

India Internet Sector 19 16 December 2015 #9. GST should benefit e-commerce players; online taxi segment could be disrupted by regulations In India, there are many taxes levied by the centre, the state governments and various GST will reduce delivery local bodies at different stages of the supply chain such as excise duty, central sales tax times (CST), value-added tax (VAT) and octroi. In addition, the state governments and various local bodies often have different taxation rates and policies. Due to such complex indirect tax regime many of the warehouses of the e-commerce companies have been suboptimally set-up. Furthermore, due to stringent compliance procedures for inter-state road transport, the transport time is significantly higher. This is the reason most of the e- commerce companies use air transport for shipments, and this increases the overall cost structure. A single Goods and Service Tax (GST) that is under discussion by the Indian government can help in solving many of the logistic challenges. A single GST will subsume all current taxes into one tax and stitch together a common market by dismantling fiscal barriers between states. While the overall tax incidence may increase due to higher likely revenue neutral rate (RNR), it may not impact the overall cost competitiveness of the e-commerce firms vis-à-vis brick-and-mortar retailers. Brick-and-mortar retailers will also have to face some impact from higher RNR. E-commerce firms should benefit from a more efficient supply chain network and can increase the share of goods transported by road. The companies we met were very optimistic about the benefits of GST. Restrictions on FDI in B2C e-commerce in India: No further progress Restriction on FDI in multi-brand retail including in e-commerce (B2C e-commerce) is another challenge. The e-commerce industry requires significant investments and highly efficient operations to run successfully and, in this context, FDI restriction can be an impediment. This has been forcing companies to structure themselves in a way that they operate purely as marketplaces. For example, Amazon, that has preferred an inventory- based model globally, has transitioned to a marketplace in India. Companies such as Flipkart have hived off their inventory operations to comply with these norms and have been increasing their exposure to third-party merchants. Given concerns about logistics and consequently the customer experience (given limited experience of the third-party merchants), these companies have invested in their own 'fulfilment' operations, assisting the selling merchants with warehousing, packaging, delivery and reverse logistics. FDI restriction could also potentially impede consolidation between a marketplace and an inventory-based model. Online taxi segment could be disrupted by regulations So far, the online taxi segment has been a great growth story in India. While firms such as Curbs on diesel cars, Ola and Uber have had some customer safety issues, they have managed to keep up their licences, and price controls growth momentum. are some of the steps being contemplated by authorities However, similar to Uber's global experience, it may also face some regulatory challenges in India. There have been protests from taxi unions and recent safety-related incidents have put these taxi companies under the scanner (e.g., the ban in Delhi). The recent guidelines by the Ministry of Road transport classifies these companies as on- demand information technology-based aggregators and not as taxi companies, which is good news for the operators but gives state governments the power the accept or reject the guidelines.

India Internet Sector 20 16 December 2015

States such as Maharashtra and Karnataka have come out with their draft guidelines that have provisions such as a floor and cap on price charged and a cap on the number of taxis registered under a platform, besides many other minor regulations. These two conditions can have a meaningful impact on the business model of Ola, Uber and Meru (albeit to a lesser extent as 35% of the Meru's taxis are owned by the company and licensed). Furthermore, the Supreme Court has ordered the app-based cabs to move to CNG by 31 March 2016. Currently, a large chunk of these players' cabs is diesel-based and a diesel vehicle cannot be converted into a CNG one easily. Hence, if these regulations come through as proposed, these could have negative implications for the taxi aggregators.

India Internet Sector 21 16 December 2015 #10. No major listings likely in the next couple of years The Indian e-commerce sector has really taken off over the last couple of years. Several companies have been operating for some years now but have started scaling up significantly only during the last couple of years. While the market opportunity is large, most of the e-commerce segments have severely competitive dynamics and the current strategy of the firms seems to be to build a moat around themselves by scaling up and outsizing their competitors. In this process, most of these companies are incurring heavy losses. The private capital interest seems to have somewhat moderated but our conversations suggest that larger and relatively more unique companies continue to draw investor interest. Our conversations with leading e-commerce players indicate no plans of public listing for Public investors may want at the next couple of years or so. The general thought process among the e-commerce firms least a path to profitability, if seems to be that a public listing could restrict their ability to aggressively invest in the not actual profitability business and that public investors may want to see at least a concrete path to profitability, if not actual profitability itself. While smaller e-commerce companies such as Infibeam and Bharat Matrimony have filed a Draft Red Hearing Prospectus (DRHP) with the regulator SEBI for a potential IPO, we do not think any larger e-commerce IPOs are likely to follow suit anytime soon.

Figure 26: Several e-commerce companies in India have been operating for quite some time

16 Age of the companies Average age of Chinese Age at the time of listing e-commerce companies 14 at the time of listing

12

10 Current age of unlisted Indian e-commerce companies

8

6

4

2

0

Note: PayTM's parent entity has been in operations for many years but the e-commerce (including payments) business is only five years old. Source: Company data, Credit Suisse

India Internet Sector 22 16 December 2015 Meeting takeaways for the listed companies Info Edge

■ Naukri business continues to maintain the lead: According to management, Naukri (recruitment classifieds) business remains a market leader by a margin. LinkedIn was initially perceived as a competitor but the Info Edge has realised that their focus areas are different and they can co-exist.

■ Moderation in competitive intensity in real-estate classifieds segment: Competitors have become less aggressive and rationality is setting in. Although the underlying real estate market remains challenged, management remains optimistic about the long-term opportunity. According to management, 99 acres is the largest player in terms of online classifieds revenue in the real estate segment now (ComScore traffic share of 45% in October though that varies from month to month). It does not intend to chase transactional revenue, given the amount of 'black money' that is involved, the time to complete a transaction and the challenges sometimes in collecting the fees.

■ Some changes in plans at Zomato: There is more focus on monetisation and cash- burn reduction, given an increasingly tougher funding situation. This should reflect in the results of the coming quarters. It expects its last round of funding to see it through break even. Given ~95% of the traffic goes to 40% of restaurants listed on the portal, the company has done some staff rationalisation.

■ Unsure about matrimony and education: Given its No. #3 position in matrimony, management admitted that it was still trying to figure out a long-term strategy for this business. In education, many of the educational institutions who used to pay for leads are under stress. JustDial

■ 'Search Plus' is very complementary to the 'local search' business: According to management, the 'Search Plus' business, even if it does not result in a large monetisation in the medium term, is complementary to the core local search business. This should eventually help the company maximise the paid listings on the platform. The company's evangelist programme is targeted towards the users in the age group of 40-plus as the company believes this segment has the most potential and also the most inertia.

■ Focus is on making JustDial a one-stop platform: The objective of the JustDial app is to have one app for all services. The company has been doing several tie-ups with third-party platforms such as MakeMyTrip, RedBus, BlueDart and EasyCabs. It has been using API integration with various third-party platforms for this purpose.

■ In the physical goods e-commerce, JustDial is more about price discovery platform than a product discovery platform, providing information on price from local merchants as well as third-party platforms (such as Flipkart, Amazon). JustDial offers a 'JD guarantee offer'—with guaranteed seven hours delivery if the order is placed before 2 pm, manufacturer's warranty and 24*7 customer support.

■ Many of the merchants are not integrated to the JustDial platform: Many of the merchants listed on the JustDial platform are not integrated with JustDial at the backend. This could create challenges relating to inventory availability and pricing.

India Internet Sector 23 16 December 2015

The company is focused on launching its "Omni" solution soon to address this and believes that it can be monetised.

■ The full-fledged launch may take one more month: The full-fledged launch of the upgraded JustDial platform may take one more month. The company is in the process of tying-up with the partners and building back-end processes. MakeMyTrip

■ A change in philosophy with focus on market share: While historically MakeMyTrip (MMT) has abstained from aggressive pricing, it is more responsive now to the competitive environment with a focus on building market share. It sees some of its traditional competitors as being strapped for cash while newer ones are competing more aggressively. With US$100 mn in cash, MMT has strong ability to compete.

■ Hotels is a large focus category: MakeMyTrip sees domestic hotels as an extremely fast-growing category. It estimates 15% of all inventory (25% if you assume occupancy of 60%) to be sold online now. It has so far had a larger focus in 4-5 star category hotels and management believes that it has leadership in that segment. For the budget segment, the company has launched the 'value plus' offering.

■ Share of packaging business may come down: There has been a trend wherein customers book tickets and hotels separately. Packages is currently close to half of the H&P (Hotels and Packaging) segment but its share can come down going forward, given the high growth in the hotel segment.

■ Margins may remain under pressure in the near term: The margins in the hotels and packaging segment have come down from 13% to 10-11% but management believes it has potential to go up in the long run. However, in the near term, margins may remain under pressure.

■ Models such as AirBnB are yet to take-off in India. MakeMyTrip is already working in segments such as guest houses.

India Internet Sector 24 16 December 2015

Appendix

Figure 27: Companies that we met Company Business Segment BigBasket Online Grocery Flipkart E-tail (Horizontal) Gaana Online Music Google India Search Grofers Hyperlocal Mobile Commerce HDFC Bank Bank Healthkart/1MG E-tail (Healthcare) HolidayIQ Online Travel Info Edge Online Classifieds InMobi Mobile Advertising ItzCash Payments JustDial Local Search MakeMyTrip Online Travel Meru Radio cabs mRUPEE Payments PayTM E-tail (Horizontal) and payments Quikr C2C classifieds Snapdeal E-tail (Horizontal) Yepme E-tail (Fashion) Zopper Hyperlocal marketplace Source: Credit Suisse

India Internet Sector 25 16 December 2015

Companies Mentioned (Price as of 15-Dec-2015) Alibaba Group Holding Limited (BABA.N, $82.49) Amazon com Inc. (AMZN.OQ, $658.64) Google (GOOAV.OQ, $568.67) Info Edge (India) Limited (INED.NS, Rs827.6) Just Dial Limited (JUST.BO, Rs916.6) MakeMyTrip (MMYT.OQ, $17.88)

Disclosure Appendix

Important Global Disclosures I, Anantha Narayan, certify that (1) the views expressed in this report accurately reflect my personal views about all of the subject companies and securities and (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report.

3-Year Price and Rating History for Alibaba Group Holding Limited (BABA.N)

BABA.N Closing Price Target Price Date (US$) (US$) Rating 29-Oct-14 98.31 114.00 O * 05-Nov-14 108.67 118.00 29-Jan-15 89.81 113.00 09-Mar-15 82.53 112.00 08-May-15 87.06 114.00 13-Aug-15 75.11 105.00 16-Oct-15 71.99 95.00 28-Oct-15 82.35 98.00 * Asterisk signifies initiation or assumption of coverage. OUTPERFORM

3-Year Price and Rating History for Amazon com Inc. (AMZN.OQ)

AMZN.OQ Closing Price Target Price Date (US$) (US$) Rating 13-Jan-13 267.94 301.00 O 30-Jan-13 272.75 334.00 26-Apr-13 254.81 320.00 26-Jul-13 312.01 330.00 25-Oct-13 363.39 439.00 17-Dec-13 387.65 449.00 25-Apr-14 303.83 439.00 25-Jul-14 324.01 431.00 14-Oct-14 308.31 422.00 24-Oct-14 287.06 395.00 14-Jan-15 293.27 389.00 30-Jan-15 354.53 410.00 14-Apr-15 385.11 412.00 24-Apr-15 445.10 480.00 24-Jul-15 529.42 700.00 09-Oct-15 539.80 720.00 23-Oct-15 599.03 777.00 * Asterisk signifies initiation or assumption of coverage.

India Internet Sector 26 16 December 2015

3-Year Price and Rating History for Info Edge (India) Limited (INED.NS)

INED.NS Closing Price Target Price Date (Rs) (Rs) Rating 21-Jan-13 334.90 470.00 O 03-May-13 357.00 430.00 18-Jul-13 316.70 420.00 11-Dec-13 454.60 540.00 21-Jan-14 569.60 540.00 N 21-Jul-14 701.40 610.00 * 22-Sep-14 874.35 800.00 16-Oct-14 849.95 790.00 19-Jan-15 808.85 870.00 01-Jun-15 809.95 890.00 OUTPERFORM NEUTRAL 27-Jul-15 880.70 870.00 08-Nov-15 712.45 800.00 * Asterisk signifies initiation or assumption of coverage.

3-Year Price and Rating History for Just Dial Limited (JUST.BO)

JUST.BO Closing Price Target Price Date (Rs) (Rs) Rating 19-Sep-14 1725.15 1650.00 N * 22-Oct-14 1636.00 1575.00 29-Jan-15 1554.20 1625.00 11-May-15 1086.35 1400.00 O 15-Sep-15 914.10 1350.00 29-Oct-15 854.75 1275.00 * Asterisk signifies initiation or assumption of coverage.

NEUTRAL OUTPERFORM

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Volatility Indicator [V] : A stock is defined as volatile if the stock price has moved up or down by 20% or more in a month in at least 8 of the past 24 months or the analyst expects significant volatility going forward.

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India Internet Sector 27 16 December 2015

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India Internet Sector 29 16 December 2015

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