E-commerce start-ups collectively overvalued: Aswath Damodaran
Mumbai: India’s e-commerce and consumer technology start-ups, many of which have raised funds at lofty valuation in recent months, may be collectively overvalued, says Aswath Damodaran, an authority on corporate finance and valuations.
While he would not hazard a guess about valuation of individual companies, taken together, the size of the macro story may not justify the micro-valuations, said Damodaran, a professor of finance at the Stern School of Business, New York University.
“I do believe that collectively, the markets that are being used to justify these valuations (online advertising in particular) are not big enough to justify the prices being paid, which I guess is a backhanded way of saying that the stocks are collectively overpriced,” he said in an interview.
Damodaran was in India to conduct a corporate finance and business valuation workshop on 10-11 August for VCCircle Network, a media and publishing company.
According to data from CB Insights, a venture capital database backed by the National Science Foundation, Indian e-commerce and consumer technology firms have raised $3.5 billion from January to June this year.
A number of these firms have seen their valuations rise with each subsequent funding round.
For instance, the valuation of e-commerce marketplace Flipkart’s is likely to have increased to about $15 billion from less than $2 billion at the beginning of 2014. Snapdeal may be valued at $5 billion from less than $1 billion 18 months ago, according to a 11 August Mint report.
While some firms in these segments will indeed become very valuable, the challenge investors face is in determining which will be those companies, said Damodaran.
According to him, venture capital (VC) investors need to ask four questions when looking to infuse money in one of these companies: Do start-ups have a plan that goes beyond users/downloads and considers how to make money? How does the company plan to deal with failure? How does it plan to deal with success? How easily imitated is the company’s basic business model or product?
Damodaran, who authored the book The Dark Side of Valuation: Valuing Young, Distressed, and Complex Businesses, says that investors must also clearly identify the business that their portfolio companies are in.
“After all, social media or an app is not a business. You need to make a judgement on how the company will make money (charge per download/advertising/retailing) and work with that market potential,” said Damodaran, adding that all valuations should be built around the stories of the start-ups.
“...with young start-ups, this is particularly true.”
Experts agree with Damodaran’s view that collective valuation seen across the e-commerce and consumer technology space is perhaps overdone and not sustainable.
“As a collective, industry valuations are rising, but investors believe those who will survive will manage to pocket returns of 30-50%—which is why they are investing at this speed,” said Kashyap A. Chanchani, managing partner at The RainMaker Group, a digital technology-focused investment bank in Mumbai. Chanchani added that valuations have been driven higher as investors—from seed investors to the VC and PE funds—are all chasing the same deals.
On the low promoter holding across the Indian start-up space, Damodaran said that this may be a consequence of the fact that the market had a relatively small number of investors, until recently.
“Perhaps, the Indian founders have to give up more of their companies because there is less competition among VCs. That will change as greed pulls in more VCs into the business. There is a danger that if the stake becomes too low, the founder/owners will just walk away from the businesses rather than expend more effort,” he said.
Damodaran’s concerns over valuations are not restricted to private consumer technology firms.
Public-listed equities in India also seem richly priced and are building in expectations of a quick turnaround in the economy, he said. “If that optimism is not backed up by action, there will be an emotional and a price letdown.”
The BSE’s benchmark Sensex returned 29.9% in 2014 and is up 1.4% so far this year. Although markets have risen, earnings of listed firms have remained weak, which has pushed up valuations.
According to Bloomberg data, the Sensex traded at 16.79 times one-year forward price-to-earnings (P/E) ratio as of last Thursday, making it the third-most expensive market among prominent emerging markets, trailing only the Philippines and South Africa.
Damodaran is critical of the Indian government’s divestment programme, saying that selling shares in the state-owned firms, while retaining control, is misleading the market.
“My problem with the government privatizations is that the government wants to have their cake and eat it too. They want to raise money from privatization by selling these companies, but they also want to preserve their rights to interfere in these companies, often with political objectives. Markets are not stupid and build the cost of this political interference into the prices,” Damodaran added.
The government has fixed a divestment target of Rs.69,500 crore for the current fiscal year.
Damodaran had a final word of advice to the many firms and investors he met during his trip to India: just “chill”.