Valuations are more a reflection on execution, says Parag Gupta

The executive director covering the technology, Internet and media industries at Morgan Stanley on why valuations are more a reflection of a global trend than a country-specific issue


On demonetisation, Parag Gupta says small vendors are transitioning to digital wallets as a means of accepting payments, and if this transaction moves across most of India as a way of life, it will make the pain point of payments a non-issue at some point of time.
On demonetisation, Parag Gupta says small vendors are transitioning to digital wallets as a means of accepting payments, and if this transaction moves across most of India as a way of life, it will make the pain point of payments a non-issue at some point of time.

The biggest entities in the Indian e-commerce space may have had their valuations marked down several times by investors this year, but Parag Gupta, executive director covering the technology, Internet and media industries at Morgan Stanley, says it is more a reflection of a global trend than a country-specific issue. Companies that are executing well will continue to command a significant premium, Gupta said in an interview.

Edited excerpts:

Big picture: How do you see the Indian e-commerce scene?

The way Indian e-commerce is shaping up is that there has been some rationalization; but that is more from the funding perspective, and to some extent, it is driven by different strategies of companies. Some are trying to grow aggressively while others are taking stock of what has happened so far and their trajectory going forward.

If you look at the bigger picture in India, the key impediment to growth is primarily the number of people who are shopping online, and that is still very small—we estimate it to be 50 million, and that is 12% of Internet users, while in China the corresponding number is in excess of 50%. So, only when you have more people coming and shopping online will the sector take off. We were looking at what has happened in some countries in specific segments.

If you look at food delivery in the US or fashion in Europe, about two-thirds of the growth in GMV (gross merchandise value) has come from more people coming to shop online, rather than the same people shopping more frequently, or at a higher order value.

We did a consumer survey in 2014, and what we saw was that among people who had been on the Internet for less than two years, only about 10% of them were shopping online.

About 70-80% were doing no transactions and only using email and social media. However, among users who had been on the Internet for more than five years, about 40-50% were shopping online. The maturity of the Internet to a large extent will propel transactions.

In India, only about 20-30% of total Internet users have been on it for more than 5 years. Maturity will come in by 2019 when 40% plus of India’s Internet users will have been online for more than five years and, hopefully, at that point of time, the convenience of shopping online will become a lot more important against all other issues. That will be when growth can accelerate organically without really having to give incentives. It will be a pull impact.

From companies’ perspective, it has to be about how we educate consumers to shop online, and you need to make that experience phenomenal from Day One—whether it be assortment of products, convenience, payment options—all of these have to be structured in such a way that people have to be lured into it, rather than the pricing. Pricing can only be a pull for a certain period of time.

You said the funding scene for e-commerce companies has got rationalized. So, how does this impact the third or fourth player in each segment? Usually, in situations like this, the big two or the largest players in the space tend to attract additional funding, and investors migrate towards them, as against widening the pool and supporting more players.

You are right. In such times, the funding will get concentrated in a few players. Investors will want to be putting money into a reasonably sized company that is hopefully executing on target, with growth being a lot more higher that other newer start-ups.

What we’ve seen so far is that funding in larger numbers has come to category leaders. Category leader does not mean just the top player alone, but market leaders in their respective categories.

Yes, funding is getting concentrated. What we are yet to see is whether this is an aberration for 2016, or it is going to be the norm going forward.

As of now, it could be that this is an aberration for 2016, because you’ve seen a lot of volatility in global markets as well. There have been a lot of investment options that have come up for investors globally. Hopefully, in 2017, you could see funds investing in a bigger way, and if that happens, players across the entire spectrum can expect to get funded. Currently, only the bigger players are benefitting because they have achieved scale, and scale is enabling them to push for additional growth. Eventually, investors will want to hedge their bets and go with the larger players—go with those who are likely to attract more funding.

The next phase of Internet growth will come from smaller towns, which do not enjoy the same purchasing power as the metros or bigger cities. Won’t the transition time therefore be longer?

The answer is ‘Yes’ and ‘No’. The reason why it will take more time is that purchasing power will be lower when compared to people in the bigger cities. So, it will take more time to start adding to the overall numbers from a value perspective. The ‘No’ is that from the volume perspective, tier-2 and tier-3 cities have become very meaningful. If you talk to e-commerce companies, you will see 60% or more volumes are coming from tier-2 or lower cities, even though from a value perspective, it may not be much. The reason for that is very simple—there is the massive issue of availability of physical infrastructure in tier-2 and tier-3 cities—we have done some reports to figure out how this compares, and have seen that the physical infrastructure of even a tier-1 town in India is only 50% of what is available in China, and China is itself multiple times smaller than a developed market like the US.

The fact that China saw massive growth in e-commerce was largely due to the fact that if there was no physical infrastructure available, people began buying it online. As India is far lower in infrastructure when compared to China, the shift towards buying online will be that much more faster.

Infrastructure, which includes delivery and logistics is much poorer in India. My view is that infrastructure will evolve with the growth in e-commerce. Bulk of the growth will come from the top 25 cities, where the delivery infrastructure to handle the current amount of volumes is reasonable enough. India today is seeing 500,000 deliveries/day. This is a fraction of the corresponding number in China.

As of now, there is enough infrastructure available for delivery. Will this be an issue in smaller towns? I am sure that innovative solutions will come up. You park your goods with larger stores than own a warehouse. You may begin using the services of India Post wherever it is efficient. You may use sellers to stock up your products and then big data to figure out which products are in demand and then stock it accordingly. GST will be big impetus for that.

If you look at warehousing strategy right now, companies are putting larger warehouses around cargo hubs; with GST, you will see smaller warehouses across the country, and you will see investments continuing in this space.

Will the ongoing demonetisation drive speed up e-commerce adoption?

About 60-70% of all online transactions are via ‘cash on delivery’. Our view is that this will give away share to digital payments. Demonetisation will be an enabler—I would say that in the long-term, as you realize the benefits of it—which is convenience. We are already seeing small vendors transitioning to digital wallets as a means of accepting payments. If this transaction moves across most of India as a way of life, this will make the pain point of payments a non-issue at some point of time. The experience of an integrated wallet is smooth and seamless even on a lower connection speed. That is what is going to be the need of the hour. For smaller cities and towns, the issue is going to be data connectivity and the speeds that you get.

What do you make of the valuations of Indian start-ups? Have they—especially e-commerce firms—not paid heed to capital efficiency?

Valuations are more a reflection on execution. If there is any sense of a slowdown, it will reflect on valuations. Second, valuations are a function of global comparables. When you are looking at multiples, you are going to be benchmarking it against what is listed globally, and you will give it a premium or discount, based on which stage of maturity you are in. If you look at global valuations, they have come off, and that will be extrapolated here as well.

Is that a reflection of India—maybe not. To a lesser effect, it is a reflection of global events. On execution, it will be specific to companies. If a company is doing well, there is no reason to give it a discount. If it is doing significantly better, it will get a massive premium. Global multiples play a much larger role—the general sense is that this is a market that is still very early in its development—bulk of the growth has happened only in the last 2-3 years as smartphones and Internet penetration were growing. I think you have to keep in mind how these firms will look three years or five years down the line, when you look at valuations, and give it multiples accordingly. My view is also that we need not worry about valuations becoming more rational. Can valuations bounce back? Of course!

Capital efficiency is an important question on every investor’s mind. Are investors looking at this issue closely? Yes! But should a company sweat about it a lot at this point of time? No.

Cash burn does not mean you are not capital efficient. There is a push impact due to cash burn, rather than people coming in naturally. For the next few years, it is a given that Indian consumers will continue to be attracted to lower pricing. The top three things consumers are looking for when they move online is assortment, convenience and pricing. Delivery used to be a big consideration for online shopping two years ago, but it has now fallen down the list. If lower pricing is going to be one of the variables, there has to be investment from the companies on that front—there will be burn to grow your consumer base.

There will be an ongoing investment to change the behaviour of consumers, and once you get that going, it will become a natural element. Don’t compare Indian e-commerce firms to global ones on capital efficiency—you need to compare how Indian firms look today to how global firms looked several years ago—maybe even 10 years ago.

Which segments are you bullish on?

I am very bullish on fashion, food delivery, travel and fintech. If you look at overall macro-picture of food delivery in India, there is a massive unorganized food delivery market—that needs to get organized. Same thing with travel. In the US, you have large hotel chains, but in India you largely have stand-alone ones, and you need to aggregate that. The threat from a supplier’s direct website is much lower in India when compared to other countries, because it is all fragmented... In fashion—it is highly profitable if you have a high percent of private labels. The margins can be as high as 60% compared to 3-4% for electronics. Fintech is interesting as cash changes into digital, and credit card penetration in India is only a few percentage points, when compared to smartphone penetration in India. Travel is interesting—with rising per-capita income, travel will get a leg-up because that is the way consumers will want to spend their money.

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