MakeMyTrip Ltd has said it will acquire Ibibo Group’s travel business in India to create India’s largest online travel firm. How much is this combined entity worth?

MakeMyTrip had a market capitalisation of $850 million before the deal was announced, besides which it had debt worth roughly $180 million. In all, it was valued at 6.1 times fiscal 2016 revenues.

After the deal was announced, MakeMyTrip’s market capitalisation rose by 44% to $1.22 billion. But that’s not all. The company’s filings suggest massive equity dilution post the deal, with the total share count expected to rise by as much as 2.4 times. In other words, investors are valuing the combined entity at $2.9 billion, or around 10.8 times estimated revenues of the combined entity.

Note also that according to the bankers to the deal, the combined entity was valued at $1.8 billion, with Ibibo contributing 40% to the total. Since when have bankers’ valuation metrics not been grand enough?

Clearly, the e-commerce space never fails to surprise when it comes to valuations. Of course, valuations were most absurd in private transactions, although even there, investors have become a bit more cautious. But in public markets, valuations used to be far more sane. Take MakeMyTrip’s own example.

It certainly looks like investors are putting the cart before the horse by valuing the combined entity at a roughly 75% higher valuation vis-a-vis MakeMyTrip’s existing enterprise value/revenue multiple.

Investors are enthused about the expected increase in profitability after the merger. After all, the cut-throat competition between the two had resulted in significant cash burn in the hotel booking segment in the past two years. In FY15, Ibibo made losses of $62 million on the back of revenues of $38 million—this was largely on account of the cash burn in the hotels business.

And since Ibibo had started giving huge discounts in this segment, MakeMyTrip was forced to follow suit. The latter ended with losses of around $100 million in fiscal 2016.

Losses can be expected to reduce as the merged company will have a market share of over 50% in both online airline bookings as well as hotel bookings. Lower discounts would result in better unit economics, besides which, the company can also be expected to have better bargaining power with airlines and hotels.

But note that this is fastest growing segment for both companies. And if discounts are reduced considerably, growth may suffer. Analysts at Jefferies India Pvt. Ltd, for instance, estimate that the combined entity’s hotel revenues of $88 million in FY16 could rise to $300 million by FY18. But such high growth may mean that losses will keep pace. Investors may have to tone down expectations on growth or profit; after all, the company can’t have its cake and eat it too.

But an immediate concern is the expected equity dilution. When MakeMyTrip shares rallied on Tuesday, it looks like the extent of the dilution wasn’t public information. Analysts at Jefferies, for instance, had assumed equity will expand by around two times to 85.8 million shares. Even though the company was asked on a call with analysts, it didn’t provide details about the actual share count post-merger.

An SEC filing reveals that China’s Ctrip, which had invested $180 million in the company in January this year, will be issued 9.857 million shares. Elsewhere, it was stated that Ctrip will have a 10% stake in the combined entity. Since existing investors are being diluted much more than they had earlier imagined, MakeMyTrip’s shares could well correct when trading resumes on Wednesday.

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