Is The Dotcom Craze Back?

These are tough times for the US equity market. The fear of a double dip recession looms large. Investors are wary and quick to punish stocks for the slightest hint of shrinking margins or slowing growth rate. Nothing surprising; investors are still licking the wounds caused by the recent crisis.

But then how do you explain Makemytrip.com? On August 12, the online travel agency got listed in Nasdaq and raised $70 million from an initial offering of five million shares at $14 each. On the first day of trading, the share price rose 89 percent. In the days that followed, its market cap crossed a billion dollars. Investment Web sites called it the hottest IPO since 2007. Now, here’s the interesting part: The company has not made a single penny in annual profits so far. It lost $6.2 million in 2010, $7.3 million in 2009 and $18 million a year before, on revenues of $32 million, $19 million and $14 million, respectively. Makemytrip.com may be among the most talked about companies in the Internet space in recent times, but it is not the only one.

The valuation of Internet companies from emerging markets has gone up significantly in the last one year. While the Nasdaq composite index grew by about 12 percent in the last one year, in many cases share prices of these companies more than doubled. For example, share prices of eLong and ctrip — both online travel agencies — grew by about 131 percent and 69 percent respectively in the last one year. The market cap of Chinese search engine Baidu went up by over 154 percent in Nasdaq. Shares of 51job.com, a recruitment company, grew by 125 percent.

Their PE ratios — or the price per share over the net profits per share, an indicator of investor expectations — also suggest optimism. Nasdaq’s PE ratio is about 21. HiSoft, a Chinese technology company which recently listed in Nasdaq, has a PE of 933. eLong’s is 129, Ctrip’s 52, Baidu.com’s 88. (Google’s by way of comparison is 20.)

Nasdaq, the epicentre of technology stocks, is also getting busier. Forty-four companies (including 17 non-US companies) got listed in Nasdaq in 2010, compared to 27 (11 non-US) a year before, according to VCCEdge.

There is a buzz in India about public equity markets as well. Justdial.com, a local search firm, said that it’s going for an IPO early next year. According to reports, it is looking at a valuation of Rs. 2,000 crore, which is 22 times its 2009 revenue of Rs. 90 crore. There are indications of a public offering from Indiamart and Ybrant as well.

Venture capital firms are keen on this space too. “There is definitely elevated activity in terms of VC interest in Internet or e-commerce companies. The feeling seems to be that we are in the middle of something interesting from an e-commerce perspective. Whether that is the case or not, only time will tell. But I have definitely seen more interesting and serious Internet start-ups in the last three months than in the last three years that I have been in India,” says Mohanjit Jolly, MD, DFJ, which has invested in companies like Hotmail and Skype.

Satish Kataria, MD, Springboard Ventures, points to a Rs. 60 crore investment in Quick Heal Technologies by Sequoia Capital, Rs. 25 crore investment in Naaptol.com by Canaan Partners, Rs. 4.7 crore investment in Foodiebay.com by InfoEdge and $5 million funding in Vriti, a test preparation company, by Intel Capital and JAFCO Asia. Fifty-six percent of VCs surveyed by Deloitte recently said they expected increased investments in new media and social networking segments.

All these entrepreneurs and investors see Makemytrip’s successful IPO as a thumbs-up for Internet and e-commerce businesses.

Makemytrip.com founder and CEO Deep Kalra himself says he is trying not to get too carried away by the market valuation. “We priced the share at $14 and it’s trading at more than 100 percent. It’s a clear demand-supply ratio. We’ll do our bit in terms of making sure that the company delivers what it’s supposed to. After that, you can’t do much on the market. I continue to tell my team that: ‘Don’t look at the market. Focus on the work you have.’”

Bubble 2.0?
Those with a historical bent of mind will find it hard to ignore the timing of Makemytrip’s IPO. Exactly 15 years back, to the month, Netscape Communications got listed in Nasdaq. Business historians today agree that that was when the Internet bubble started. When Netscape listed, it had not made a single penny in profit either. On listing, Netscape shares boomed, making millionaires of its founders and early investors.

What followed in the next few months created new stars, throwing out the old rules on valuation. People left stable jobs to start their own ventures, with no clarity on how they could make money. Investors lost their sense of perspective. In 1998, one company, Books a Million, announced that it was going to launch an improved Web site. The result, its share prices went up 973 percent in just three days.

What is happening today carries some of the flavour of those heady days. Here are some similarities:

1. Eyeballs vs. revenues: During 1999-2000, eyeballs, or the page views a Web site attracted, became a widely tracked metric, and companies were valued based on that. Today, revenues has probably replaced eyeballs as the defining metric, says Sanjay Soni, MD of Logix Microsystems, which provides e-commerce solutions for the automotive industry and also runs Carazoo, an online car sales Web site. While it is an improvement over eyeballs, revenue by itself doesn’t say anything about the sustainability of a business. Many listed companies during the dotcom boom had revenues, but they failed because they were burning cash faster.

2. In Internet, we trust: The bubble in the late ’90s was sustained for a long time because people were essentially betting on the rapid adoption of the Internet rather than the business model of a specific company. Now, there is only a slight shift in that — now the bet seems to be on the deepening penetration of the Internet and the belief that e-commerce is closer to the inflection point (that critical point after which economics turns in their favour).

K. Vaitheeswaran, who left his job at Wipro during the dotcom boom days and has been running Indiaplaza, an online shopping Web site, for the last many years, says that things have changed. The Internet was a new medium in the late 1990s. Now, people know its power and at least 50 million have access to the Net. But Vaitheeswaran knows that he is stepping on slippery ground when he says that. “When we were 3 million, we thought 20 million would be an inflexion point. But that was not to be. But still there is room for optimism because it took a long time to reach 50 million from 3 million. It will not take so long to go from 50 million to 100 million.”

 

 

3. The missing business plan: But that still doesn’t solve the problem with business plans. During the last boom, one of the biggest drivers of the bubble was the examples of companies that did not earn revenues but were everybody’s darling. Entrepreneurs quoted them to ask for more funds and investors looked at them to justify their own actions. The argument goes: Google did not have a business model for a long time. Twitter came up with a revenue model only recently with its sponsored tweets. Things haven’t changed much today, partly because technology is still evolving. Rohit Regonayak, co-founder and CTO, Trellisys.net, a software services firm that focuses on technology start-ups says, “The need to be profitable from the start is overtaken with the hope of being one of the torchbearers in the next evolution of the Internet.”

A Different Turn
Yet, there are crucial differences. “We have to make a distinction between overvaluation and a bubble,” says Avnish Bajaj of Matrix Partners, which has invested in Asklaila, Quickr, and 70mm. “A bubble has no logic, it is irrational. But overvaluation has a logic behind it. Even there, you can make the mistake of pricing it to perfection,” he says.

In the dotcom boom days, companies with unproven business models got lapped up by an irrationally exuberant public. But, Makemytrip.com has been around for 10 years, trying to replicate an offline model online. Ctrip.com, a Chinese online travel agency, has a market cap of $11 billion. But, it also has a net profit margin of over 30 percent. Can Makemytrip.com scale to that level? Bajaj says that it is fair to expect it to go to $300 million in revenues in the next few years. “At that time, will they have a net profit of $50 million to $80 millions? Then the billion dollar valuation seems reasonable. But, it is also possible that they make only about 12 percent net profit, in which case people might be overvaluing,” he says. What’s giving customers optimism is India’s consumption story. DFJ’s Mohanjit Jolly adds, “I believe Makemytrip.com has shown that there is significant appetite overseas for leaders in spaces that are seen as large and growing in India. The ‘India-is-a-China in the making’ mantra is held by many, even with all of India’s challenges.”

You can argue that Makemytrip is overvalued. And it’s true that there is a lot of activity in the Internet space. But to become a bubble, such overvaluation has to become a mass activity, says Suvir Sujan, co-founder of Nexus Venture Partners. Earlier he was co-founder and co-CEO of Baazee.com that merged with eBay in 2004 to form eBay India.

But all bubbles start that way. They start with a slightly higher than reasonable price, and then more people get into the market, and more money chases a sector. “A bubble by definition is hard to recognise, as you only know later if the expectations of the future of the sector actually came true, much like negative thoughts on a sector that ends up doing well,” says Manik Arora, founder and managing director, IDG Ventures India, which has invested in companies like Ajuba networks and Myntra.com.

Arora looks at indicators such as a company that was earlier unable to raise capital getting it without a change in strategy or performance. Large buyout funds going to smaller deal sizes; a large quantity of secondary deals driven by investors desperate to get a piece of action.

“I believe entrepreneurs and investors are much more focussed on fundamental business metrics today and the key drivers of revenue and profitability are very critical to understand for both concerned,” says Kanwaljit Singh, MD, Helion Venture partners, an investor in Makemytrip.com and Humming Bird. While some of the metrics seem similar, they come with a twist and they are usually taken in with other metrics. For example, take user statistics (which is like eyeballs in many ways). When entrepreneurs and venture capitalists talk about users today, they necessarily look for a huge scale. “It is not possible for too many companies to build scale — say, hundreds of millions of users. Without that kind of scale, you cannot raise money,” says Sujan of Nexus.

Twitter is a case in point. It might not have made money, but it has the scale and dominant position that give it certain advantages. The data collected on Twitter is now so valuable that a lot of organisations are queuing up to pay Twitter to data-mine tweets to pick up on consumer trends and for decision making systems. Twitter would never have gotten this large if it were a paid service. Kataria of Springboard Ventures sees a lot of monetising opportunities in the Twitter model. “But yes, I will shy away from say some idea which is attempting to be its clone,” he says.

There is also a shift towards paying customers. “I think the most interesting metric being looked at over the past few years is the ‘conversion rate’. How many of your free users can be converted to paid or premium users? Eyeballs and sticky eyeballs only focussed on how many users visited the site without much analysis of what kind of users visited or what sections they visited,” says Trellisys’s Regonayak.

The history of business is also a history of bubbles and crashes. Can we ever learn at all?

“Individuals learn. I am not sure about collective learning. We have devised ways to fall in the same hole that others have fallen into. We ignore the warnings, and say things are different now,” says Ashish Gupta, a co-founder of Helion Ventures, and who sits on the boards of Jivox, Naukri.com and SMS Gupshup.

Yet, he doesn’t think we are anywhere close to 1999. “Bubbles don’t happen in the same sector. They go from one to another,” he says.