More importantly , loosely defined terms used interchangeably with `revenue’ are bandied about. “Many terms are unconventional but startups use them in PR and public communication to highlight growth,“ said Rutvik Doshi, director at Inventus Capital Partners. By signalling big growth numbers, startups drum up more investor interest and pump up valuations.
“These metrics signal these companies are in a hyper-growth phase,“ said Doshi.With more investors wanting in on highgrowth firms, valuations tend to get pushed upwards. “Valuation is a function of supply and demand,“ said Doshi.
“There is also a fair bit of pressure on entrepreneurs to showboat in public and talk up their numbers to lay a claim to being the forerunner,“ said Sumanth Raghavendra, co-founder of Deck App Technologies. Because of the premium placed by investors on category leaders, entrepreneurs are also pressured into talking about bigger numbers. “The day a startup raises funding by an institutional investor is the day it is signing up for continuously demonstrating progressively bigger numbers,“ he said.
Investors know the truth behind the numbers but choose to play along. “If these companies are using forward numbers or GMV to pump up their valuations, it is only because their investors are willing participants in the process,“ said Aswath Damodaran, professor of finance at the Stern School of Business, New York.
“Unconventional numbers are used as a proxy for growth, but investors do dig and are aware of real financial numbers hidden beneath,“ said Doshi.
GMV , or the total value of goods sold on a platform, is a number that can be easily gamed. For instance, the sale of items with a high price tag can push up GMV dramatically. Not just that, critics have questioned the discounted sale of expensive items that encourages the practice of sellers buying goods themselves under other names.
“As these are high-ticket items, they can significantly bolster the GMV metric but in real revenue terms, the actual addition is zero or even negative,“ Raghavendra said.
CLARITY AT AMAZON
Among ecommerce companies, Ama zon is an example of accounting clarity. The company does not talk about GMV but revenue that it earns by selling its own inventory, cloud services and commissions its gets from selling third-party goods.
As an investor backing one of the top two Indian ecommerce giants pointed out, comparisons with Amazon or Alibaba don’t apply here. “The reason Amazon is ahead of others in revenue multiples is because of its web services business, which is profitable,“ he added. In the quarter ended March, Amazon posted $1.57 billion, or 7% of revenue, from Amazon Web Service.
Alibaba has a market capitalisation of $243.3 billion while GMV for 2014 was $370 billion.
“Why would somebody buy Flipkart when Alibaba is trading 0.7x of its GMV?“ an investor said. To be sure, new age companies are often valued on the basis of growth potential. Some key questions Damodaran asks while valuing a company: What are the cash flows from existing investments?
What is the value that the company will create in the future? How risky are these cash flows and when will the company become a mature business? Investors are often enthused by the Indian Internet market, which according to a Morgan Stanley report in February, could rise to $137 billion by 2020.“There is no fraud here, just greed on both sides. If you don’t like the way the game is played, don’t play it,“ Damodaran said.
Sharad Sharma, an angel investor and the co-founder of software products think tank iSPIRT, places the blame for the bubble squarely on investors.
“In a transaction, buyer determines the ceiling, seller controls the floor.Since VCs (venture capital funds) buy equity, they are responsible for the bubbles,“ he said.
A bigger danger, as flagged by Sharma, is that this valuation bubble could potentially even affect startups outside the ecommerce sector, especially those building software products and enterprise solutions.
“This can’t sustain too long, maybe another 12-18 months. We must insulate the pockets that are not in a bubble.Otherwise collateral damage can happen and bring everything to a halt,“ he said.