Partying like it's 1999: The e-commerce boom has all the makings of a Y2K bubble

The e-commerce excitement in India is for real right now with Wall Street pumping billions of dollars into a sector that is yet to turn profitable and is only chasing topline. Logic? Despite negative cashflows, e-commerce biggies like Flipkart and Snapdeal are high growth companies and private equity is only bothered about returns- buy low now, sell it five years later when the valuations have shot up. But how sustainable is this model?

The issues faced by e-commerce companies are no longer a secret. Large players poured in millions of dollars to build alternatives to brick-and-motor stores and are spending huge sums on marketing costs but none of them are making profits even at the operating levels. Add to that customer stickiness, which in the current scenario is lost due to too many players having similar business models and raging price wars.

Just a month after it raised Rs 3762 crore from Japanese investor SoftBank, Snapdeal is targeting gross merchandise value sales of $ 3 billion annually (Rs 18,000 crore) by March 2015, a Business Standard report said today . In August this year, it achieved $ 1 billion in sales and in November it touched the $2 billion mark while rival Flipkart had announced GMV sales of $ 1 billion in March this year. Such jaw-dropping annual run rates can only be achieved by rolling out big bang consecutive rounds of discounts and flash sales, backed by high pedigree investors like Softbank & DST. By chasing a larger market share, the situation is akin to land grabbing by investors who want to make sure they do not miss the bus, thus leading to a classic bubble-like situation.

Take a look at these numbers: Snapdeal alone has raised around $1 billion this calendar year.The Delhi-headquartered online retailer received $133.7 million in February from investors led by Chinese e-commerce company Alibaba and $105 million in May from a group of investors, including IT billionaire Azim Premji’ .And in October it got another $627 million from SoftBank. The company has also got investment backing from Tata group chairman emeritus Ratan Tata.

Flipkart, on the other just closed a $500-600 million fresh financing round led by its existing large investors at a massive pre-money valuation of $10 billion. The company could raise anything between a $2 billion and $3 billion in the next two years. So far, Flipkart has already raised $2.3 billion in funding and is all set tohit a $3-billion revenue run rate. The GMV is multiplied by about 2-2.5 times to get the valuation of the firm.

And the boom has as been fueled further by the listing of Alibaba on Wall Street, which has become the biggest IPO of all time, raking in a record $25 billion for the Chinese online retailer. All the sudden rush of money into the system in such a short span has pushed up these valuations to unrealistic levels.

And if you thought it was just the big three( Snapdeal, Flipkart and Amazon) that were making the most of the early-mover advantage, think again. As this Business Standard report points out , “Niche players such as CBazaar (clothing), Pretty Secrets (linegrie), Happilyunmarried (lifestyle products), Fashionandyou, Firstcry (baby products), Limeroad (fashion), Pepperfry (online furniture), Housing.com, Zomato (food & restaurant listings), Bigbasket (online grocery, Urban Ladder (online furniture) have all raised anywhere between Rs 1 crore to Rs 60 crore in multiple rounds valuing each of them at nearly 2-2.5 times their gross merchandise value (GMV) or total sales value of merchandise sold over a period of time.”

To top it all with reports suggesting Alibaba is all set to enter the Indian market, one wonders as to what extent these sky high valuations will go before the bubble pops as none of these companies are making profits currently. The industry is already consolidating with many multi-category players such as Flipkart and SnapDeal acquiring niche players in order to widen their offerings. According to a report by Dinodia Capital Advisors, 70% of venture-funded Indian e-commerce companies are expected to disappear over the next one year or so, as the local industry undergoes significant consolidation which is why it is imperative for investors to look atnew “white spaces” in this sector such as a specialized logistics providers or players offering innovative products / services or go back to basics and only back those existing players who possess robust business models and visible profit margins and have a clear path to provide an exit.

Clearly, the current e-commerce funding wave is similar to the enthusiasm that one witnessed in the Indian retail as well as the real estate sector between 2002 and 2007. Several retail and real estate companies were funded by PEs at exorbitant valuations and profitability became a casualty then. So is the case now. Those that invested prior to 2008 made money, but those who pumped money later got burned because they were unable to achieve a successful exit for their investors. And it is this love for hyped-up valuations and unreasonably high stock prices that led to the Y2K bubble, the real estate bubble and the sub-prime crisis. The logic is simple: Is Indian e-tail really growing that fast that a firm which was valued at $1billion in November 2013 is now being valued at $10 billion a year later? ( Read Flipkart).