The Indian digital economy is living in interesting times. At one end we are witnessing investments running into billions of dollars in Indian e-commerce and at the other end we have tens of millions of dollars being invested into early stage digital ventures. Add to that, there are a slew of potential public offerings that are knocking on the D Street’s doors.
Oftentimes, investors find it difficult to value these businesses and justifying their getting into these businesses at early to mid stages of maturity. Comparing early stage Indian digital businesses to their mature western counterparts will not do justice to the former’s growth potential and at the same time underplay the unique challenges that come up in the Indian context.
We decided to take this billion dollar question head on (with certain presumptions, the benefit of hindsight and a rather limited sample set). Even with these caveats, the conclusion that we came to was quite startling – If you’ve invested in a market leading Indian digital business at any stage of the virtuous cycle, rest assured that you’ve bet on the winning horse.
To test our hypothesis, we analyzed the track record of two companies – InfoEdge and Justdial. The reasons for picking up these companies were easy:
1) Leadership: They have both been unqualified market leaders in their segment of the digital economy almost throughout their investment history (both as public and private companies). While Justdial operates in a single segment, InfoEdge operates in several ones. Its’ core recruitment offering has been a clear market leader and several of its other offerings and investments (99 acres, Zomato, Policybazaar) are arguably leaders in their respective segments as well.
2) History: The investment histories of the two companies can be scrutinized over a meaningful period of time (between 8-14 years), their core offerings are stable and mature, they have seen at least one economic recession and have seen life both as a public and private company.
3) Data: Data on these companies was readily available through their public and ROC filings over their investment history.
Most importantly, these are classic digital business which put the virtuous/ vicious cycle theory into play.
Exhibits #1 and #2 show how the share prices of the two companies performed against the Sensex – astonishingly, both these companies have beaten the Sensex hands down, both as private companies as well as public ones:
We analyzed the share price performance of InfoEdge from its first institutional fund raise from ICICI Ventures in April 2000 to November 2006 when it finally listed and Fidelity bought a secondary stake into the company. During this period, while the Sensex rose by 169%, InfoEdge rose by 1663%, 9X times the Sensex.
From the time of listing of InfoEdge in April 2006 till August 2014, while the Sensex has risen by 90%, InfoEdge shares rose by 372% beating the Sensex by over 4X.
We analyzed the share price performance of Justdial from the time SAIF invested into the company in December 2006 to its listing in June 2013. Along the way there were numerous primary and secondary transactions with Sequoia, Tiger Global and SAP Ventures participating. Sequoia in fact, made one of its largest investments in the country, with a transaction size of INR 326 crores in June 2012 to push the IPO by a year. During this period (December 2006- June 2013), while Sensex rose by 41%, Justdial rose by a staggering 1276% beating the Sensex 31X.
Post Justdial’s listing, in a short period of 14 months, while the Sensex rose by 32%, Justdial shares rose by 203%, beating it by over 6X.
These are eye popping numbers. Given that the value of these firms has been driven by “smart” institutional money throughout their lifecycle and we are talking about their performance for a decade or more, it is hard to dismiss them it as a bubble or a mere coincidence.
The real reason behind driving this shareholder value is market leadership – and this is the fundamental premise on which digital businesses differ from the real economy. Leadership in digital businesses drives disproportionate value – to the company’s growth as well as its profitability, which reflects in their share price.
In the digital world, businesses operate in either a vicious cycle or a virtuous cycle. This is precisely the reason why huge sums of money are invested initially to ensure that the vicious cycle is broken and the virtuous cycle is put in motion and high barriers to entry are created. This is also the reason why acquirers pay mountains of cash to buy rather than build.
Naukri has the highest number of CVs of employable candidates. This is why it attracts the highest number of recruiters – and in turn, this ensures that it is the default destination for candidates for filing their CVs.
Similarly, Justdial has the highest inbound traffic for local searches. This lures the maximum number of merchants to list their offerings on their platform, and this in turn ensures that it retains the highest traffic.
The results of this virtuous cycle and consequent high barriers to entry are reflective in these companies’ financial performance (Exhibit 3 and 4). The operating margin for the recruitment business of InfoEdge has been between 42% (FY10) and 51% (FY14) and the EBITDA has registered a CAGR of 17% between FY10-14. Similarly, Justdial enjoyed operating margins of 26% between 31% between FY12 and FY14 and registered a CAGR of 33%.
This leads us to our next big question – once you start riding on the coat tails of a market leader, what are the pointers that you need to need to look out for? When does the music stop playing? In our opinion investors need to keep a close watch on the following:
- Is enough being done to consolidate market leadership: Companies have contrasting approaches to exploit their pole position For instance, InfoEdge has taken the “go wide” approach by incubating/ investing into market leading properties in other verticals ( 99 Acres, Zomato). On the other hand Justdial has taken the “go deep” approach by creating a marketplace around its core offering.
- Is the company’s business model up for disruption: Are there new elements out there which have the potential to “Move the Cheese” and disrupt the business model of the incumbent market leader? Examples of this are rife in the technology industry. However, it’s a discussion that merits a separate post.
In our opinion, the Indian digital economy, especially from the investors’ perspective has slowly but surely come of age.
Many transactions in the public eye may not justify their valuation when viewed from the prism of conventional metrics. However, when we view them in context of the “winner takes it all” digital world, where an early start and sustained leadership creates disproportionately large value for shareholders, it all starts making a lot more sense.
[Guest article by Kashyap Chanchani, Executive Director-