Bubblegum

Some crazy stuff is happening here. Recently, I read an article on vccircle that left me completely stunned. Flipkart, a company with FY11 topline revenues of approximately Rs 6 crores per month, is raising private equity funding at a $1 bn valuation. I have to admit though that I have no idea about the profitability of the company; but just the thought of a company with a $ 16 mn turnover having a $ 1 bn valuation seems bizarre. Just to give a comparison, Infosys reached a market capitalization of $ 1 bn some where in 1998-99 when its revenues touched $ 100 mn (and this was public market valuation, which are generally much higher than private market valuations)

Hot Internet companies seem to be commanding astronomical valuations these days; both domestically and internationally.

Facebook, the poster boy of the new dotcom frenzy, is currently expected to have a shocking valuation of $ 100 bn when it goes for its IPO later this year. Zynga, the social-network games company, has been valued at $9 bn. Profitless Twitter is said to be worth $10bn. Groupon, the pioneers of group buying, rejected a $6 bn offer from Google and is considering an IPO with a valuation of $15 bn.

It seems that investors are desperate for growth and hence are willing to take on more and more risks. One measure of the frenzy is the astronomical share prices for these Internet stocks relative to their earnings.

Take the example of Linkedin. It had a successful IPO in May 2011. It went public at $45, and the stock increased about 109% on its opening day to reach a price of $94.25. The current price of the stock is close to $80 with P/E ratio of 1200. That compares with an average P-E of 14.2 for the S&P.  For the 12 month period ending on 31/12/2010, Linkedin had revenues of $ 243 mn, net income of $ 15.38 mn and operating cash flows of $ 55 mn. However, the current market cap of the company is $ 7.5 – 8 bn! In the Marwadi school of economics (that I learnt in Kolkata), one of the basic methods of evaluating a business is to see the cash payback period from the business. Even if you assume that the cash flow from operations grows at an annualized rate of 50% per annum compounding (though that is a mathematical impossibility for any extended period) it would take close to 10 years to just recover the capital.

Take an another case - MakeMytrip (MMT) . For the 12 month period ending on 31/12/2010, MMT  had revenues of $ 122 mn and a net income of just $ 4.83 mn. This is the first positive PAT that it has reported; the previous 3 years were losses at the EBITDA level. Cash Flow from Operations is a negative $ 6.33 mn. However, the market cap of the company is an astounding $ 700mn ! In fact, the company has practically had negative cash flow from operations every year for the last 3-4 years (although the revenues have trebled in the last 3 years). Its currently trading at a PE multiple in excess of 150 !! Theoretically, if I buy the entire company today at $ 700 mn and if the revenues keep growing at 50% per annum compounding, then, at the same profit margins, it would take at least 10 years just to recover the capital ! Forget about the returns mate.

Maybe I am missing some big trick here that other shrewd investors are able to see. Coming back to Flipkart, if some investor is giving them a valuation of $ 1 bn now, and assuming that they want to exit in 3-4 years, then say at a 40% IRR, the company is expected to achieve a valuation of  $ 2.7 bn in 3 years in $ 3.8 bn in 4 years. Could be possible, given the way the markets are.