Did Chinese deliberately dump capital in Indian startups to artificially inflate valuations to shore up their profits?
When I left Microsoft India in 2007, Microsoft’s goal was to make $1 Billion dollars from India, which it achieved one year later in the year 2008. You would think that 12 years down the line the revenue would have at least doubled to $2 Billion, given that 12 years have elapsed and doubling your revenue in 12 years is only achieving a CAGR of 5.94%, even lower than the reported GDP number of India in the same period. How hard can that be?
If you Google Microsoft’s India revenue you will discover to your surprise/shock/amusement that the revenue of Microsoft India is still $1 Billion. In 12 years the number of rupees required to buy 1 dollar has gone from 40 to 75 and Microsoft is still trying to get up to speed with the exchange rate to maintain 1 billion dollar revenue. This is when Microsoft has some of the hottest products in the IT industry and operates at a gross margin of 68.17%.
Now that we have set the context of how dollar growth looks like in India lets look at what is happening in the Indian venture scene and why the valuations make no sense and this looks like a case of capital dumping by the Chinese.
Lets look at the different business models the entrepreneurs (not including Vijay Shekhar Sharma - that I am still working on, along with CRED’s) are working on in India:
- Software & SaaS
- Content (social media, edtech, content etc.)
- Physical goods selling (e-commerce, grocery, apparel etc.)
- Food delivery (deliver food)
- Fintech (nobody knows what fintech is)
- Manufacturers (making physical products)
I am not explaining these models here as people complain I write too long articles.
What is the maximum addressable market for all these business models in India?
India has about 400 million smart phone devices connected to its telecom network with more than 90% running on 4G. This is the maximum number of WhatsApp accounts that can be made on smartphones, and the maximum number for any service that is bound to a device for running an account, such as Google Pay and Phone Pe, unless you are a fan of toggling phone numbers. This is also the maximum number of YouTube customers we can have in India. So if you are an app aspirant and you have reached 400 million downloads you have done it, you are the winner in whichever category you are in 🏆.
Who are the people behind these devices?
According to the Periodic Labour Force Survey, 2018 there are about 240 Million households in India with 4.2 persons per household out of which there are about 80 million households in urban India, with a household size of 3.9 which translates to 313 million people in urban India and 170 million households in rural India with a household size of 4.3 this translates to 731 million people. As you can see the number of people residing in urban areas of India is more than 300 million, roughly the population of United States of America, or about one and a half times the population Western Europe (Germany, France, Netherlands, Belgium, Austria, Switzerland, Luxembourg, Monaco, Liechtenstein). This urban population statistic is on the first slide of every product manager, VC, founder, Managing Director of a company operating out of India. This is an incomplete story and a totally misleading one at that.
The PLFS 2018 survey focused on finding who earns what in India, and the survey found that in the urban centers only 47% (of the working) have a regular salaried job earning 17,473 rupees ($232) a month, approximately 38% are self employed earning 15,000 rupees ($200) a month, about 15% are casual laborers earning 316 rupees ($4.21) a day. Of the salaried barely 0.2% of India make more than 100,000 a month, 63% make less than 15,000, 10.8% make between 15,000 to 20,000, 21.9% make between 20,000 to 50,000 and 3.4% make between 50,000 to 100,000. Similarly for the self-employed the numbers are 80.3%, 9.7%, 9.1%, 0.9% and 0.1%, details of which can be viewed here.
In the rural areas the percentage of people having a salaried job is about 13% of the working population, self-employed 58% and casual labor about 29%. In rural the salaried earning drops to 13,206 rupees ($177) per month, self-employed earning drops to 8300 rupees ($110) and the casual labor earning decreases to 262 rupees ($3.49) per day. Roughly translated this results in a rather wobbly pyramid that is unlike something we have seen before and brings the rural population as a viable consumer of tech and other stuff into the picture, a demography that most startups have ignored as not worth wasting time over.
Crunching all these numbers we get 116 million people who earn a steady income in India and 33 million people who are casual labor (and these add up to approximately 150 million people who between them own 400 million smartphone devices). Of the 116 million we have 32 million (24 million in urban areas and 8 million in rural areas) people who potentially have the capacity to make discretionary purchases every month, i.e. people who can on internet potentially buy OTT subscriptions, buy edtech classes, order food from Zomato and Swiggy, buy branded clothes and stuff priced at more than Rs. 200 (reason why Shein was so popular). Long story short 116 million people who will make a capital purchase at least once a year and make essential purchases like grocery, mobile phone plans and out of these 116 million people there are only 32 million people who can make discretionary purchases every month.
The telcos, e-commerce apps, search, social media, UPI wrapper apps (aspiring super apps), games, and news apps target the bigger universe of 400 million devices, with their free to use apps and delivery of essential products. Delivery companies also can potentially target 116 million people. This is the large sphere dominated mostly by American companies except for PubG, Bigbasket & Delhivery which are backed by Chinese companies. TikTok was a part of this universe till it was banned in India. Most of these companies make money from advertising on their platform or from selling essential goods for a margin.
The smaller universe of 32 million users is the one being targeted by Zomato, Swiggy, Tinder, ByJu, Netflix, Uber etc., as you can see this universe is much smaller than the free and essential app universe and much more crowded and funded mostly by the Chinese companies and Softbank. Most companies in this universe are making money by acting as a marketing intermediary for a vertical like food or transportation or selling content subscriptions. Needless to say it is tougher selling subscriptions.
How should we value these companies then?
The recent success of Jio in raising funds at a massive scale establishes that funds can be raised at large scale if valuations are right and business model is established, so lets assume Reliance Jio as the gold standard of Indian companies that has the formula to generate revenue from these 400 million devices. Now, Jio is estimated to be generating about $34 in revenue per device and if we assume 116 million earning people, then Reliance Jio is generating about $100 per person per year. This is a simplistic way of looking at things but in the absence of reliable data from other companies this is the best we can do in estimating best possible average revenue per earning user in India. When we compare Jio with other startups and no matter how we cut it, most companies on an average are not able to eke out $34 in revenue per user per year. In comparison to Jio, YouTube is estimated to have made less than $1 per user per year in India.
As you can see in the chart above Ola, Zomato, PayTM etc trail Jio by a wide margin on the revenue per user and needless to say they even trail Jio in aggregate revenue.
If we look at what these companies are valued at as a multiple of revenue, you can see Jio trails almost all the companies except Amazon in valuation as a multiple of revenue where for some strange reason PayTM leads, followed by Byju’s.
As you can see the non American & non Jio companies are leading the valuation charts with low revenue, low ARPU, low addressable market and no roadmap to operational profitability, and they all have investments from Chinese companies Tencent, Alibaba, and Softbank.
If this sounds strange and looks like incredible, lets look at the valuation to revenue ratio of global startup companies with market valuation in excess of $10 billion, here again One 97 a company with no business model, market leadership or even business, is valued more than 80% of the companies, the only companies valued at a higher Revenue to Valuation ratio are Snowflake which makes software, Samunmed a biotech company close to major drug discoveries in arthritis, Alzheimer etc., and Didi and Global Switch two Chinese companies with opaque financing structures and finances.
Are the current valuations realistic?
Of course these valuations are not realistic, the valuations look more like being decided by people playing russian roulette in a casino and less like thoughtful investments by professional investors. For example if you look at One 97 Communications Limited, popularly known as PayTM its valuation was $300 million in 2011 when SAP ventures invested which rose to $1.5 billion in 2015 when Alibaba invested, which rose to $5bn in 2016 when Mediatek invested, rose to $10 billion in 2017 when Softbank invested and this rose to $16.5 billion in 2018 when Berkshire Hathaway invested, all this while PayTM continued to crash and burn with losses overrunning revenue and facing the challenge of UPI which all but wiped out its flagship wallet business model. Interestingly Alibaba, Mediatek and Softbank are all linked to each other so it is entirely possible that there is some back scratching going on to raise valuations.
Why are the Chinese dumping capital in India?
It is amazing that a back of the envelope calculation suggests that even though all valuations are inflated by at least 100%, still Tencent, Alibaba and Softbank are investing in Indian tech companies at these valuations! It cannot be true, there has to be something that they can see which we cannot! Sadly there is nothing which I could find which could justify the valuations of Ola, PayTM, Zomato and even Byju. When you cannot find rational reasons you look for irrational reasons and then you speak to the Chinese and ask them why why why and they say — simple — to inflate their profits. Wait What?
Tencent always had an investment arm which became even more aggressive, it is rumored Tencent has a portfolio approaching 750 companies, according to a person close to the company, and it has recently raised $6bn in debt to deploy in startups, in addition to a cash pile of $24 billion. Tencent mainly takes a minority stake in vertical players who are category and traffic leaders in their segment. Tencent increased its focus on investing when it suffered a major setback in 2017 when its new games were banned by Chinese government, and its stock dropped dramatically. Tencent now needs approval from Chinese government for its games to be launched. In this backdrop Tencent has upped its investment game to shore up its stagnant profit in China, Tencent made 7% of its profits from investments in 2016, 22% in 2017, and 20% in 2019. In 2018 it suffered a loss on its investments.
Alibaba has a conservative approach to investing as it invests mainly in companies that have synergies with its own businesses, like companies in e-commerce, food delivery, fintech etc. It starts with a small stake and then moves to take a larger or majority stake in the company. Alibaba also has $54 billion of cash on its books to be deployed. Like Tencent, Alibaba made 14% of its profits from investments in 2017 and 30% in 2018.
Softbank The third wheel of this valuation car is Softbank, sitting on mountains of cash Softbank acts in conjunction with Tencent and Alibaba in pushing up the valuations. Lately Softbank has become another troubled giant that has capital to deploy and has properties that are turning lemons faster than Musk’s launching rockets, it needs to quickly show gains and that is why it loaned Ritesh Agarwal money to buy stock in his own company at a higher valuation.
Naspers The fourth wheel of this car is Naspers an early investor in Tencent and now a major investor which often acts as the fourth partner in pushing up valuations. You scratch any Tencent investment you will find Naspers somewhere, Google Swiggy and Byju and you will find them there together.
Together these four have wreaked havoc in Chinese and Indian market by dumping capital to shore up their own profits and edge others out. A long term Chinese internet analysts says:
(Tencent and Alibaba) are a further risk in that, as deep-pocketed buyers, Tencent and Alibaba are themselves part of the forces pushing valuations sky-high (for Chinese companies). The duo are behind virtually all China’s unicorns, with the notable exception of news feed and short video app Bytedance, and more traditional financial investors have long complained about being crowded out.
This has resulted in a situation where the Americans and other fund managers are wary of making large bets in India as the valuations are sky high and the Indian entrepreneurs fail to evolve a sustainable growth strategy for their businesses, as they party on cash fueled strategy of attracting customers. This has led to a situation where the Indian startup ecosystem instead of being creative and innovative to solve Indian problems have become a fake enterprise being run for the benefit of its investors.
Why should we care?
This cash fueled funding party has likely killed entrepreneurship, strategy and innovation among Indian companies as they dumped cash on customers to gain market share as a business strategy. The party stopped as the Indian government tightened the norms on Chinese funding in India and now the companies are left in a limbo with no business model and no incoming cash. It would be interesting to see if these companies can raise money at these valuations if the Chinese embargo continues.
You can find me on Twitter at Manish Sharma .
