Why is Flipkart keeping it private?

The infusion of $1 billion in to Flipkart by private equity funds last week was greeted with awe and pride by the financial markets. That global funds are willing to bet big money on a Indian start-up is a proof of the entrepreneurial talent available in the country. It also goes to highlight the exciting prospects of e commerce companies.

Flipkart has been growing at a scorching pace over the last few years as more and more Indian discover the pleasures of shopping online, especially for books. This growth has been funded by successive rounds of funds from private equity investors such as Accel India, Tiger Global, Iconiq Capital and Singapore’s investment arm, GIC.

Interestingly, the investors involved in the earlier rounds such as Accel India and Tiger Global have decided to participate in successive rounds too, thus pushing the time for exit further away. The stake of the Bansal-duo is reported to have reduced to single digits after the recent deal.

This is all working out quite well for the promoters who get the money from willing investors and for private equity players who have a high-growth avenue to deploy their funds. But the private equity fund’s gain is the Indian investor’s loss.

These deals seem to be nudging the Indian capital market and investors out of the way. Others start-ups such as redBus, FundsIndia and Policy Bazaar are also doing the same. Why is that so?

The obvious reason why these companies have given capital markets a go-by is due to the moribund state of our primary market over the last couple of years; with just three primary offers in 2013.

Promoters issuing shares close to market peaks at extremely high valuations --over the past decade-- has resulted in investors suffering large losses. Investors were also hurt when some promoters and market operators colluded to take the price steeply higher after listing.

This resulted in a steep fall once the manipulators exited the counter. The dull secondary market over the past five years is also to blame.

The regulator has been active over the past three years, pulling up errant promoters and investment bankers and thus helping clean the primary market. It is expected that with the revival in the economy, the IPO pipeline will also revive.

But for that, the promoters need to take the initiative and approach the market with primary offers. Promoters have been putting forth various reasons for not using the primary market.

A common reason put forward by promoters is that the business is not yet ready for listing. This is debatable in most cases. The promoters of Flipkart are reported to have announced that the gross value of merchandise sold on the website has already reached $1 billion (Rs 6,000 crore). This revenue is much larger than the sales clocked by many of the companies currently listed on Indian exchanges.

Amazon.com was incorporated in 1994, it went public in 1997. The company reported its first profit in 2001. Similarly eBay listed in 1998, three years after it was formed. Rakuten, a Japanese e-commerce company too, was founded in 1997 and the company went on to make an initial public offering on the JASDAQ in 2000. In comparison, Flipkart is seven years old.

Of course listing comes with its share of head-aches, compliance, accountability, disclosures and so on. The company is perhaps not yet ready to reveal to the public and its competitors all the numbers besides the revenue. But equity is long-term funding and comes without the pressures of performance attached with private equity funding. Once the company establishes its credibility, approaching the market in the future to raise funds is also not that difficult

The common assumption among promoters of start-ups is that the Indian investors are very profit-focused and they tend to punish a stock if it slips even slightly. They are therefore not likely to accept a company like Flipkart that is yet to turn profitable. While this is true of Indian investors, the investor fraternity in other countries too behaves in a similar manner. US investors punish stocks if the earning guidance slips by even 10 cents. The same investors are willing to buy Twitter, that does not even have an established revenue stream.

Again, with a number of internet companies listing on the US and other stock exchanges in recent times, there are many comparable peers available. For instance Facebook trades at a market capitalization to sales ratio of 19. The ratio for Twitter is 26. Flipkart that appears to have been valued between 5 to 7 times its revenue, is not as stiffly valued.

But Flipkart’s immediate peer, Amazon.com trades at a much lower price to sales ratio of 1.7. eBay too is similarly cheap at 4. Compared to its e commerce peers, the recent deal therefore appears expensive. We are shooting in the dark here since we don’t have access to all of Flipkart’s numbers.

But if they had been available, Indian investors too would be able to take a call on it.

It would not be right to say that Indian investors are not mature enough to understand these businesses. There are two reasons for this. One foreign investors form a dominant force in our country. These investors can apply the wisdom gained in developed markets to valuing companies in India too. Second, it maybe recalled that when the search service provider, Just Dial, went public in 2013, the retail portion of the offer was oversubscribed three times, despite the valuation of 60 at the higher end of the price-band.

If there are some investors who seem sceptical, the regulator can help to prepare the ground and educate investors on understanding and valuing such companies. But ultimately, it is the Indian promoter who needs to let go of his misgivings take the plunge.