Is this the start of an Indian E-com Bubble?

BANGALORE-BASED RAVEEN SASTRY, WHO QUIT ONLINE APPAREL RETAILER MYNTRA.COM in March to start hoopos.com, a site that sells baby products, was recently funded an undisclosed amount by Helion Venture Partners, a Mauritius-based, India-focussed fund. Great news. Except that his business is expected to start later this month. Sastry’s isn’t the only e-commerce startup that’s been funded even before it’s gone live. Entrepreneurs and venture capitalists (VCs) say there are at least half a dozen others, including Urbantouch, a beauty products retailer, that have received funding in the last six months.

Kunal Bahl, co-founder of Snapdeal.com, a group deal site that recently closed its second round of funding of $40 million (Rs 184 crore), says that a year or so ago, if there was one VC willing to fund you, today there are 10. Industry sources say that the Hoopos deal was concluded in just three meetings with the investors.

“There is fear and greed at work,” says Mohanjit Jolly, managing director of Draper Fischer Jurvetson India, a private equity (PE) fund, trying to put things in perspective. He argues there’s frenzy in the market because nobody, especially the funds, wants to get left behind.

Asked if high valuations and easy funding could be signs of an e-commerce bubble in the making, entrepreneurs and VCs alike refused a straight answer. However, they admitted that they were uncomfortable with the exuberance building up, especially in the last couple of months.

A leading VC from New Delhi says he gets calls from peers in the U.S. asking for the best way to get into the sector because they believe that’s where all the excitement is. “Some of the investors don’t have a domain expertise in e-commerce and when everyone wants to get in, you start wondering if the bar is getting lower,” he says.

Sure, there are 100 million Internet users, growing at an annualised rate of 15% over five years; throw in 3G and Internet access on mobiles, and the number rises. A healthy chunk of these users are happy to buy online, as seen in the success of online bookstore Flipkart and retailer Myntra. But is this enough to justify the pace at which money is being poured into this entire segment?

According to VCC Edge, the research arm of VC Circle, a company that tracks PE and venture capital deals, $285 million has been pumped into online ventures in the first eight months of 2011. Some 35 deals have been signed this year; the buzz in VC circles in Bangalore indicates that closer to 52 deals have been signed in the last 52 weeks (till August) with a total value of nearly $350 million. Remember, a lot of deals go unreported.

IN ALL OF 2010 some $75 million entered the sector. Only two deals that year were above the $10 million mark, while in 2011, the ninth-largest deal was at $10 million. What’s changed in a year? If anything, the economic mood has worsened and inflation has risen, as have interest rates.

Of course, nearly 20 million Internet connections have also been added. And some of the fervour is fuelled by the news that Amazon is set to enter India. A likely outcome being imagined is that it’ll then buy domestic e-commerce sites, like Groupon bought sosasta.com, an Indian e-commerce portal. (Amazon didn’t respond to Fortune India’s queries.)

Then there’s the success of Flipkart. In March 2010, the company closed the financial year with revenues of Rs 80 crore. In an interview with Fortune India in May, Binny Bansal, co-founder and chief operating officer of Flipkart, said, “We are targeting revenue of Rs 500 crore for the current financial year,” referring to the company’s plans to diversify into selling electronics, music, and home appliances.

In June, Flipkart raised its third round of $20 million from Tiger Global, a U.S.-based fund. Flipkart was valued between $250 million and $300 million then. Now there’s buzz that it’s in talks with General Atlantic Partners for raising another $150 million at an enterprise valuation of $1 billion. (Both General Atlantic Partners and Tiger Global refused to comment.) Flipkart did not want to comment on the current revenues or the level at which the company is being valued. However, people close to the deal say that its revenue figures are on track and the valuation today is 15 times sales.

A VC who has seen the dotcom bubble of 2000 says that companies that are market leaders and have demonstrated consistent growth have a greater chance of meeting investor expectations. “The lifestyle industry is valued at $50 billion and is growing at 15%; it will be worth $100 billion by 2015. Even if you consider that about 5% of this business will be online, you are looking at least two or three $1 billion companies,” says Mukesh Bansal, CEO of Myntra, which has been growing at 30% over the last 12 months.

But, as the same VC explains, just because a Flipkart or a Myntra is raising the stakes doesn’t mean all websites deserve the same treatment.

Draper Fischer’s Jolly tells the story about an e-commerce startup that was looking for money. It had an annualised gross merchandise value—the metric used to indicate the value of the goods or services sold online—of $500,000 of high-end electronics. “They were looking to raise $7 million to $8 million and were expecting a pre-money valuation of $20 million. That translates to a post-money valuation of almost 56 times sales for a company that has been in existence for less than a year.” He didn’t fund them.

THIS IS WHY ENTREPRENEURS such as Hitesh Dhingra, founder and CEO of Letsbuy.com, an online retailer of electronic products, are spooked. “When you see valuations jump in such a short time, it scares anyone.” He’s afraid that if there’s a bubble that bursts, it’ll pull down the good with the bad.

Alok Mittal, managing director, Canaan Partners India, a venture capital firm, explains that there are two benchmarks for valuing companies: one is the accepted norm of sales multiples at different stages of investment, and the other the kind of valuations that global players are commanding. Currently, Series A funding (early stage) is at seven to nine times sales, while later stage is around 10 to 12 times sales, sometimes even 15. “Amazon currently trades around two times sales and Chinese e-commerce companies tend to command three to four times sales due to higher growth, which might be a reasonable exit benchmark,” he says. “But if investors are entering in the later rounds with 10 times valuations or more, it’s going to be very tough for the company to deliver.”

The founder of Naukri.com, one of India’s most successful e-commerce companies which survived the previous meltdown, Sanjeev Bikhchandani, says e-commerce is capital hungry and investment intensive, and its ability to make profits needs to be tested case by case. Entrepreneurs, he says, could be too focussed on revenues and not profits.

It’s equally true, as Sudhir Sethi, chairman and managing director, IDG Ventures India, says, that the very nature of VCs is to invest ahead of the curve and investors who are getting into the game are smart enough to understand the risks. “There is enough due diligence done before any investment is committed. And for every 50 deals that get financed, there are 500 that don’t.” But the question on everybody’s lips: Is too much happening too soon?