Groupon fiasco puts the spotlight on Indian e-commerce bubble in India?
Moneylife Digital Team 04 April 2012

Groupon, the icon of new e-commerce businesses, has announced an accounting restatement and has got sued by a shareholder. Will the private equity investors who have created a mini e-commerce bubble in India meet the same fate?

Groupon, the icon of new e-commerce businesses, has announced an accounting restatement and has got sued by a shareholder. Will the private equity investors who have created a mini e-commerce bubble in India meet the same fate?
Many venture capitalists and private equity firms have invested close to a billion dollars in the e-commerce space. They are possibly dreaming of exiting with huge gains as and when these companies do a public offer in a fashion similar to that of Groupon of the US—or are taken over. According to Avendus, an investing banking company, as much as $829 million have been invested in the Indian e-commerce and digital space. However, they may have troubling thoughts given what has happened to Groupon in the US.

Groupon, the icon of new e-commerce sites, has been sued by a shareholder who accused the company of misleading investors about its financial prospects and concealing weak internal controls. Groupon, which came out with one of the biggest initial public offerings (IPO) in recent times, was valued at as much as $10 billion. Now the company is valued at 25% below the $20 IPO price.

Groupon has made financial restatements which it has confessed were due to “material weakness” in internal controls. Groupon’s statement said, “The revisions resulted in a reduction in fourth quarter 2011 revenue of $14.3 million. The revisions also resulted in an increase in fourth quarter operating expenses that reduced operating income by $30.0 million, net income by $22.6 million and earnings per share by $0.04.” According to the company, the revisions are primarily related to an increase in the company's refund reserve accrual to reflect a shift in the company's fourth quarter deal mix and higher price point offers, which have higher refund rates. This impacts both revenues as well as cost of revenues. In America, it is rare to have a restatement soon after an IPO because a lot of “material” information is usually disclosed with the Securities Exchange Commission (SEC) at the time of an IPO.

Groupon’s confession is bad news for Indian e-commerce investors. There have been suggestions that Indian e-commerce sites, too, have used creative accounting—this development will surely cause a lot of frowned brows. Groupon’s success had spurred a number of venture capitalists and private equity firms to jump on the e-commerce bandwagon in India. Over the last two years, we’ve seen investments in several e-commerce sites take off, most notably Flipkart, Snapdeal, Myntra, Naaptol, Zansaar, Fashions and You, to name a few. The list is simply too large to list out here. The following are some of the notable deals that transpired last year:

  • Flipkart, an e-commerce website similar to Amazon.com raised as much as $20 million from Tiger Global in June 2011.
  •  Inmobi, a digital advertising firm, raised a whopping $200 million from Japan-based Softbank.
  •   Fashionandyou.com, a fashion e-commerce portal, raised $40 million from Northwest Venture partners and Intel Capital.
  • Yatra Online, a travel portal, raised $44.5 million from Northwest Venture partners, Intel Capital and Valiant Capital partners.
  •  Myntra Designs raised $14 million from Indo-US ventures, Tiger Global, Accel India and IDG Venture.

To attract seed funding and command high valuations, it is believed that companies resort to accounting tricks. For example, discounts offered to customers are apparently capitalised, not expensed, thereby inflating balance sheet figures and asset values.

With the proliferation of so many e-commerce websites and questionable accounting practices, what is their future? India, unlike America or other developed countries, has very poor broadband penetration and getting users to buy online en masse overnight and regularly would be a difficult proposition. According to ITU (International Telecommunication Union), a United Nations specialized agency for information and communication technologies, India has only 1.53 Internet users for every 100 inhabitants (as of 2010). According to Avendus report, There are an estimated 80 million Internet users in India today, which represents a penetration of 7% of the population (17% of urban population). This is significantly lower than global benchmarks (average 31% of total population). Moreover, when it comes to payments, India is known to be a “cash-only” economy, with 95% of the payments through cash. Most, if not all, e-commerce sites prefer the facility of electronic payments, with few offering cash on delivery.

Taggle.com, which was run by Bangalore-based Taggle Internet Ventures, was one of the first victims of the e-commerce boom in India. It started off with $1 million and took nearly a year to start selling online. It was set up as a group-buying website which included services and products. However, intensive competition and driving down of prices, much the same way as the airline industry, forced Taggle.com to shut down.

Mahesh Murthy, the founding partner at Seedfund has been a very vocal critic of the new e-commerce sites. He has been asking, how can a company with a topline of Rs50 crore raise money at a valuation of $1 billion? In his opinion, private equity investors have been insane in putting money into e-commerce sites.

Mr Murthy’s arguments look stronger after the Groupon scandal. Will all the me-too Indian e-commerce companies go down as part of another dotcom bubble?

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