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The Easy Money in Dot-coms

The dot-com boom in India is reminiscent of the dot-com bubble in the US and could be doomed to a similar fate

In my earlier avatar as a full-time journalist with a daily newspaper, one of the things I was responsible for was bringing out a weekly management supplement. An interview with a management guru was a regular part of this supplement.

One of the standard questions that I put to these management gurus was what their definition of a business model is. Usually, I got very long answers which were half baked and full of management jargon.

One day I got lucky and one management guru told me that the business model is how a company hopes to make money one day, some day. After the interview got over he asked me to edit that out, telling me that he had said it in jest.

Nevertheless, that is the best and the simplest definition of a business model that I have come across over the years, even though it was said in jest. Typically, the best way to judge a new company which is currently not profitable is to look at how it expects to make money some day. And that some day can't be very far in the future.

Take the case of the dot-com companies in India. They are currently bleeding and losing a lot of money. The situation is similar to what happened with the dot-com companies in the United States in the late 1990s and the early 2000s.

As Gary Smith writes in Standard Deviations: Flawed Assumptions, Tortured Data and Other Ways to Lie With Statistics: "A dot-com company proved it was a player not by making money, but by spending money, preferably other people's money... One rationale was to be the first-mover by getting big fast... The idea was that once people believe that your website is the place to go to buy something, sell something, or learn something, you have a monopoly that can crush competition and reap profits." This is precisely what is happening in India as well. Take the case of Flipkart, probably the most famous dot-com in India right now. A recent newsreport in the Mint newspaper points out that the various Indian entities of the company made total losses of ₹719.5 crore in 2013-2014. This on a revenue of ₹3,035.8 crore. In 2012-2013, the company had made losses of ₹344.6 crore on a revenue of ₹1,195.9 crore.

What this clearly tells us is that the company is more interested in increasing sales rather than making profits. In fact, the promoters of the company had admitted to the same in an interview to the Business Standard newspaper in July 2013, where they had said: "We can be profitable from today if we want. We can stop investing in one area and start making profits; it's definitely possible. But we don't want to remain as a small profitable company."

A similar strategy is being followed by many other dot-com companies. The only reason why these dot-coms have managed to survive despite running huge losses is because venture capitalists and private equity firms have been falling over one another to invest money in them.

In the aftermath of the financial crisis that started in September 2008, after the investment bank Lehman Brothers went bust, the central banks in the developing countries have maintained very low rates of interest. The Federal Reserve of the United States, the American central bank, has been leading the way by maintaining the federal funds rate in the range of 0-0.25 per cent. The federal funds rate is the interest rate at which one bank lends funds maintained at the Federal Reserve to another bank on an overnight basis. It acts as a sort of a benchmark for the interest rates that banks charge on short- and medium- term loans.

This has basically led to two things. One is that investors can borrow money at low rates of interest and invest it in financial and other asset markets all over the world. Second, with low rates of interest on offer in developed countries, it has increased the appetite for risk for overseas investments. This explains to a large extent all the 'easy money' that has been coming into Indian dot-com companies. The question is what can cause trouble in this paradise? As Smith writes: "The problem is that, even if it is possible to monopolize something, there were thousands of dot-com companies and there isn't room for thousands of monopolies. Of the thousands of companies trying to get big fast, very few can ever be monopolies." While Smith is talking about the dot-com companies in the US, this applies equally to the current crop of Indian dot-com companies as well.

Long story short, while some dot-com companies will survive, most of them will go bust. The second problem that can arise is that the era of easy money can come to an end. While currently it doesn't seem that the central banks in developed countries are in a position to increase interest rates, this is a perpetual risk that remains. And if interest rates do start to go up, Indian dot-com companies will get into a serious funding trouble sooner rather than later. Further, some dot-com companies have got used to this era of easy money. Take the case of Housing.com. The Economic Times recently reported that as per the filings with the Ministry of Corporate Affairs, the dot-com reported losses of ₹48.8 crore on a revenue of ₹1.9 crore for 2013-2014. What these numbers clearly tell us is that the firm does not seem to have any business model and is surviving on the investor money that has been coming in. There are many other similar dot-coms going around.

To conclude, it is worth repeating what the stock market investor Rakesh Jhunjhunwala told CNBC TV 18 in a recent interview: "Where is Flipkart's complete business model? Forget about valuation. I want to know Flipkart's business model. I want to know how you will be profitable?" While, Jhunjhunwala may or may not turn out to be right about Flipkart in particular, he will definitely turn out to be right about Indian dot-coms in general.

Vivek Kaul is the author of Easy Money. He can be reached at [email protected]

This column appeared in the May 2015 Issue of Mutual Fund Insight.