Bernanke's address yesterday has once again got the economic slow-down in the US and possiblity or rather lack of QEIII into focus. So where does an investor put his money? Angel investing in the US has been seeing stellar growth, so much so that the word bubble is becoming a part of almost every blog I know.
In this context, mSolve Partners, a firm I work with frequently, asked me for my opinion on the Indian economy. The following is an article I wrote for them. Thought I'd post it here as well:
India these days brings out very mixed sentiments. From investors focused on the market, phrases like 'This is where the money is' are quite commonplace. And from western developed markets we hear phrases like 'Inflation and corruption will be the bane of India'. So what's the real story?
In summary, the Indian economy is continuing along a strong growth trajectory, However, due to head winds in terms of inflation, regulatory uncertainty, corruption etc, public markets and FDI, post a strong rebound after the credit crisis, have not reflected the same optimism be it in terms of relative valuations to the west or in absolute trajectory. Telecom and IT services specifically continue to see growth in revenues and investments and I feel this trend will continue over the near future given strong government support and definite needs. The question is which are the sectors where we will see the strongest opportunities?
A brief look at Indian numbers shows a dynamic economy which would be the envy of any of the developed markets. GDP in 2012 is expected to grow at 8.8% in real terms after growing at 8.2% in 2011. This compares with the 0.5% GDP growth of UK and 1.8% in the US.
The stock market can be a relevant indicator of positive sentiment and anticipated growth rate of an economy. However here we have an aberration. As of Dec 2010, the Indian BSE Sensex was trading at a P/E of 22.5x. Compare that with the S&P 500 which is trading at 23.3x. A comparative story in 2009 was the BSE Sensex at 22x and the S&P 500 at 20x.
The differential is bourne out by the investment trends seen in the Indian economy. Foreign direct Investment into India has decreased from a peak of $41B in 2008 to $35B in 2009 and $23B in 2010. (Source: OECD) As a percentage of GDP that has decreased from 3.3% to 1.5% in 2010.
The decline can in part be attributed to the close to 12% inflation figures and anticipated contraction in the economy driven by higher interest rates. However, what is relevant to our story is where the investment is flowing, how relevant is telecommunications in this scenario and which are the sub-sectors where the real opportunity lies? The trend for FDI flow has been as shown below:
Source: Ministry of Commerce and Industry
India's IT and services sector has a significant exposure to developed markets and hence an initial decline in revenues and valuation was anticipated. However that was counterbalanced as a greater number of firms began outsourcing functions to cheaper off-shore destinations such as India in a bid to cut costs. The telecom sector has consistently constituted around 13% of total FDI. A deep dive into the sector throws up some interesting paradigms.
Subscriber numbers have been increasing consistently. As of March 2011 wireless subscribers stood at 812 million, a growth of 2.6% over Feb 2011. To put the numbers in perspective, the largest market after India is the US at 302 million. A worrying trend on the other hand has been the decline in ARPU across the sector driven by an increase in the number of players in the market and greater competition. The situation was hardly helped by the lack of spectrum availability and the delay in issue of 3G licenses by close to three years.
As a result, even though overall telecom sector revenues have grown by close to 8% over the FY 2009-2010, the declining ARPU and lack of spectrum have had a negative impact on the sector valuations in 2010. Some of the leading telecom operators are trading in the range of 20-24x while VAS players are 12-14x. (Bharti Airtel – 23.2x; Idea Cellular – 23.9x; OnMobile Global Limited – 14x)
This is significantly lower than 2006 when various telecom deals saw P/E multiples of over 50x. Having said that, it continues to be higher than developed markets represented by the iShares Global Telecommunications ETF (IXP) trading at a P/E multiple of 12x. In this scenario, before looking at any opportunity in India it is necessary to identify whether it has a greater exposure to the strengths of the sector or the potential threats. There have been three significant developments which are impacting the Indian telecom sector:
3G The 3G spectrum allocation is a huge boon for the sector as data revenues begin to countermand the decline in voice and SMS revenues. Operators are increasingly focusing on revenues from m-commerce and m-entertainment. VAS providers operating in a SAAS model and providing both 2G and 3G related services hope to benefit both from the growth in subscriber numbers as well as the diversity of 2G and 3G across rural and urban markets respectively. Specifically with respect to Bharti Airtel and their acquisition of the African Zain Telecom, VAS and other service providers have the additional benefit of addressing a larger market consisting of both Indian and African subscribers.
Investors are also looking for growth stories in the mobile solutions space. In the last few months, Intel Capital has invested close to $18 mil from a $250 mil India focused fund in opportunities ranging across mobile media and online solutions. Bessemer Venture Partners has raised a $1.6B fund, quarter of which is focused on Indian investments. One of their investments is the leading VAS provider, OnMobile. Over 2006-07 Sequoia raised a $700 mil India focused fund for investments across early and growth stage firms. One of their recent investments in May 2011 was $10 million in a mobile application development firm Sourcebits. Other investments from US and Indian VCs have ranged across mobile social networks, video content platforms, video streaming platforms, gaming etc.
Banking on 3G growth, there has also been a spate of consolidation across telecom operators. To name but a few, in April 2011, Vodafone acquired the remaining 33% in their India holding from their partners, the Essar Group, for $5 billion. In 2008, NTT Docomo had acquired 26% of Tata Teleservices (TTSL) for $2.7B. They have recently invested another $180 mil for TTSL's 3G expansion.
Outsourcing of telecom infrastructure Very early on Indian telcos began outsourcing their service requirements to outsourced management providers. This included billing, CRM, fraud management etc. Step two was the outsourcing of telecom infrastructure. Over the last 2-3 years several large PE funds have invested in outsourced telecom infrastructure firms which are a huge boon for telcos considering the diverse economic density and hence telecom requirements of the country. Telecom operators have opted to share infrastructure in rural areas, and increasingly in urban areas, rather than incurring the capital expenses on their books.
In 2008, KKR invested $250mil in Bharti Infratel for an enterprise valuation of $10-12 billion. Macquarie SBI Infrastructure Fund invested $300 mil for an 11% stake in mobile tower firm Viom Networks in August 2010. June 2010 saw GTL Infrastructure acquiring the tower assets of Reliance Infrastructure and Aircel Cellular creating an independent behemoth supplier to various telcos.
Further, in March 2010, AT&T acquired 8% of Tech Mahindra, an IT outsourcing specialist. In March 2011, UK based Apax Partners baked enterprise solutions, data warehousing and consulting specialist iGate in acquiring 65% of Indian software firm Patni Computers for $1.2B.
For the infrastructure providers it is a very profitable model as it leads to higher utilisation charges and the ability to bulk bargain with equipment vendors. The model is also leading to innovation along the lines of solar powered base stations and the like.
Regulation In recent times, there has been a spate of corruption cases against and imprisonment of key players in the Indian telecom industry as well as implicated government officials. These events have had a negative impact on the relative valuation of the sector.
However, with a clean-up of the regulatory environment, there is hope that there will be faster and more efficient allocation of additional 3G spectrum as well as the availability of 4G over the next 1-2 years. Both will work to the advantage of telecom operators. Additional services such as quad play packages and ubiquitous video services will become more wide-spread. This is an opportunity both for Indian firms as well as tech firms in the US and Europe to enter the Indian market. For example, mobile video sharing firm Vuclip has recently raised $8 million to expand into Indian and Indonesian markets. Getjar raised $25mil recently to expand their sales and marketing initiatives in Asian markets.
In summary, the Indian juggernaut continues to be a great growth story which is seeing a current valuation dip due to the negative impact of regulation and corruption. However, there are still very profitable business development prospects abounding for US and European firms across the telecommunication spectrum.
My aim is to help identify the right partnerships and business development and investment opportunities across the Indian IT and Teleom diaspora.
I’d be amiss if I don’t take note of the LinkedIn IPO on Wednesday. Stellar is an understatement.
The question is: Are we seeing a bubble or is there just too much money in the market that investors don’t know what to do with?
First the facts: The IPO was for 7.84 million Class A common stock, 4.8 million new shares and 3 million from existing shareholders. The firm continues to hold 86.7 million Class B common stock which has voting rights of 10:1 as compared to 1:1 for the Class A stock. The stock opened at $85 and by mid-day it was trading at a peak of $122.7. At end of day, the stock was at 94.25 with a market cap of $8.9B.
As of March 2011, the firm had 102 million registered members. Revenues have grown from $78.7 million in 2008 to $243 million in 2010. The firm has moved from making losses to a profit of $15.4 million in 2010.
So, here we have a few multiples:
P/R: 36.7x
P/E: 578x
P/member: 87.4x
The question is - when it comes to social networking sites, what do you monitor? No. of page views, no. of clicks, no. of members? I know LinkedIn isn’t exactly Facebook or Renren since it even has paying members. Revenues may come from advertising but the focus is on providing recruiting and other related corporate solutions. In such a case, P/E and P/member taken in conjunction may be the right monitor.
Source: SEC Filing
So that means 578x and 87x – phew!! And that too for a firm with a free float of 8% and voting rights of 0.1%! Perhaps it is because it’s only a freefloat of 8% - low supply greater demand.
I was looking at some numbers for LinkedIn according to SharesPost. At the end of March, 2011, the company was being valued at $2.4B with a per share price of $30.8.
3.5 times in 2 months. Does seem a bit of a bubble, doesn’t it?
Now, is it just excess money in the markets. We've all heard enough about the impact of quantitative easing on markets and the trillions which are raising the prices of commodities world wide and causing inflation in emerging markets. Is it relevant in this case?
Investing in the US has certainly come back into fashion since September last year. Both the S&P and NASDAQ have risen by almost 25-30% with the NASDAQ outperforming by about 5%.
This may explain part of the excitement related to the IPO. At the same time, let’s also take a look at the iShares S&P 500 Growth (IVW) vs Value Index (IVE).
Once again since September, we see a 5-8% out-performance of growth stocks as compared to value stocks.
I guess it’s fair to say that the market is looking for interesting growth stories and they certainly don’t come better than the LinkedIn types. $250 million in revenues, 40% growth, profitable.....it's not just a dotcom story.
So, is it a bubble? Right now, I do think so but we should certainly see the numbers settle down lower. However I still think it will stay higher than it’s IPO list price (going out on a bit of a limb aren’t I?)
Now that the month is coming to an end, here's a short review of one of the sectors which saw some action and that is online billing companies. Cloud based services in all forms have been the flavour of the season and that has a catalytic effect on SAAS based subscription billing services.
Vindicia a company that provides an on-demand billing platform in a SAAS model, raised $20 million from FTV Capital, Bertelsmann Digital Media Investments, DCM and Onset Ventures. Vindicia supports SAAS providers, gaming, dating and such forms of online merchants with their billing and fraud management solutions. The firm charges its fee at 2-3% of the revenue billed for merchants on their behalf and had revenues in the range of $6-8 million in 2009. Their total funding till date has been close to $41 million including a $1 million Series A from Symantec in 2003.
Some of the firm’s competitors include Aria Systems, Zuora, Metratech, Digital River, Monexa.
Zuora, which has focused its solution on subscription based billing, has also raised $20 million in November from Redpoint Ventures, Benchmark Capital, Shasta Ventures, Marc Benioff and Tenaya Capital. The firm has been cash flow positive since earlier this year and boasts customers across media, telecom and cloud computing.
And then, there are Aria Systems offering billing and subscription management with investors such as Hummer Winblad and Venrock. Aria last raised funds in 2008 with a total investment of $14 million. Monexa provides on-demand subscription billing services to Salesforce customers among others. They have average quarterly revenues of $800-900k with EBITDA losses of over $296k in Q3 2010.
Vindicia and Zuora certainly come across as the strong, innovative players in the SAAS based subscription billing services. Zuora provides billing along with additional services such as flexible pricing, multiple rate plans, subscription changes, renewals, up sells etc which is a distinct advantage as compared to payment gateways.
The threat is newer players nibbling at the flanks. One such competitor is Recurly which charges 1-3% of transaction revenues on a monthly basis as compared to on a transaction basis. Works well for start-ups. Another player is CheddarGetter – their differentiator being the billing model which is a flat fee of $39 per month rather than percentage based fees.
The sector should soon be ready for some M&A activity. The question is would the acquirer be someone like Facebook, Zynga, Playspan, Paypal or perhaps the traditional billing vendors like Amdocs and the like making their online entry. For Zuora the bet would be on Facebook but for the other players I might actually consider Amdocs. With the QPass acquisition, the firm made its entry into billing digital goods and services. They must be ready to extend their sphere of influence from telecom to billing for gaming, online media as well as cloud based services.
A very interesting new development from IBM: The firm has launched a new cloud services platform targeted at carriers and service providers which will enable them to offer cloud computing to their customers. The platform includes hardware, software and additional managed services.
Telecom operators providing cloud services are certainly in the news these days. A few days ago we covered the sector from the perspective of Vodafone, AT&T, France Telecom and BT. Now there’s news of Telecom Italia focusing on the sector to garner incremental 7-8% revenues from shared software and storage services.
Verizon has been tooting their major expansion into CAAS services since earlier this year. We are talking about new and expanded space in over 200 data centers connected to Verizon’s MPLS network to provide cloud based, converged solutions for network, application, content, security with additional managed professional services.
IBM’s proposition is interesting because of its positioning. According to the company, telecom operators can focus on their core offering but at the same time provide the integrated managed offering with a much faster deployment time. In addition, there is the possibility of additional services such as unified communications, field force management, collaboration and sales tracking.
Four years ago when the idea was broached between a telecom operator and IBM – we called it reselling – reselling IBM’s services along with the operator’s core infrastructure. After all, provisioning the infrastructure – network and data center – falls far more into the purview of the operator.
The new positioning does indeed sound very interesting. It’s a build up from telecom outsourcing deals like Bharti’s $750 million contract signed with IBM in 2004. Since then the contract value may have exceeded $2.5B both with the growth of the Indian market as well as Bharti’s expansion into Africa.
IBM has signed similar deals with various other players in emerging markets. However I believe the new platform can be targeted only at Tier-II and Tier-III operators or else MVNOs - players who choose not to manage their applications and services but would certainly like to offer their clients a more rounded portfolio offering.
Managed services have always been a key element of the telecom operator portfolio – at least one sure-shot means which keeps them from becoming dumb pipes.
For AT&T, wireless data/ managed services account for close to 25% of total revenues (2009). Verizon had initiated their focus on managed services a while back and it was further reinforced by their acquisition of Cybertrust in 2007.
Closer home, we have BT Global Services which provides converged and managed IT infrastructure – a combination of network, IT and professional services. France Telecom has Orange Business Services acquired from SITA in 2005. They currently provide managed WAN, LAN, security, video and mobility services.
All these services entail multiple data-centres which act as central network monitoring and management centres. In most cases this also permits the operators to include collocation services for clients looking at outsourcing their complete network and IT requirements.
Hence it came as a big surprise that Vodafone has outsourced the hosting and support for its m-Pesa service – it’s not being maintained in-house, or with another telco but Rackspace Hosting. While Vodafone is not a wireline operator, my assumption would have been that they would host client service applications in-house. After all, it is very much like the hosting services for the back-end of Vodafone 360 (which we will comment on another time). And they do have three of their own data centers in Italy, Ireland and Germany (maybe more – Turkey if I recollect was flooded a while back).
To the uninitiated, M-Pesa is a mobile payment solution to complete simple financial transactions through the mobile phone. The service is aimed at users who do not have a bank account or else do not have sufficient funds to justify an account. The service has seen very strong pick-up in Kenya and Tanzania and has been rolled out to various other parts of Africa and other emerging markets as well. If news reports are to be believed the service currently has close to 16 million customers worldwide.
It really is a big kudos to Rackspace.
The firm will be utilising satellite streaming technology to send and receive real time transaction data between users and the hosted servers. The sizing and clustering of the application and web servers enables them to handle close to three million transactions per day.
A little trivia on Rackspace – it’s a NYSE listed firm based in Texas. The firm received funding from Norwest Venture Partners and Sequoia Capital in 2000 and then listed in 2008. The IPO wasn’t too well received and lost almost 20% in value after the listing. However that can be blamed on the market environment in 2008. The stock is almost 150% up since those dark days.
All in all, it is an interesting trend. Perhaps we’ll see MVNOs and their likes co-locating their billing systems in independent data centres as well. Further with the anticipated pick up in cloud services this is certainly a company to keep an eye on.
