Indonesia VC: Work in progress

Alibaba Group's acquisition of a majority stake in Lazada for around $1 billion in April represents the first sizeable exit from an e-commerce company in Southeast Asia - a market that is attracting ever larger amounts of capital due to its rapid growth and favorable demographics, but where the returns are so far largely on paper only.

In the space of less than four years, Lazada raised more than $700 million across multiple rounds of funding and established itself as a leader in a space that had never seen substantial scale. The sale to Alibaba, at a valuation of $1.5 billion, saw a string of investors take money off the table, including Germany-based incubator Rocket Internet. Most investors held on to some shares in the expectation of future upside.

For Rocket, the takeaway was $137 million and the satisfaction that, in this instance, its strategy of taking internet concepts from developed markets and rolling out near replicas in emerging markets has worked. While Rocket has been able to establish a platform and related infrastructure in a landscape largely untouched by meaningful competition, the role of pioneer is a difficult one, and the wider community has benefited from the company's endeavors.

This is a very early stage in a large growth opportunity. Many of the companies we see are just at the cusp of something very exciting but at the same time there are going to be risks – Shane Chesson

"Rocket has accelerated the region by maybe 3-4 years in terms of e-commerce," Vinnie Lauria, founding partner at Golden Gate Ventures, told the AVCJ Indonesia Forum earlier this year. "Part of that has been spending on marketing - billboards saying you can buy things online. In Jakarta that is now second nature, but five years ago it wasn't the case. So, like them or not, Rocket has put a lot of money into educating consumers and making them comfortable with buying something online."

Even those who are likely to feel the pressure as Alibaba steps up its presence in Southeast Asia recognize the Lazada transaction for vindicating the investment thesis. "Somebody is providing an exit scenario for e-commerce and I really think this is going to enable the market," said Eka Himawan, Group CFO of Orami, the product of a merger between rival Southeast Asia e-commerce sites Moxy and Bilna.

Comparisons are inevitably drawn between Southeast Asia today and where China was 10 years ago. In Indonesia alone, investors see similar growth-on-growth scenarios, where they can leverage rising disposable incomes and increasing smart phone penetration - at scale and in the expectation that e-commerce will shoot upwards from its current level of about 3% of retail sales. Needless to say, they also think about China-style returns, even though the exit routes are as yet unclear.

Emerging market

While still a fraction of the China levels, early and growth stage technology investment has certainly taken off in Southeast Asia. The annual total had never passed $300 million when, in 2013, it topped $860 million, more than the previous six years combined. Commitments have remained in that range ever since, with nearly $700 million invested so far this year, according to AVCJ Research.

The number of transactions has also increased, comfortably beating 100 every year from 2013 onwards, but the significance of larger growth deals should not be underplayed: a number of companies are able to raise sizeable rounds of funding, with the online marketplace Tokopedia and ride-hailing platform Go-Jek the stand-out cases in Indonesia.

The speed at which the country has moved was captured by Irzan Raditya, co-founder and CEO of virtual personal assistant service YesBoss. Approximately 12 months ago, when the company was founded, Raditya recalled working out of his co-founder's apartment, with a mosquito swatter placed on one side of his laptop and a can of mosquito repellent on the other.

YesBoss received seed funding from 500 Startups, Convergence Ventures and IMJ Investment Partners last October and is now scaling up, with a team of 66 people who handle SMS inquiries from customers looking to book flights, buy movie tickets and make restaurant reservations. "The challenge is more like how to manage people and get talent," Raditya observed. "It is about how we can combine the human and technology sides so things operate efficiently and we can fulfill the needs of the customer."

YesBoss is still relatively young and it remains to be seen whether the company can leap through funding rounds like Tokopedia or Go-Jek. But even these comparatively more mature companies have only been around since 2009 and 2010, respectively - which means their backers have been involved for less time than the average holding period for a US tech start-up. Exiting at this stage would likely mean leaving money on the table.

"We understand this is a cyclical and risky industry and at every stage of a company's growth we need to continually look at is it the right time to hold on or is it the right time to do an exit and return some capital to our LPs," said Shane Chesson, founding partner at NSI Ventures, which is an investor in Go-Jek. "This is a very early stage in a large growth opportunity. Many of the companies we see are just at the cusp of something very exciting but at the same time there are going to be risks."

Liquid value

There are two drivers behind this preoccupation with liquidity. First, industry participants note that a sprinkling of M&A and the odd IPO is not enough given the amount of capital entering early and growth-stage tech deals; their worry is that interest will peter out if investors fail to secure a few big wins.

"Until you have venture funds that are beginning to post good returns and return money to LPs it is going to be a little challenging for the institutional LP base to pour money into this region," said Jeffrey Chi, vice chairman for Asia at Vickers Venture Partners. "But once it does happen the money will come."

Second, the Indonesian government is looking for ways to facilitate the industry, and exits is a natural area of focus. Earlier this year, a presidential delegation visited Silicon Valley and Rudiantara, the minster for communications and information technology, announced plans to create 1,000 quality start-ups by 2020 (there is even a WhatsApp group with around 300 members, including Rudiantara and Trade Minister Tom Lembong, through which founders can ask questions). He also raised the prospect of a technology board as part of the national stock exchange.

Officials from the exchange have been reaching out to potential listing candidates, with the CEO of e-commerce player Bhinneka among those sounded out. While venture capital investors are generally positive on the initiative in theory, they remain circumspect about how it might work in practice, at least in the absence of implementation guidelines.

"Do I believe it is beneficial to the Indonesian market for the government to do so? Absolutely. Do I believe that governments in the region should start thinking about providing some liquidity to some of their domestic tech companies? Absolutely. Do I believe it's going to work? I have my doubts," said Chi of Vickers. "The only place I have seen a board like this work is in China, with the NEEQ [National Equities Exchange and Quotation], also known as the New Third Board."

The experience of other markets in the region - Hong Kong's GEM board and Singapore's Catalist board, both designed to accommodate smaller companies, have yet to become hotspots for tech offerings - suggests a difficult audience for high-growth companies with no or low profit. Concerns center upon the difficulty of building an investor community that is sufficiently appreciative of the business models involved to deliver the kind of valuations and liquidity available on NASDAQ. Much rests on the role of the brokerages and the development of a sponsor community for these offerings.

Golden Gate expects M&A to be the main driver of exits in Southeast Asia, predicting a more than six-fold increase in deal flow to 250 transactions per year by 2020. This is a reflection of limited historical public markets activity as well as strategic interest in fast-growing markets like Indonesia. Golden Gate noted in a report that Southeast Asia had seen 11 IPOs by technology companies since 2005, none of them Indonesian. Meanwhile, Indonesia accounted for 26 out of 127 tech M&A deals during the period.

Lauria added that the Singapore Exchange has courted several of the larger locally-based start-ups, but the response was lukewarm. "They are going to be the guinea pig, the first large tech company to list on the exchange; they know they are going to get beaten up on valuation, and they know it is unclear what the next year will be like and how the market will measure them," he said. "The more the government does at a macro level to encourage entrepreneurship and investment is definitely a good thing. But anybody thinking about a tech IPO is still looking at New York."

Risk factors

The Lazada deal - plus Rakuten's $200 million purchase of Viki, a Singapore-headquartered video streaming site, in 2013 - indicate that strategic investors will play an ever more significant role as the start-up scene develops. A domestic IPO option simply adds to the alternatives for investors whose analysis of exits is shaped by an awareness of risk. According to NSI's Chesson, the most pertinent risks to Indonesian start-ups are global competitors arriving in the market and a fightback from local players.

"It's very important for regional investors like ourselves not to just come here and say, ‘Let's invest in disruption,' without expecting some reaction from the incumbents," he said. "In Indonesia in particular there are many longstanding family-founded businesses, and for them disruption is not just a bullet point on a fancy slide, it is potentially disrupting their legacy and what they would hope to pass on to their children. We need to be constantly aware of what could be the reaction."

Broadly speaking, this reaction comes in one of two forms. First, these family conglomerates could call in favors with politicians and regulators, and also leverage the supplier and distributor relationships from their varied existing businesses, to try and suffocate a start-up before it can combine disruption with scale. Second, they can embrace technology by hiring teams to create products that are digitally competitive or by setting up captive VC units that invest in start-ups that complement the core business.

Sinar Mas Group, one of the country's largest conglomerates, falls into the latter category, having created Sinar Mas Digital Ventures. "Technology is very disruptive and you can react to that in different ways," said Roderick Purwana, the unit's managing partner. "But at the end of the day if you don't embrace it, eventually it will disrupt you. For Sinar Mas, we want to embrace it and we are learning here."

These tensions are not unique to Indonesia, local nuances notwithstanding, and they will likely be played out in other segments of the technology sector in due course. Investors have yet to exhaust opportunities in e-commerce; online retail verticals are seen to have untapped potential, while the country's payments infrastructure is notoriously underdeveloped, with only 6% of the 250 million population holding a credit card and fewer than half having bank accounts. There is also logistics and the need to address the challenges involved in transporting goods ordered online to the customer.

Whatever areas investors target, Golden Gate's Lauria warned they must bear in mind the sheer pace of change in Indonesia, and that those who fail to adapt are likely to get left behind.

"How many Indonesians still have a BlackBerry here?" he asked the forum. "If I'd asked that question three years ago everyone would have raised their hand. Think about how fast these things change. Incumbents don't want to lose, and some may have the ability to fight and make it difficult to lose now, but at the end of the day people will always go for convenience. If you put your heels in the mud you are going to have a problem."

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• Topics
• Southeast Asia
• Technology
• Consumer
• Venture
• Early-stage
• Expansion
• TMT
• Indonesia
• Singapore
• Golden Gate Ventures
• NSI Ventures
• Vickers Venture Partners