India tech M&A: Treading water

As an active investor in India's tech start-up scene, Helion Venture Partners has learned to factor in the possible moves of the country's internet giants. It has seen these companies make inroads into the territory of several of its portfolio companies, including online grocery business BigBasket and mobile payment solutions developer Ezetap.

Yet the firm's views on the likes of Flipkart, Snapdeal, Paytm and Ola - which between them control sizeable portions of the e-commerce, online payment and transportation services spaces - extend only to concerns about competition. So far it considers trade sales to be an unlikely exit opportunity, because for the most part these companies simply seem to be uninterested.

"Most of the larger giants have still not made very large acquisitions," says Rahul Chowdhri, a partner at Helion. "There are very few examples, unlike in the US where a Google or a Cisco Systems or a Yahoo will make multi-hundred-million-dollar acquisitions. India still does not have enough of those examples."

Every two or three years we have a big rally up and then we have a quick correction down. And in that, only three or four companies will stand - Ben Mathias

Despite the absence of big-ticket sales, India's major tech players have shown increasing interest recently in expanding their businesses. Their desire has brought both caution and excitement to the VC community, as investors balance the possibility of selling their portfolio companies with that of suddenly facing a rival with much deeper resources.

At the same time, size does not equate to freedom of movement for these giants. They must be careful about their exposure - ever conscious of the dangers of overreaching when competitive threats remain in their core markets - and are therefore likely to remain a small part of India's exit market, at least for now.

Close to home

The areas in which India's tech giants have shown the greatest interest in recent years are online-to-offline (O2O) local services and financial technology. This interest has taken several forms, and the companies involved have tended to mix their strategies depending on the situation.

One route that has proven popular is that of acquiring a start-up that is already pursuing the business in which the larger company wants to become involved. A prominent example of this was Snapdeal's purchase of mobile wallet FreeCharge; the online marketplace paid $400 million for FreeCharge in April.

"None of these companies has been around long enough to be shy of buying talent or buying teams and businesses," says Rahul Khanna, managing partner at venture debt firm Trifecta Partners. "So Snapdeal acquiring FreeCharge is an example of that, where they said, ‘Look, here's a business we think we should own, why bother repeating it.'"

Both Snapdeal and rival online marketplace Flipkart have led the way in terms of acquisitions. Snapdeal, however, has accelerated its buyout activity recently, making five acquisitions in 2015, according to AVCJ Research - as many as in the previous five years combined. By comparison, Flipkart has made seven acquisitions since 2011 and three in the last year.

On the other hand, Flipkart has outdone its competitor in terms of venture capital transactions. It has made three investments this year, as opposed to one for Snapdeal.

Other major tech players, such as Amazon India, e-commerce and mobile payments platform Paytm, and taxi aggregator Ola, have been more restrained on this front. AVCJ Research has no records of acquisitions in India for any of the three, and no records of VC investments for Ola - though in this category Amazon and Paytm have been more active. Amazon has made four VC investments since 2000, two of them in the last year, while Paytm has made three, all in 2015.

The factor that unites these different approaches is that they are meant to expand the core business, rather than entering entirely new areas. Ola's approach shows this; the company has taken steps to broaden its own offerings through internal initiatives rather than through M&A, taking advantage of its network of drivers to enter the grocery and food delivery verticals. The company has also entered the crowded fintech space with its own mobile wallet app.

"Now that they have spent a significant amount of customer acquisition money, it makes a lot of sense for them to try and increase the activity of these same customers, rather than expecting a very large amount of activity just from the cabs business," says Vishal Pereira, managing director at investment bank and consultancy firm CreedCap Asia Advisors.

In this way, adding additional lines of business in this way helps the giant generate more revenue from its existing customer base. It is an important consideration, because once a company has attained a large enough scale, it may no longer be feasible to rely on organic expansion to meet revenue needs.

The M&A activity of the other majors fits this pattern. Flipkart's well-publicized acquisition of online fashion and apparel shop Myntra in 2014 boosted its previously weak representation in the fashion sector. Snapdeal's purchase of FreeCharge stemmed from a desire to have its own payment system rather than partner with one of India's many independent fintech developers, which would have taken a cut of the revenue and made use of Snapdeal's customer information as well.

These companies are at a disadvantage in this regard, compared to their counterparts in other countries. Though they have raised large amounts of money, the major Indian players have not achieved the national dominance of a Google or Amazon in the US, or of an Alibaba Group or Tencent Holdings in China.

Because of this, the Indian giants have to focus on winning in their core business sectors before trying to attack new areas, which leads to the complementary nature of their deals. Though Alibaba and Tencent have also pursued investments to expand their own businesses, they have been able to pursue a broader focus, both in terms of industry sectors and geographies. Some Chinese giants have even made inroads into India, as when Alibaba invested in Paytm, or when Xiaomi launched a research and development center in Bangalore.

Another limiting factor in the India market is the fact that the tech giants are not yet showing a profit. Rather than making acquisitions from their own money, the companies are still reliant on outside investment to support their expansion strategy.

"They're still getting their own business models right, and they're actively trying to recruit senior management to come and run these core businesses, and drive them to profitability," says Ben Mathias, managing director and head of India at Vertex Ventures, the VC arm of Singapore's Temasek Holdings. "So they don't exactly have the bench strength to go and expand into new business areas, and be nimble about it."

This means that despite their deep pockets, managers at the major players cannot count on the flow of money continuing. They must divide their attention between raising additional funds and running their own businesses. This is another difference between the largest Indian internet players and their Chinese counterparts, which are profitable and in many cases are listed companies, giving them additional streams of capital.

Coming consolidation

While there is still plenty of competition in India's start-up sector, industry professionals warn that this is not likely to remain the case. In the fintech space, for example, the many available payment options are likely to create confusion among consumers, resulting in pressure for affected companies to rally around a common standard.

"Today I need to have Paytm if I want to use Uber; I need to have the Ola money wallet if I want to use Ola; I need to use FreeCharge if I want sweet deals on Snapdeal shopping. It's just very hard for me as a consumer to figure out where to keep my money," says Dhiraj Poddar, director at TA Associates. "I think it's still early enough that multiple players can try to build or acquire this, but at some point you'll expect the customer to decide where he's really focusing on keeping his money, and he'll do it where the use case is highest."

Other sectors are already starting to see consolidation. CreedCap Asia's Pereira, who told AVCJ earlier this year that he expects no more than one in five local logistics start-ups to make it past the seed round, says the shakeout has already begun, with overeager investors that jumped into the space without enough forethought having to take a loss.

"Some of them will have burnt their fingers. For example, in the hyper-local logistics space there has been so much consolidation, where companies have been sold for as little as $10,000," he says. "It's bound to happen when they make rash decisions about wanting to invest in a sector just because others have."

If the crowding of the market is a warning sign for India's tech investors, the growing interest of the major internet players could offer the prospect of relief. The increasing moves toward acquisition certainly indicate that an investor holding on to the right property could find a willing buyer.

Flipkart's purchase of Myntra is an example of the possibilities of this approach. However, Helion's Chowdhri is one of various industry players who say they do not consider the chance of a trade sale to be worth making it a major part of their plans.

For one thing, the tight focus of the tech giants on their core business means that start-up backers cannot be sure that their portfolio companies will be attractive to the giants. For another, many investors feel that India's exit market lacks clarity.

Flipkart is a case in point. When the company launched in 2007, its founders were planning to sell out to Amazon after a few years. That goal was upended when Amazon itself launched in India in 2013. However, since then Flipkart has continued to raise funds; indeed, the company has raised more money since 2013 than it did before the US giant entered the market.

The continued success of Flipkart has raised the hopes for many Indian investors of following a similar path and finding the next unicorn themselves. Pereira says this is the focus of the biggest investors today, though not all VC professionals agree that just following up a success story is the priority. Vertex's Mathias notes that many investors focus on building up companies so they can weather the swings of the investment market's cycles.

"I've learned in India over the last 10 years that there is significant value to being able to survive cycles," says Mathias. "And India does have cycles sort of in a compressed fashion. Every two or three years we have a big rally up and then we have a quick correction down. And in that, only three or four companies will stand."

Even when a sale to a tech giant is available, investors may be wary of handing over control. An acquisition can be a boon for a start-up, with the availability of additional resources, more freedom to operate, possible synergies with the parent company, and access to a larger customer base.

On the other hand, if the parent does not understand the company it has purchased, it might not manage it properly, causing friction within the larger group and reducing efficiency of operations. A sale that goes badly runs the risk of hurting everyone involved.

Where to next?

Investors are confident that India's tech giants will continue their expansion and strengthen their presence in the M&A markets; the question is which sectors will they turn to next.

Pereira thinks that e-commerce players might turn toward the logistics space next, in order to own the entire supply chain and better control costs, while Mathias believes that an omni-channel sales strategy might be in store, with online retailers investing in brick and mortar retail outlets to reach a new customer base. Both caution that this is only speculation, however.

India's VC investors cite this uncertainty as the reason that it is critical not to plan on the actions of the tech giants when they make their investment decisions. Helion's Chowdhri points out that the tech sector is still very young, and that few of the features that are taken for granted today were even conceived of ten years ago.

"Just because mobile phones were being used, nobody knew whether cash-on-delivery would take off or not. A lot of other things have to come," Chowdhri says. "It's like making a movie; a good movie is not about one particular thing, it is about multiple things coming together. So, I just shrug if somebody says they knew this would happen, or this was the data point, and it was obvious."

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