"With special permission from Business World"

Sanjeev Bikhchandani's phone wouldn't stop ringing. Over the last 6-12 months, the CEO of India's leading online jobs portal, Naukri.com, had been receiving calls from investors of every hue, including American venture capital (VC) firms who wanted to put money into his company. The chase ended on 2 February 2006, when Kleiner Perkins Caufield & Byers (KPCB), one of the leading Silicon Valley VCs, took an undisclosed stake in Naukri along with Sherpalo Investments for, ahem, an undisclosed amount. This, say industry sources, is less than six months before the company is due to raise funds through an IPO (initial public offering).

Life, it appears, has come full circle for the Indian Internet industry.

In 2000, in the days before the dotcom bust, similar scenes were the order of the day. At that time, just about every VC — with or without credentials — would issue cheques to entrepreneurs as long as they spoke the Web lingo. The treasure hunt, of course, didn’t last. While Bikhchandani’s was one of the few Internet businesses to turn in a cash profit early, many of his peers gave up on their dotcom dreams and returned to their regular jobs. And the VCs disappeared overnight.

The next five years have seen a long lull. But it was also a period that saw the gradual rebuilding of Internet businesses by a determined few. Bikhchandani, for instance, quietly built Naukri into one of India’s largest Internet services firms. At an estimated Rs 75 crore-85 crore in revenues in March 2006, his business is as mainstream, and as sound, as any leading offline recruitment agency.

And the investor, not one to miss an opportunity, is back. This time around, however, they represent the highest pedigree from Silicon Valley — KPCB, Norwest Venture Partners, Draper Fisher Jurvetson, Bessemer Venture Partners, and Battery Ventures, among others. And their investments? Google, Amazon, Netscape, Skype, Overture… you get the picture. More than anything else, it points to the soundness of the Internet business in India today.

Bikhchandani leads a pack of a dozen-odd entrepreneurs who suddenly find themselves being chased by these premier investors. Deep Kalra, founder and CEO of Makemytrip, says that he has met more VCs in the last three months than in the last five years. And Alok Kejriwal, CEO, Contests2win, says that he is back to meeting a VC a week for the first time since 2000.

Such parleys have begun to show results. Besides the Naukri deal, WestBridge Capital has taken a 2.9 per cent stake in Indiatimes in November 2005 and more recently an undisclosed stake in Shaadi in February 2006. Industry sources say that next in line will be one or two online advertising firms.

Now that the Internet has reached some scale, these businesses have begun showing 25-50 per cent growth in online revenues. Having survived the downturn through various strategies including offline presence and cost control, many of these are now profitable, mainstream companies with earnings in the range of Rs 15 crore-100 crore.

Players like Shaadi, a matrimonial site, reckon that their current needs would be met adequately with private equity funding. Says Anupam Mittal, chairman and CEO, Shaadi: “We will go for an IPO later when we know we want to raise five times what we will through private equity funding.”

Investors are comfortable funding these mid-to-late stage ventures, which are backed by players who have lived through the downturn. Says Vab Goel, a partner at Norwest: “We are looking for companies who have revenues of $5 million-10 million and can take that to $100 million in 2-3 years. That gives them a valuation of $500 million at the time of exit.” Most VCs are interested in a 10-30 per cent stake if it’s a mid-stage company. For a high-value (late-stage) company like Indiatimes or Naukri, it could be between 1 per cent and 5 per cent.

But naturally, where the quibbling starts is on valuations. Internet valuations for mid-stage companies are being done like traditional media companies at 2-3 times revenue multiples, though Indiatimes commanded a valuation of six times revenues when WestBridge took a stake in it. Says Sanjiv Agarwal, partner (transaction advisory services), Ernst & Young: “VCs usually look at the EBITDA (earnings before interest, tax, depreciation and amortisation) multiple. If the firm has grown consistently at about 25 per cent annually over a 2-3 year period and is expected to grow similarly in the foreseeable future, the valuation could vary between 15 and 20 times EBITDA. Also, if there is a lot of competition, the multiple is normally less than 15, otherwise it can be over 20.”

It is the premium that ‘dotcom survivors’ are commanding that is causing heartburn. The supply of such firms is limited, so investors are outbidding each other. “Valuations are high as there is a scarcity value that these 4-5 Indian Internet companies present. With high entry barriers, they are best positioned to reap future profits,” says Rashesh Shah, CEO, Edelweiss Capital. That, obviously, doesn’t make investors happy. Says Goel: “Money is the last positive we bring in. More important than that is our experience, discipline, failures and network.” But that, snort the entrepreneurs, is something they already have. The debate on valuations, therefore, still rages.

Some investors are doing the unthinkable, investing in startups. Consider the burgeoning online travel space. Three VCs — Norwest, WestBridge and KPCB — have funded new sites. KPCB has backed Cleartrip.com, founded by a US-based Internet consultant; Norwest (along with Reliance Capital and TV18) has funded Yatra.in, founded by two UK-based online travel professionals who worked for e-bookers, Europe’s largest online travel portal; and WestBridge has backed travelguru.com, created by two Harvard Business School alumni.

Further, industry sources say that several other online travel portals like ghumo.com and iyatra.com are being aggressively chased by top-notch investors. While that may appear like the onset of another me-too rush, it may not quite be so. As Bala Deshpande, director (investments), ICICI Venture, explains: “There is space for all these online travel players to jump in, because, as yet, there is no single player who completely dominates the industry. In the US, besides the two to three huge players, there are dozens of small players who address niche travel needs.”

Besides travel, other online plays like classifieds (jobs and matrimonial), and media and advertising will also see new players challenging the incumbents. Most VC firms confirm a significant increase in Internet business proposals. Says S.K. Jain, managing director (Bangalore), WestBridge: “Till two years back, we hardly reviewed business plans in the wireless and Internet spaces. Now, 20-30 per cent falls in this category.”

These plans are significantly different from anything that came investors’ way in 2000. These include mobile Internet applications, internet-based solutions for DTH broadcasters and alternative payment mechanisms. Draper, for instance, made its first investment in India in an online DVD rental store modelled around US-based Netflix.

However, everything is not hunky-dory for startups. For one, not all things Internet-related are attracting investments. So far, most investors are looking at Internet consumer services companies. Norwest plans to close 4-8 deals in Internet consumer services companies in 2006, and WestBridge is looking at 6-8 deals. But for proprietary Internet technologies, other countries are deemed better bets. Says Goel: “For product companies, our focus is on Israel.”

THE SMILE’S BACK: John Doerr, general partner, KPCB; Ram Shriram, managing partner, Sherpalo Ventures; S.K. Jain, managing director (Bangalore), WestBridge

Then, Internet startups perhaps miss out on funding since they require too little investment (less than $2 million). Though there is some angel investing happening by American or Japanese investors, it is limited. Most Indian private equity firms like, say, ICICI Venture, usually raise $200 million-500 million. These funds need to be invested within 3-4 years. But since such firms typically are unable to execute more than 15-20 deals in a year, fund managers look at deals worth at least $5 million-10 million.

With the new US VCs coming in, that is changing, since they come with a 4-8 year timeframe. Their risk appetite is higher since their rule-book says that it is all right for four out of five investments to fail as long as one succeeds well enough to make up for the failures.

That, perhaps, is just half the truth. Says Ajit Balakrishnan, chairman and CEO, Rediff: “Most Indian VCs are full of ex-investment bankers who haven’t had any experience in running tech startups. Unlike Wall Street, most of them don’t understand Internet businesses.” These investors, he thinks, won’t be able to invest in startups because that requires taking a call on what future online businesses would be.

At the cost of sounding clichéd, we will say that in 2006, the investments in India’s Internet businesses are different. Three reasons. One, the nationality of the money coming in. Most of these (usually seasoned) US investors weren’t around during 2000. They bring with them the confidence of creating the greatest Internet companies worldwide. They recognise the market opportunity that could pan out a couple of years from now if India, as widely expected, does manage to double its existing Internet user base to roughly 80 million. The mobile revolution has given them hope, and they reckon that the Internet will follow a similar momentum. Says WestBridge’s Jain: “Indians are having their first experiences with technology through their mobile phones. That should also make them comfortable to experience consumer services online.”

Two, even the Indian investors, many of who made big bloomers in 2000, have matured. In 2000, any bunch of college geeks with only a burning desire to succeed and no experience could get funded. Says Ranu Vohra, managing director, Avendus, a Mumbai-based investment banking company: “We had youngsters saying they wanted to replicate western online models like eBay and E*TRADE.” This time, though, such copycat ideas from raw 20-somethings are a definite no-no.

Says Jain: “We can’t say that (because) India doesn’t have a successful healthcare portal like the US does, therefore we need to create one. We have to check whether India has enough insurance users who would need such a service online.” This attitude, coupled with the knowledge of what realistic online business models are, is translating the way VCs evaluate the risk this time around.

And three, the growing size and steady profitability of Indian Internet companies, which suggest comfortable exits for investors, either through acquisitions or market listing.

For instance, the four big Indian players — Naukri, Indiatimes, Rediff and Sify — are getting ready to list on the public markets this year or, at most, next year. Also, US investors now form a substantial portion of trading volumes in the booming Indian stockmarket. That makes entrepreneurs more comfortable about listing, knowing that these foreign investors understand the industry metrics. Says Manik Arora, who leads Battery Ventures India Investments: “There is an increased investment appetite in the US public markets for Indian Internet leaders that look like Yahoo!, Monster or Expedia.”

Then, in the last couple of years, several global Internet companies have sent their teams to look at potential acquisitions in India. Neville Taraporewalla, director & country general manager, Yahoo!, confirms that his company was in talks with Indiatimes last year to acquire it, but Indiatimes wanted to stay in the business themselves. Similarly, industry sources confirm that Google is in talks with Indian Web & wireless search technology firms that it thinks may be able to enhance its search service (like visual search).

Other leading US Internet players like Match (dating), Travelocity (travel) and CareerBuilder (jobs) are interested in launching in India since these segments are seeing considerable growth. Not surprisingly, these companies are currently in talks with their Indian avatars for deals. Says V. Ramani, CEO, Mediaturf, a digital marketing company: “In the last six months, four of the big worldwide advertising networks have met us.”

An entrepreneurial vacuum, though, exists. Says Norwest’s Goel: “There is a disparity between the market potential and the number of Internet entrepreneurs. There are enough exceptional professionals working at India’s great technology companies, but nobody is willing to take the plunge.” Goel has a point. All the big names of today were founded in the pre-2000 days. The dotcom stigma has dissuaded potential entrepreneurs from getting off the fence.

Investors, though, feel that the disparity is transient. Says Avendus’s Vohra: “It’s a cycle. Companies like Naukri drive mass usage online. Once Indian investors see the valuation that these big companies get, Indian entrepreneurs and angel investors will join hands.”