Another Ice Meltdown

The higher they rise, the harder they fall? In late March, the legendary Mark Mobius, chief of Templeton Emerging Markets, declared that US stockmarkets were ripe for a massive crash. Oops. The seemingly never-to-end rise of the Nasdaq index, the tech-heavy US stockmarket, where most software and all dotcom companies are listed, halted. A slow fall began. Then, on Friday, April 14, the US Labour Department announced that inflation was on the way up, ending its five-year hibernation. To investors, that meant short-term interest rates may be pushed beyond the expected quarter-point hike. Waves of selling immediately swamped US stocks. The three major Wall Street indices - Dow Jones, Nasdaq Composite and Standard & Poor’s 500 - logged their biggest one-day point declines in history. The Dow lost a record 617.78 points, or 5.66 per cent. The Nasdaq Composite was driven down 9.67 per cent. When Black Friday ended, the Composite had lost 1126 points in a week and was 34 per cent down from its March 10 high of 5048.

Indian bourses followed suit. Between April 11 and April 20, the bse Sensex fell by a stomach-turning 16 per cent, from 5541.54 to 4657.42. The mayhem started in the tech stocks, but soon spread to companies across the board as hundreds of scrips hit the lower circuit filter every day, that is, their prices fell so much that trading in these shares was stopped by the exchanges. Market darling Infosys announced its annual results: net profits up by 115 per cent, and its stock price was hammered down 26 per cent in the next seven days. Blue chip software maker Satyam Computer Services declared net profits as 69 per cent higher than last year, and its price slid 18 per cent. ice (infotech-communication-entertainment) stocks, seemingly invulnerable even a month ago, were suddenly in the trash can.

And the New Economy - that panacea, that glorious wired future towards which the planet had been striding firmly - seemed just another piece of propaganda. Was the New Economy dead even before it learnt to walk properly?

No.

As the Sensex bungee-jumped, Outlook asked dozens of experts around the country this question. And the only answer we got was: "No."

In fact, everyone we spoke to - fund managers, investors, bankers, entrepreneurs - seemed almost relieved that this correction in share values had happened. Amazingly, everyone we spoke to, said, at some point, with slight variations in wording: "Now the men will be separated from the boys, and that is good."

THE Nasdaq crash was on the cards for several months now," says Dewang Mehta, president, Nasscom. As for Indian stocks, says Rashesh Shah, managing director, Edelweiss Capital: "Microsoft’s profit-earnings ratio is 40, but Infosys’ was more than 200. Is that realistic?" One, the euphoria had to end some time. Two, when share prices of globally competitive companies like Infosys shot up, the prices of a lot of hole-in-the-wall firms claiming to be in that magic software business also rose. Finance companies changed their names to include the word Infotech and their prices zoomed. That could now be a thing of the past. Which is a definitely positive outcome. Says Deepak Ghaisas, chief financial officer, i-flex Solutions (formerly CitiCorp Information Technology): "There are two kinds of tech stocks in India - those with strong business models and those which are close to being fly-by-night operators. There are no entry barriers in the segment these companies operate in, and a shakeout has been imminent. Companies that are being set up to derive valuation and then exit are the ones which will be affected by this meltdown. " Agrees Vetri Subramaniam, chief advice officer, sharekhan.com: "The herd mentality that has persisted in software stocks is unlikely to repeat itself."

And though words like "meltdown" and "bloodbath" have been used most frequently in the last few weeks to describe the market goings-on ("crash" is the mildest), are these appropriate? "The Nasdaq is now at the level it was at in October ‘99. So what is lost is the gain of just these few months," points out Shah.

"These things happen in life. Investors with a long-term perspective don’t need to be concerned." Says Subramaniam: "The Nasdaq had gained over 400 per cent in the last four years. So the sell-off might appear catastrophic to somebody who entered the market in March, but for somebody who got on the bus in January 1996, it’s not the end of the world. In fact, as of today (April 17), the Nasdaq has gained 50 per cent since January 1999." Shrugs Atul Jalan, managing director, Netkraft, an e-services company: "This is just a long overdue correction. If it seems like a crash, it’s because the hype was based on a lot of unfounded sentiment and the depression now also bears no logic."

Well, that’s the way stockmarkets have always operated. Says U.R. Bhat, director, Jardine Fleming India Asset Management: "Everyone wants to be around when the party is on, but one alarm, even if false, is enough to have everyone running to the exit to be the first one out."

But why should the Sensex follow the Nasdaq? "Investors are getting common, fund managers are getting common, so global trends affect bse," says Shah. "It happens in every industry. If hemlines are higher this season in America then the local industry will follow suit because we all watch Ally McBeal!" But Vivek Reddy, ceo, Kothari Pioneer Mutual Fund, also points out that the Nasdaq is now going through a recovery phase while Indian markets haven’t really picked up. Reddy feels this is due to the fact that sizeable investors in India borrow to invest and when the market goes down they have to sell their stocks to square up: "The continuation of the downside in the Indian scene is because of the lack of holding power of our investors."

And as far as Indian tech companies go, when company after company can register 100 per cent annual growth, how can we use the temporary volatility of the stockmarket to deduce ideas like the tech sector is finished or the bubble has finally burst? Says Ravi Ramu, chief financial officer, iVega Corporation: "The true potential of Indian infotech companies will be realised only in the next three to five years, so these companies deserve a higher valuation." Ved Prakash Chaturvedi, ceo, Cholamandalam Casenove amc, feels that "Indian companies have demonstrated their high level of competence not only in providing services but also in maintaining healthy bottomlines. The fall in valuations is good and it means this is the time to go ahead and buy."

But the other burning question is: what about the dotcom goldrush? It has been impossible to open a newspaper in the last six months without having to read about a new dotcom success story, as new entrepreneurs have overnight raked in venture capital, run up stratospheric valuations for companies that seemed to have no hope of earning any revenues, and become the pin-up boys for the 21st century. As US dotcoms debuted on Nasdaq at market capitalisations of billions of dollars, it seemed a matter of time before Indian companies matched their success. And venture capitalists were crowding the streets with signed blank cheques in hand.

This will be a thing of the past. "The rules will change," says Jayesh Vaidya, ceo, India operations, chaitime.com. "Earlier every person with an idea could raise money. Today too you can raise money but your idea has to be very strong and backed by a sound revenue model. A lot of VCs and investors who put money in dotcoms are waiting for them to perform and their patience is now wearing thin."

In fact, the ceo of contests2win.com, Alok Kejriwal, believes that the stockmarket dip will have some very positive results in the dotcom world. Firstly, it will put some sense into heads of wannabe entrepreneurs that an idea is not enough to make an enterprise. "This will clean the clutter of idea generators, and thank god for that," he says. Secondly, he says, everyone is now talking of revenue models. "Now for the first time we’re being asked: Are you making money? Are you cutting invoices or cheques?" This is reality check time.

No longer will vague projections about advertising revenues and the prospect of e-commerce taking over our lives do. Kejriwal has done some back-of-the-envelope calculations. "dhl says it is delivering 100 packages bought off the net a day in India. Assuming even Federal Express is doing 200 and other 100-200 deliveries of cassettes, books etc and the average value is Rs 200, we are talking of sales of Rs 30 lakh a month. Is it possible for hundreds of dotcoms to survive on Rs 3.65 crore sales a year? What e-commerce are we talking of ?" As for advertising on the net, he claims that 250 of the 300 top Indian brands have not even stepped into the water.

Vivek Agrawal, ceo, egurucool.com, agrees that attention is now shifting to revenue potential in valuations. "Two years back what mattered was hits on websites and page views and what advertising or e-commerce would get was secondary," he recalls. "The assumption was that once you had traffic coming to your site, you could be creative and devise ways of making money on the site. Now people are saying page hits won’t do. What is in your site for which people will pay?" Says Manish Modi, ceo, NetAcross, "Now every person and their aunts have dotcoms. Henceforth, aunts will stop coming in."

But isn’t that how it should have been from the beginning? Well, yes. But fact was, till a month ago it was not uncommon to hear people talking about the need to change accounting principles for dotcom businesses on the plea that traditional revenue and profit-focused accounting cannot cope with the realities of the New Economy. Suddenly, you don’t hear that any more.

But, as Shah of Edelweiss puts it, the Internet isn’t going away: "The net has changed a few things forever. So even if the markets crash, it isn’t as if I’ll quit using the net and return to the phone. Therefore companies that can use this new medium to create a good business and good value will stay. What will go are the companies that hoped that every rupee they invested will yield a hundred or a thousand times that." Which, says Bhat of Jardine Fleming, will be 95 per cent of dotcoms: "The rest will either merge or exit."

But the other five per cent will become stronger and the ushers of the New Economy. "We will see almost a replay of what happened in the TV business," says Sunil Lulla, ceo, Indya.com. "Only the strong will hang around." For them, money will not be a problem, and blips like the Nasdaq floundering for a week won’t matter. Says Renuka Ramnath, assistant vice-president, icici Ventures: "Propositions which have value will continue to attract money, talent and customers. There is no panic there." According to Mehta of Nasscom, "There will be consoliation now. World over, only one in 10 dotcoms make it. In India, it had not yet come to that. Now we will see that happening."

In the meantime, the Indian market will continue to be affected not just by international fund flows but also by the dominant investment themes and strategies that prevail elsewhere. In the short term, it take its cue from the Nasdaq, the world’s leading indicator for technology companies. This is unavoidable. But in the longer term the paths will diverge simply because the companies, their business models and strategies are different.

Ghaisas of i-flex sees the volatility continuing for another year or so, till the separation of the grain from the chaff happens. "The winners will be companies in infotech services with strong skills in internet architecture and technology infrastructure. Click-and-mortar - not just click, not just brick-and-mortar - will be the way of the future."

The real negative impact of the current volatility will be borne by companies which were preparing to raise money on the Nasdaq in the near future. They will now have to bide their time. Even strong US companies like net search engine AltaVista, Yupi Internet, a network of Spanish language sites, and data mining firm iSky deferred their ipos after the Nasdaq crash. In the week following the crash, only two companies, German high-speed isp QS Communications and Canadian fibre-optic network builder 360Networks, run by former Microsoft cfo Gregory Maffei, tested waters on the primary market.

It will be the same for Indian bourses. And that too will be good. At last count, there were more than 150 Indian software companies lined up for ipos. Many of them would surely be frauds and no-hopers. A market which’s got its fingers singed will not fall so easily now for spurious siren songs.

In the end, the way you’ll look back a year from now at the market mayhem of the past fortnight will depend on whether you are a speculator or an investor with some sort of long-term plan. If you’re the latter, you may not even remember this in April 2001.