Why is traditional accounting not good enough for Internet businesses? Instead, use technology edge to consider them for investing?
The recent IPO of loss-making companies has got mind-boggling valuations. Some people attribute it to the bull market madness and want to avoid it. In contrast, others are participating in it to ride it as long as it continues.
However, I like to invest at high valuations, but I can see the pricing power of the business. So I have an investment checklist and a business checklist. Then I apply the fundamental analysis to it. Further, I have my investing rules to evaluate the stock.
Please note that I am not recommending investing in any company that is mentioned in the article. I am not a SEBI registered broker to recommend any stock. Instead, I have chosen to name a few stocks to help my readers understand how to analyse a business. Still, I will not talk about the price information, and everything I am sharing here is already available in the public domain.
Back to the new age of Internet businesses, none of the IPOs has passed my criteria on investing in. However, some traditional companies like Burger King or Clean Science do pass the requirements.
Still, being an Internet Entrepreneur, I think the traditional method of accounting is not good enough to value any new-age Internet business.
Let me first share an example.
Let’s say you want to set up a traditional business to manufacture shoes.
First, you will buy land. Then you will construct a factory. Next, you will order the raw materials. Now you will hire workers to manufacture the final product from raw materials.
The final product has a direct correlation to raw materials. Therefore, the more raw material you add to the manufacturing units, the more output it generates.
In accounting terms, the purchase of land and the setup of a factory become assets.
The raw materials and workers that use them to generate final products are the expense. The sale of shoes generates profit.
New Age Internet Businesses
Let’s say you want to set up an e-commerce app to sell shoes from various manufacturers.
You will hire developers and provide them with a place to start building the app. Assuming you own the space, still, the salary to the developers is an expense, but they are building the asset (Your Online App).
Once your app is ready, you list in the marketplace and then have a sales team to get vendors to signup and sell the shoes. The finally, the marketing team brings in the customers who purchase the shoes from the vendors.
As an app owner, you charge a fee for the sales of the vendor’s product.
However, the product that makes money for you does not correlate with development efforts. So even if there is no development for a few months, you can still be making profits because the sales and marketing are on.
Traditional Accounting Vs Internet Businesses
For a traditional business, with the inception of the idea, you decided to buy land. You spent a lot of money to get the land, but it is not a loss but an asset on the books.
For an Internet business, you decided to develop an app, and you hired a developer. As a result, you spent a lot less money. , But, still on the books, it is a loss, and there is no asset to show.
Let’s view the same example a little differently to help you further clarify.
You decided to clone Relaxo’s one of the factories. So you outsource it to a company. They quote you a price of ₹10 Crores. You pay them the money and get the factory in 2 years. So on the books, you have an asset worth ₹10 Crores.
You decided to clone Amazon’s e-commerce app. So you outsource it to a company. They quote you a price of ₹1 Crore. You pay them the money and get the app in 2 years. On the books, you have a loss of ₹1 Crore.
My Real Life Internet Business Example
We share 3 to 4 videos per week. However, there were weeks or even months when we shared nothing. Still, there was no significant change in our earnings.
The domain and channel is an asset for the business. For example, we have almost 400 videos online now. But in accounting terms, everything is an expense in the form of a salary.
How to Value an Internet Business
As an investor, I like to value an Internet business based on the edge (MOAT) that they can have with the help of technology.
- Zomato is a great food delivery app. But, does Zomato have the power to prevent me from going to Swiggy?
- How many payment processors do you have installed on your phone? Can PayTM prevent me from using GPay?
Investors are comparing these stocks to Facebook, Apple, Amazon, Netflix, Google. I am not sure if they have any idea that there are hundreds of such Internet companies listed in the US, and among them, only a handful of them are a success.
The successful ones have an edge with the technology.
Everything else is bleeding. Groupon is one such company that has lost 95% of its value since the IPO. It was valued very high but not anymore because there is nothing unique about their product or service.
Real-Life Example of Affle India
Be wary of any company that uses the terms like artificial intelligence, machine learning. You will not see such phrases used by Google or Facebook. They use Data analytics at the most.
As per their website,
Affle India is a technology company with a proprietary consumer intelligence platform that delivers consumer acquisitions, engagements, and transactions through relevant mobile advertising.
If I put it very simply, it is a mobile advertising company.
So you build a free app and have ads on them (Aka True Caller). As an App developer, you can sign up to become a publisher to Affle India. Once approved, you can serve their ads.
With the help of those ads, they deliver ROI for the advertisers.
For me, it is only a data analytics company that can predict when you are about to sign up or buy a specific product and show you that relevant ad.
Google or Facebook also does the same. They provide ROI based on Clicks, but Affle provides ROI to its clients based on conversions.
The business is fantastic for Affle, but there is no MOAT for the company. Based on the employment history of Affle available on LinkedIn, I am yet to see a high-end team of developers to build an AI or machine learnings stuff.
To invest in Affle India, I need to interact with a publisher and ask them the effective CPM or cost per thousand impressions they can generate from ads. If they can beat Google’s Adsense, they have an edge but not otherwise. I tried becoming a publisher but didn’t have any response from them.
So once you can find a company with an edge, you should consider it but not otherwise.