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2020s Vision: Can only China save EM’s tech bubble?

    Nirgunan Tiruchelvam
    Nirgunan Tiruchelvam

    Head of Consumers Equity Research

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    Tellimer Research
    9 December 2019
    Published byTellimer Research

    “So tonight I’m gonna party like it’s 1999!” – Prince

    2019 has had an eerie similarity to 1999 – a year of irrational exuberance. In 1999, the dot com bubble reached astronomical levels. Back then, tiny startups such as Webvan and Pets.com had vast ambitions and valuations, but negligible revenues. These early e-commerce firms were burning through their IPO proceeds in a year.

    VCs and bankers lined up to put money into e-commerce startups in 1999. The boom ended in tears in the spring of 2000. With the Nasdaq collapse, e-commerce suffered several years of poor funding. Many darlings of 1999 fell by the wayside.

    Today, e-commerce is a massive asset class in both DM and EM. EM e-commerce is striving to replicate Amazon’s success. The drivers of EM e-commerce are threefold:

    1. Internet penetration in the EM world has leapt forward, powered by cheap data.
    2. Smartphones have become the principal means of e-commerce, as cheaper accessible models flood the market.
    3. E-commerce is often the first step for millions of emerging market consumers to access retailing.

    Blood on the dancefloor

    But the growth is drawing red on the cashflow statement. E-commerce companies are bleeding cash at an alarming clip, which is reminiscent of 1999. This is particularly the case in emerging markets. Jumia, ostensibly Africa’s Amazon, may burn cEUR200mn in FY 19 and FY 20, which means it will exhaust its cash in two years. Similarly, SE UN, ASEAN’s Amazon, has chronically poor cash generation.

    Chart: E-commerce EBITDA margins (%)

    Chart: E-commerce EBITDA margins (%)

    Source: Bloomberg

    Investors are facing a dilemma. How do we determine which companies will be the survivors in another 2000-type crash? We have introduced a metric that may hold the answer. The Cash Sustainability Index (CSI) is a metric to assess the viability of e-commerce companies. The CSI rates the historical EBITDA margin, CFO margin and FCF margin. The higher the CSI, the more sustainable the business.

    The sustainability index

    The clincher in the sustainability of these enterprises will be their cash-flow management. EM e-commerce companies have high costs of goods, opex and capex. This means that they are negative CFO and FCF. We note that many in the peer group have been FCF negative in the past five years.

    Table: Cash Sustainability Index

    Cash generativeComfortableDanger zone
    BABA US EquityPIK SJ EquityJMIA US Equity
    EBAY US EquityZAL GR EquitySE UA Equity
    MELI US EquitySHP SJ Equity3690 HK Equity

    Source: Bloomberg, Tellimer Research

    Alibaba (BABA US) and Mercado Libre (MELI US) fare well on this metric as they are cash-generative, having achieved scale. JMIA US and SEA US fare poorly, with overstretched balance sheets. They are in a precarious position where they are depleting their cash reserves.

    The froth in China’s web industry could be the salvation for EM e-commerce. In our view, this is the principal difference between 1999 and 2019. At the turn of the century, internet penetration in China was less than 4%. Most people had creaky dial-up connections. Today, there almost a billion smartphones in China. Chinese companies such as Alibaba and Tencent have accumulated a war-chest of capital. 

    The fanfare over China’s infrastructure investments has overshadowed its e-commerce investments. Chinese companies have aggressively taken non-controlling stakes in EM rivals. Alibaba and Tencent have invested US$21bn between them in the past five years. They are, by far, the leaders in EM venture capital. 

    EM e-commerce cash bleed is a worry. But, the sector may avoid another 2000 type crash, because of the Chinese tech behemoth.

    It is time to party like its 2019!

    Read our full 2020s Vision: 20 themes for the next decade report.