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Why Snapdeal debacle may compel Nexus to rethink its future direction

LiveMint logoLiveMint 24-05-2017 Snigdha Sengupta

Mumbai: By this time, Nexus Venture Partners, one of India’s top venture capital firms, should have been sitting on a substantial pile of cash from the sale of its stake in troubled e-commerce company Snapdeal. Instead, for more than three months, the Mumbai-based firm has fought a bitter (but losing) boardroom battle to save its investment. At this juncture, it may have little choice but to walk away from what could have been its most lucrative bet with its principal investment and pride barely intact.

Delhi-based Snapdeal (Jasper Infotech Pvt. Ltd)—it has been widely reported—is up for sale and for a song. Japan’s SoftBank Group Corp., Snapdeal’s largest investor, is desperately trying to merge the company with its larger Bengaluru-based rival Flipkart in an all stock transaction that values the former at about $1 billion. Snapdeal was valued at $6.5 billion at its peak not too long ago.

SoftBank founder Masayoshi Son. Photo: Bloomberg

As part of the transaction, SoftBank, which owns about 33% of Snapdeal, has offered to buy the stakes of Nexus and Kalaari Capital, another early venture capital investor in the company, for $60 million and $30 million, respectively. They each own about 10% and 8% of Snapdeal and enjoy veto rights on critical matters such as the proposed distress sale. Until recently, both were opposed to the terms being offered by SoftBank. But, early this month, Kalaari Capital managing director Vani Kola resigned from the company’s board. That doesn’t necessarily mean the Bengaluru-based venture capital firm loses its veto rights. However, if the move signals acquiescence to SoftBank’s terms, which is more likely than not, it leaves Nexus with little leverage in its standoff with the Japanese media and internet conglomerate.

It isn’t difficult to understand Nexus’s dogged resistance. The venture capital firm hasn’t liquidated any of its stake in Snapdeal, acquired at an estimated investment of more than $40 million over multiple funding rounds. On the other hand, Kalaari Capital, whose overall investment is estimated at $27.5 million, has already harvested a reported $100 million by selling a portion of its original stake to SoftBank more than two years ago.

Nexus’s predicament, however, brings up a couple of pertinent questions.

One, like other early-stage investors, why didn’t it sell its stake, even partially, before Snapdeal fell off the wagon? According to three people familiar with developments at the company who spoke on condition of anonymity, the venture capital firm had at least two prime opportunities to do so well before matters spun out of control.

Two, does Nexus need to re-evaluate its own strategic direction as an early-stage investor in the Indian technology start-up market?

Nexus declined to respond to an e-mailed questionnaire.

A fatal error in judgement?

When SoftBank entered Snapdeal in October 2014 with a $627 million investment, it is believed to have made offers to buy the stakes of some of the company’s existing investors. Since Snapdeal’s valuation had vaulted to a reported nearly $2 billion with SoftBank’s entry, many of its early investors stood to reap a significant upside. Apart from Nexus and Kalaari, the other early investors in the company at the time included Bessemer Venture Partners, Intel Capital, eBay Inc. and Saama Capital. Some passed up on the offer. Others such as Kalaari and Bessemer decided to cash in. Bessemer, which owned a 4% stake, sold shares to SoftBank and hedge fund Stanley F. Druckenmiller (see chart).

SoftBank declined to respond to queries.

Nexus is also believed to have been among those who passed up on the offer to sell. It had its reasons. Just months before SoftBank arrived, the firm had rolled up its investment in Snapdeal by participating in a $134 million funding round led by Nasdaq-listed e-commerce marketplace eBay. The investment was reportedly made from its $110 million India Opportunities Fund, a sidecar fund raised for the specific purpose of follow-on investments in potentially successful later stage portfolio companies such as Snapdeal. It probably reckoned that with the financial muscle of SoftBank on board, the going could only get better.

And, for a brief while it did. About nine months later, Taiwanese manufacturing company Foxconn Technology Group, Chinese e-commerce marketplace Alibaba and SoftBank led a $500 million funding round in Snapdeal. Existing investors Temasek Holdings, BlackRock, Myriad Asset Management and Premji Invest also participated in the round. Snapdeal’s post-money valuation jumped to $4.8 billion. This time, eBay decided to cash in. It sold 1.16% of its 9% stake to Foxconn.

Around the time that the Foxconn-Alibaba funding round was being closed, Canada’s largest professional pension fund, Ontario Teachers’ Pension Plan (OTPP), came calling at Snapdeal. It made offers to buy the stakes of some of the company’s remaining early investors. Bengaluru-based venture capital firm Saama Capital cut a deal to sell its entire stake to OTPP. The deal closed in November 2015. Saama Capital managing partner Ash Lilani told Mint in March last year that the sale was profitable enough for the firm to return its second fund, the $26 million Saama Capital II, to its investors or limited partners. Saama had invested about $4 million over multiple funding rounds in Snapdeal. Lilani declined to share details about the size of the stake sold.

Again, Nexus is believed to have been among those that OTPP approached. The venture capital firm passed up on the offer. At the time, Snapdeal’s valuation had climbed to over $5 billion and Nexus’s stake would have been worth well over $500 million. Email queries to OTPP remained unanswered at the time of going to press.

“There was a small mismatch in the valuation… Nexus turned down the (OTPP) offer because it wanted a slightly higher valuation,” says one of the three people cited earlier. That error of judgement may have cost Nexus possibly the most profitable exit from its portfolio. Snapdeal hasn’t been able to raise any significant primary capital since the Foxconn-Alibaba round and its valuation has plummeted due to external and internal factors.

“Timing is everything in the venture capital business. Especially when it comes to exits. In this case, greed seems to have obscured that judgement,” says the second of the three people cited earlier.

Whether it was greed or whether Nexus allowed itself to be blindsided by SoftBank’s financial muscle is something there are no clear answers to yet. What’s incredible though is how a frontline venture capital firm failed to see that it could never be anything but incidental to a devastating game of oneupmanship that was playing out between two of the most powerful investors in India’s start-up market at the time.

Nikesh Arora vs Lee Fixel

Before SoftBank announced its arrival in India, New York-based hedge fund Tiger Global Management enjoyed unobstructed access to some of the country’s fastest growing technology start-ups. The hedge fund employed a swift pace of dealmaking and higher-than-market valuations to edge out some of the most experienced venture capital investors at the deal tables. By late 2014, the firm’s private equity arm, led by secretive fund manager Lee Fixel, had put an estimated $2 billion to work in buying up prime stakes in frontline start-ups such as cab hailing services Ola, online classifieds platform Quikr and Flipkart.

Tiger Global’s rising fortunes in the Indian market soon attracted a myriad of global investors from hedge funds to sovereign wealth funds to strategic investors. Like Tiger Global, they were often willing to pay a hefty premium to corner a piece of the world’s fastest growing consumer internet market. Among them, SoftBank had the most resources and ambition and, it lost no time in matching Tiger Global dollar for dollar. Led by Nikesh Arora, a former high profile Google executive who had recently taken charge as vice-chairman, SoftBank quickly deployed nearly $2 billion across start-ups such as Snapdeal, Ola, property listings platform Housing, budget stays aggregator OYO Rooms and grocery e-tailer Grofers in a matter of months and, not surprisingly, at peak valuations.

Venture capital firms such as Nexus, though relegated to the sidelines of the battle between these two investors, didn’t have cause for complaint.

Valuations were only headed north and as long as the money continued to flow in, they were happy to ride the wave. Their investee companies, among them Snapdeal, Flipkart and Ola, also rode the wave. Encouraged no doubt by their deep-pocketed investors, they threw caution to the wind and went on a spending spree to corner market share. Vanity metrics such as GMV (gross merchandise value) trumped boring ones such as unit economics.

Then the music stopped. Some time during the last quarter of 2015, Tiger Global and a host of non-traditional start-up investors were compelled to scale back their investments. China had just devalued the yuan and global public markets were in turmoil.

With the hot money gone, it didn’t take long for valuations to crash across the board. India’s start-up market, especially the consumer internet sector, slipped into a downturn that continues to this day. Layoffs, fire sales and investment write offs became commonplace. And suddenly, the premium valuations that investors such as SoftBank had paid during the good times became untenable.

Things may not have turned as bad as they did for Snapdeal and Nexus, in particular, but for one surprise development in the middle of last year. Arora, who was tipped to succeed SoftBank founder Masayoshi Son as chief executive officer, suddenly quit.

The reason for his somewhat unceremonious departure was that Son wanted to keep the CEO’s job for a few more years. Arora didn’t think it was worth his while to wait.

His departure, however, almost immediately turned off the funding tap for SoftBank’s portfolio companies in India leading Nexus to its current predicament.

Time to change track

Nexus is no minnow in India’s venture capital market. It commands a portfolio of more than 75 companies and has raised $1.2 billion across four funds, making it the country’s second largest venture capital firm. It is also fairly popular with global limited partners (investors in venture capital funds). It latest fund, the $450 million Nexus Ventures IV, was raised in the midst of the ongoing downturn and is the biggest it has ever raised. Despite those credentials, however, the Snapdeal debacle may compel the venture capital firm to revisit how its wants to play the market, especially in India, in the years ahead.

Founded over a decade ago by Naren Gupta, Sandeep Singhal and Suvir Sujan, Nexus has always been a bit different from other homegrown venture capital firms. It has one foot in the US and one in India and spreads its investments across the two markets. Gupta, a successful former technology entrepreneur in Silicon Valley, leads the firm’s overseas investments from Menlo Park in California. Singhal, who earlier co-founded Mumbai-based venture capital firm eVentures India, and Sujan, co-founder of online auctions platform Baazee, lead investments in India out of the firm’s Mumbai and Bengaluru offices.

The dual market strategy has helped the firm to deliver exits from the portfolio relatively early in its history and, unlike many of its peers, fairly consistently year-on-year. It scored one of its earliest ones in 2011 when DimDim, a web conferencing services firm, was acquired by Salesforce.com for a reported $31 million. Other early exits from the portfolio include Cloud.com, acquired by Citrix for a reported $200-250 million, Gluster (acquired by Red Hat), Netmagic (acquired by NTT Docomo) and Astrid (acquired by Yahoo Inc).

In all, the firm has exited 16-odd companies from the portfolio. But, there’s a catch. Ten of those exits, nearly all of them very profitable, are from investments in overseas companies, usually based in Silicon Valley. Many of those companies do have fairly extensive back-end operations in India but essentially constitute the firm’s overseas portfolio. On the other hand, the handful of exits it has been able to push through from its India portfolio are less remarkable. Among Nexus’s better known exits from the India portfolio are hotel aggregation platform MagicRooms, which was acquired by Yatra in 2011 for an undisclosed sum, classifieds platform OLX (it sold its stake to South African internet and media conglomerate Naspers), and the sale of its stake in Komli Media’s India business to SVG Media for an undisclosed sum.

The consumer internet portfolio, in particular, has been a rough ride for the firm. In early 2015, Mumbai-based Housing, one of its earliest investments which also, incidentally, had SoftBank as co-investor, turned into a public spectacle when the company’s founder and CEO Rahul Yadav engaged in an ugly and very public spat with its investors. Yadav was ultimately ousted by the investors led by SoftBank and Housing was merged with rival PropTiger this year in an all stock transaction. The outcome of that investment now depends on how well PropTiger performs. Another early investment, budget stays aggregator Stayzilla, recently shuttered operations after it was unable to raise fresh capital and is now trying to pivot to a new business model. The firm has also had trouble with its investments in TinyOwl and Roadrunnr. About a year ago Mumbai-based food ordering service TinyOwl closed its operations and merged with Bengaluru based Roadrunnr, a hyperlocal delivery service, in an all stock transaction put together by the investors of the two firms. The merged entity was rebranded and relaunched as Runnr. Recent media reports suggest Runnr is now up for sale after being unable to raise fresh capital.

A profitable Snapdeal exit would have helped the firm reverse that track record and establish its credentials as a bankable investor in India as much as one in the US. There is an outside chance that the firm may still be able to salvage its investment in Snapdeal.

It isn’t clear yet whether the payout being offered by Softbank for its 10% stake includes a stake in Flipkart if the merger materializes. But, if that is not the case, it may be time for Nexus to rethink its future direction. Incidentally, last year, the firm upped investments in the US market. Seven out of the 12 deals it closed involved start-ups based there. It would not be surprising, and probably neither unwelcome to its limited partners, if the firm decided to shift strategy to being a largely US-focused investor while continuing to invest opportunistically in India.

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