Chinese AI Quartet’s conundrum

Why high startup valuations should be taken with a pinch of salt

China has been focusing a lot on increasing its AI prowess over the years. The fuel to China’s growth engine can be attributed to a kernel of four startups: SenseTime, Megvii, CloudWalk Technology and Yitu. They are also known as China’s AI Quartet accounting for nearly 60% of China’s computer vision market. Baidu, Alibaba, Tencent (BAT) along with DJI are the other set of companies investing heavily in cutting age technologies.

China’s AI prowess: Credit to four companies

Over-expectations and Under-delivery

Lets understand the situation taking analogy of the Dot Com bubble that popped in the late 1990s. The market was in a frenzy and everyone wanted to ride the Internet wave. In fact a majority was afraid of missing the wave and hence the opportunity. Funds were showered by private investors as if these were money minting machines. This gave rise to some of the big Tech giants such as Amazon, Google, eBay in USA and Alibaba, Tencent, JD.com in China. But there are many that went lost in the history books. A good example could be pets.com focused on home delivery of your pets needs. With its quirky Superbowl ads and promises of a revolution, the company attracted everyone’s attention, even Jeff Bezos’. Despite its creaky business model and poor performing unit economics, Amazon invested in it taking 50% of its equity. The company went for an IPO and was making losses every month. As a result, within 9 months its shares fell from $11 to $0.22. Its biggest investor, Amazon lost 30% of its share value.

History repeats itself. Private investors are nowadays betting big on businesses working on the new-age internet, i.e. Artificial Intelligence. This is giving rise to crazy valuations. Out of the total 45 AI unicorns existing globally, 19 are in China valued at a total of whopping $ 43.5 bn. Every single company claims to be revolutionary. Most of them are running deep into losses.

A curse in disguise

The problem is that no one wants to miss the bus. And in a desperate attempt to do many are jumping in front of it. Businesses are implementing these cutting-edge technologies just for the sake of implementation so that they can be perceived as revolutionary. The outside-in approach of fixating on a technology and then looking out for the spaces where it can be applied is prominent in the industry.

When you have a hammer, everything looks like a nail

The industry has not been able to live upto the expectations. Although there have been many revolutionary upgradations, but we are yet to see self-driven flying cars or the drone home-deliveries that everyone expected to be a commonplace. All of these projects are either under the research stage or the regulatory approval stages. China, the powerhouse of global AI revolution is the first one to realise the brunt of it. Private investments are drying up as investors have started believing the existing valuations are overheated. The high valuations can also be seen as a curse in disguise: Finding an investor offering a higher valuation keeps on getting difficult in every successive attempt.

How does high valuations harm?

Silver line in the sky

What the businesses need to do in such a situation is the creation of new businesses. All four members of China’s AI quartet have their research concentrated on facial recognition and surveillance systems. Diversification of portfolios is the need of the hour today. Using their core competence rooted in AI, they can design multiple end-products deriving nourishment out of these roots.

As private fundings are drying up, they can look for newer sources of funding. Most of these quartet startups are already attempting to go public by launching an IPO. But companies are scared as the retail public investors might not value their firms as high as the private investors had in the past. And they have good enough reasons supporting this concern: Firstly, Internet companies are fundamentally different to traditional ones so investors don’t know the right metrics of valuation. The conventional P/E valuation models are not applicable to them as these companies run into operational losses every year. Secondly, the private investors have a comparatively longer time horizon in mind at the time of investment focused on company’s growth potential in future. A large section of retail investors are a bit impatient in this regard and are participants in the market just to make some quick and easy money. Therefore, expecting loyalty out of retail investors for an already loss-making franchise is a major sin that should not be committed.

What can the overvalued companies do then?

Lessons for India from China’s experiences

India right now is following China’s footsteps, although slow-footed. Although, the advent of global investors like Tiger Global Capital in the Indian startup space has provided much needed funds for expansion but rather than going gung-ho we should take it with the pinch of a salt. Tight regulatory checks and balances should be brought in place to weed out the bad apples emerging.

Is India transforming into a young China?