Turn off the lights: The IPO party is over

The massive rise and fall of new-age startups that got listed on stock exchanges during 2021 could perhaps not be better described than this.

In this article, we look at six such companies- Paytm, Nykaa, Zomato, Cartrade, PolicyBazaar and EasyMyTrip. Any investor who purchased a stock of each of these companies at its highest price after listing would have spent 8,143 are doing so. As of March 4, the value of this investment will be approx. 3,845, a loss of around 53%.

Of course, this is only a theoretical possibility, but it tells us what happened to these stocks. They have been beaten up badly. The best signing stock of this era is Paytm, which is India’s biggest Initial Public Offering (IPO). The company issued stock at a price of 2,150 and on March 4 their price will be around . Was 785 per share, more than 63% below the issue price and 60% below the highest post-listing price.

The stock that has performed the worst ever is CarTrade Tech, a market place for both new and used vehicles. This is about 67% below its issue price and 66% below the highest post-listing price.

So, what went wrong with these companies? And what does the future hold for them? In this section we try to analyze it.

a free ride

Economists often talk about public goods and the free ridership they attract. Steven E. Rhodes in The Economist’s View of the World defines public goods as “goods for which consumption is non-rival (i.e. many people can simultaneously consume the same good).” Therefore, only a person can enjoy the food that they eat. But several people can walk on the same sidewalk at the same time. Therefore, the sidewalk is a public good. And there is no food.

The trouble is, public goods attract free riders. Take the case of a residential housing society, which charges a monthly maintenance fee from the residents to ensure that the facilities are well maintained. Some families may decide not to pay monthly maintenance, and still continue to use the facilities. Such people are free riders.

The companies we are talking about are similar to these free riders. After going up the market for some time they came to the stock market. And they redeemed it by selling their shares at prices much higher than the money they were earning.

Of course, investors bought these shares. Retail investors are attracted to stocks only when they have seen a rise in prices for a period of time. Take a look at Figure 1, which shows the total number of demat accounts (on the left-hand axis) and the BSE Sensex (on the right-hand axis) levels from April 2015 to January 2022.

As the stock market has gone from strength to strength (represented by the Sensex), so has the number of demat accounts. In fact, over the past two years, they have progressed more or less parallel. The only possible explanation for this is that more and more retail investors and high-net-worth individuals entered the stock market as it went up.

As of the January Bulletin of the Securities and Exchange Board of India, the stock market regulator pointed out: “Partly due to the urging of investors to participate in IPOs, now an average of 27.63 lakh new demat accounts are being opened every month. (ie. , 2021-22). Those preferring the mutual fund route also increased their purchases of equity-oriented schemes to ride out the IPO bull run… with the domestic mutual fund industry now averaging 23.91 lakh new investors every month Folios are being added.” This increase in demand helped new-age startups sell shares at very high prices.

benefits of free ride

Existing investors in new age startups also used this opportunity to sell their shares. In case of Paytm, the total amount raised through IPO was 18,300 crores. Its, 10,000 crores went to existing investors who sold shares through IPO. When it came to CarTrade Tech, the whole issue 2,999 crore went to existing investors. In Nykaa’s case, the company raised 5,350 crore in total. Its, Rs 4,720 crore was used to make payments to existing investors. In case of PB Fintech (parent of PolicyBazaar), out of the total 5,700 crore raised, 1,950 crore went to existing investors. In case of EasyMyTrip, the total amount of 510 crore went to existing investors.

Of These five companies raised 32,859 crores, 20,179 crore or over 61% went to pay existing investors for selling their shares. This essentially meant that the companies didn’t really need much money to expand. In that sense, retail investors and high net worth individuals largely ended up paying for early-stage investors to exit these companies at higher valuations.

Of course, only a certain percentage of the shares in an IPO go to retail investors and individuals with high net worth. Nevertheless, even though mutual funds and insurance companies are classified as qualified institutional bidders, they are ultimately investing money raised from retail investors and high net worth individuals. The exception to this was Zomato. out of the total marks size of 9,375 crore, only 375 crore went to sell their shares to existing investors.

Zomato, however, has been regularly buying other companies since its IPO. This is a strange situation where a loss making company is using the money raised through IPO to buy other companies. In November 2021, the company said it plans to invest $1 billion in startups over the next two years. The company made this clear in a draft of its red herring prospectus where it said: “Acquisitions and inorganic development initiatives can be taken.” Of course, the loss-making company is raising money through IPOs to invest in other loss-making companies. Retail investors are typically taken on a level of risk by venture capitalists. The stock market regulator has since put a cap on the portion of IPO proceeds that can be used to acquire undisclosed companies for inorganic growth.

What does the future hold?

With prices for new age startups falling well below their highs, is this a good time to buy them?

In the long term, new age startups should benefit from the network effect. The humble telephone is by far the best example of this. The more people who use the telephone, the more people want to own the telephone. Other great examples are WhatsApp, Facebook, Uber, etc. In fact, thanks to the Internet and the network effect, these are all new-age startup platforms. Platforms are not in the business of creating goods, but are marketplaces that allow other businesses to sell their goods. So, once many consumers decide to order food from Zomato, it makes sense for restaurants to be on it as well. Once people start buying insurance online from PolicyBazaar, it makes sense for insurance companies to sell their policies on it.

Platforms are asset light. Uber, the world’s largest taxi company, does not own taxis. Airbnb, the world’s largest room rental company, does not have any rooms. Similarly, Zomato does not own any restaurant and Easemytrip does not own any airline.

The thing with the platform is that once a sufficient number of people start using it and once a sufficient number of businesses sell their wares, it can potentially lead to a monopoly or a monopoly situation and a lot more. There can be money. done in the process. This is a theoretical argument.

So will these stocks give good returns in the long run? As Jonathan A. Nye writes in Platform Delusion: “The fact that many of the best digital businesses are “platforms” doesn’t mean that most platform businesses deliver better returns or that it’s the platform position of demonstrably superior businesses. which is responsible for their better results. In fact, consistently better returns can be achieved only through structural competitive advantage.”

The question is, do these new age startups have a competitive advantage? Let’s start with EasyMyTrip, an online travel company. There are dozens of companies operating in this area, which offer more or less similar products. This is a commoditized business and any talk of any competitive advantage is an illusion at best. Of course, it needs to be said here that the company, unlike many other companies in this business, is profitable. But remember that we are talking about monopoly type profits here. A similar argument can be made for CarTrade Tech which is in the business of buying and selling cars. There is a lot of competition in this space, from traditional automobile dealers to companies specializing in selling used cars.

It has some early mover advantages in the business of selling insurance online in the web aggregator space when it comes to PolicyBazaar. Nonetheless, the competition is huge. As the recent draft red herring prospectus filed by the Life Insurance Corporation of India states: “As of 27 December 2021, 24 web aggregators are registered [the] Insurance and Regulatory Development Authority of India (IRDAI).” In addition, everyone from banks to individual insurance agents to the websites of insurance companies are in the business of selling insurance.

Nykaa has the potential to become the Amazon of makeup in the long run. If more and more women take up paid jobs, it will obviously benefit. But the huge risk the company is facing is beyond its control. The female labor participation rate in India has been falling over the years, which basically means that more and more women who enter adulthood are not taking up paying jobs.

When it comes to Paytm, the company’s business model is so ubiquitous that being able to profit from network externalities becomes a monopoly. Also, the rise of RBI-backed Unified Payments Interface (UPI) will eventually limit its growth in the digital payments space as well.

In the end, this leaves us with Zomato. It will be difficult for any new competition to quickly replicate all the infrastructure the company has in place with restaurants and delivery. In this sense, the company has some competitive advantage. Apart from this, it has only one major competitor and that is Swiggy.

But ultimately, Zomato and all the other companies here are in the service business and their continued growth will largely depend on how well people are doing, not just the well-to-do lot. In the past, economist Rathin Roy has talked about India’s economic growth being driven by spending by the top 100 million people in a population of close to 1.4 billion.

In fact, there are five individuals in an average Indian household, which means that the spending capacity is roughly 20 million with households. For Zomato and Nykaa to perform well, this number needs to increase in the coming years. The growing inequality of the society at large remains the biggest risk before them.

In this scenario, any retail investor looking to invest in these stocks is advised to buy them as a very small part of his overall portfolio, as overall, the investment base does not sound very good. Is.

Ultimately, it’s worth remembering what Knee writes in The Platform Delusion: “The strong network effect, as is commonly believed, is not demonstrated in all platform businesses.” This is its long and short.

Vivek Kaul is the author of Bad Money.