What investors can learn from Paytm IPO

whereas Paytmdevelopment since DEMONETIZATION-Most payments have been exponential as a company, the company has made mistakes. Some pivots were opportunistic and smart; Others came across as reckless and cruel. Works one of a kind when sitting on huge piles of cash.

Its entry into e-commerce through Paytm Mall was a case of careless diversification. No one ever believed that Paytm had a sniffle chance of making its e-commerce gambling a success. While Sharma was busy building Paytm Mall, PhonePe and Google Pay were creating alternative payment solutions that would pose a serious threat to Paytm’s core business.

Over time Paytm became ‘everything for all’. It earned many labels from wallet company and mobile commerce firm to payments bank and being the largest fintech company in India.

Paytm’s ‘Go Big or Home’ philosophy helped it capitalize on opportunities but deviate from it at some defining moments of its journey, initial public offering (IPO) being an example. Anyone who has been part of any IPO understands the importance of optimizing the size and price of an IPO—neither too little to leave significant value on the table nor too much to disappoint retail investors. Is. In its desire to be seen as the biggest IPO ever, the company made a mistake in both the size and price of the offer.

The company’s coverage of global brokerage firm Macquarie Research sums up the problem: “Paytm has a history of shutting down multiple business verticals without achieving market leadership or profitability. Paytm has been a cash burning machine which has led to the closure of many business lines with no visibility on achieving profitability. Despite factoring in aggressive ~50% CAGR growth over the next five years in non-payments business revenue led by the distribution business, we expect Paytm to generate positive free cash flow only till FY30E.

In contrast, business models of companies such as zomato And Nykaa is relatively easy to understand. While Zomato may be a loss-making company, its path to profit and the levers available to get there are clear. It is difficult to understand Paytm’s business model and its path to profit. Therefore, investor caution is quite understandable. Paytm’s reception in the stock markets highlights the dichotomy between customer love for the product and investor dislike for the stock.

Cheap money driven by the Fed’s zero interest rate policy has created an unprecedented frenzy and FOMO (fear of missing out) has resulted in a stampede for Indian technology IPOs.

The flood of IPOs, including the planned IPO, has given rise to many questions. Do retail investors have the ability to understand the complexities of investing in loss making companies? Can they evaluate businesses that are expected to rely on unprofitable growth for a few years before they can expect to make money? Do analysts and brokerages have the ability to accurately forecast future scenarios and calculate the correct share price for these companies? Are sophisticated institutional investors running out of the gate after inexplicably dumping their stocks on retail investors? Is this optimism and bull-run expected to continue, or was 2021 an extraordinary year as there was an abundance of cheap money driven by the pandemic? In the end, when the tide turns and cheap money disappears, who’s left?

The correction in Paytm shares after listing makes us think through some of the answers, and everyone from retail investors to analysts and even the Securities and Exchange Board of India (SEBI), the regulatory body This is a lesson for the stakeholder. The country’s securities and commodity markets.

(However, Paytm shares ended the day up 17.27% on Wednesday 1,753.15.)

But, before we get into the answers, it would be interesting to explore and understand some of the changes that are sweeping the startup landscape across the globe.

private capital methods

Companies that went public in different ecosystems over the past 10 years have been private for longer than companies that went public in earlier periods. Even when the timing of listing has remained the same, the market cap has grown exponentially at the time of IPO. Take the example of Infosys. It took 12 years for an IT services exporter to go public. At the time of its IPO in 1993, it was a company worth less than $100 million. Zomato, on the other hand, took almost the same time to list (13 years) but its market cap on listing was 130 times that of Infosys.

It’s a trend that is likely to continue, one that points to two interesting and perhaps obvious changes that have quietly come about in the way new-age businesses are built. First, business models in prior periods were more linear and tended to become profitable within very short runways and second, they did not consume excessive capital. Both of these indicate that the new business model is far more complex and audacious.

Over the years, private Capital market have evolved to fund ideas that require a great deal of capital and time to demonstrate a proof of concept. While the clear implication of this is that retail investors do not have the opportunity to participate in a company’s value creation process and the upside for too long, is not necessarily a bad thing. Retail investors are best left to attend a stage when the story behind how and what makes money a company becomes more obvious to the less savvy mind.

What private capital has achieved with such panache over the past decade is the spotting—and the acceleration of systemic trends by large-scale funding—startups that get the initial smell at new inflection points.

The pandemic affected many businesses, but also set new trends and accelerated some others. Presumably, the pandemic was an inflection point for the entire edtech and e-commerce sectors. Geoffrey West, author of the seminal book Scale, points out that startups in China grew at a similar pace to American startups, even though the Chinese market was relatively nascent. They conclude that the only logical conclusion is that in a vigorous fast-track setting, competitive free-market dynamics are sufficiently powerful for systematic trends to emerge relatively quickly. This is as true for India as it is for China.

One could argue that private capital’s desire to fund audacious ideas by placing big bets on inflection points that were vaguely visible on the horizon, and unclear to many, is the 21st-century financial The market is innovation. No company that made its debut in the stock market in the last one month could have been created without the unprecedented and heavy participation of private capital. This was possible because the scale used by private capital to evaluate market opportunity and value creation is very different from that used by public markets.

Private capital takes a very long-term perspective, so much so that the intermediate steps a company has to go through to reach its long-term end position can be distracting to the faint-hearted.

Private capital uses a more weighted approach favoring momentum and trends rather than traditional fundamentals. In the process, they help create companies that otherwise could not be built in a public market setting. And as a result, some companies operating at the confluence of a mega-trend, a large addressable market, and aspiring founders have received a disproportionate share of all venture capital funding in recent years.

Much of this money has been used to change consumer behavior and drive consolidation through mergers and acquisitions. However, at times, there is also a spending frenzy due to excessive capital which gets complicated by serious issues of corporate governance. There were some casualties along the way. But, that’s the nature of the startup beast.

According to a research report by CB Insights published in September 2018, “Venture Capital Funnels Show the Chances of Creating a Unicorn Are About 1%”, with less than half of the startups that raised a seed round raised a second round of funding. , Fewer companies lead to a new inflow of capital each round, and of the companies they researched, only 15% raised a fourth round of funding, which typically corresponds to a Series C. In the end, less than 1% of these companies became unicorns. This is a huge drop by any stretch. By this stage, most of the startups in any given group would have ended up in the graveyard or were acquired.

These findings were put together by following a group of more than 1,100 startups since they raised their first seed investment. The gloomy statistics present another good reason to celebrate the success of the startups that are now getting listed.

takeaway

I am sure the questions raised earlier were anticipated and considered by SEBI before they introduced regulatory changes that would have made it easier for Indian startups to get listed on domestic stock exchanges. There are pros and cons of allowing loss-making companies to be listed with no clear visibility on the profitability. SEBI, at its discretion, observed that the pros outweigh the cons and a change in the guidelines was sought.

Sebi may now be tempted, or even forced, to introduce additional checks and balances, based on some lessons from the technical IPO episode. However, the fact remains that whatever is going on, including losses suffered by enthusiastic retail investors, is an essential part of mature financial markets.

Analysts and market participants will soon understand how to value and value new age companies with complex business models. The markets, especially the institutional investors participating in these IPOs, will learn quickly, even though they may be short-term victims of self-inflicted bouts of irrational glee.

Retail investors may also lose money initially, but this should not prompt SEBI to create undue restrictions and guardrails. Retail investors should ideally stay away from investing in businesses they don’t readily understand and instead stick to traditional methods of value or growth investing in mature companies. Alternatively, if they are very keen to participate in the potential profits of new age companies, they can invest modest amounts based on their risk appetite – after reading credible research reports by trusted analysts or brokerage houses. .

It is clear that analysts and brokerages have also begun to understand these businesses and put forth thoughtful and well-researched recommendations. International brokerages have learned from covering similar companies in other geographies and have brought those learnings to their coverage of Indian startups. The coverage of the various recently listed startups is quite nuanced and reflects their understanding of complex business models. Macquarie Research is an example of this.

The last wave of first generation entrepreneurship created companies like Infosys and TCS. Both are now $100 billion dollar companies by valuation. It took 28 years for Infosys to go from $100 million to $100 billion. Together, IT outsourcing companies are expected to be a $350 billion (by revenue) industry by 2025. Now it will be exciting to see the next wave of entrepreneurship reach the finish line and this wave is expected to be much bigger than the last one. , Not likely, the current wave will end anytime soon.

While we take lessons from Paytm’s IPO route, it is also high time we celebrate all the entrepreneurs and other stakeholders who have built these amazing companies with patience and perseverance. He has faced countless ups and downs. Near death moments, even. The businesses, brands they created have changed and simplified our lives beyond imagination. This will have a profound effect on the economy in the coming times. These businesses can potentially change the lives of over 500 million Indians.

TN Hari is the HR Head at BigBasket and co-authored the book ‘From Pony to Unicorn: Scaling a Start-up Sustainable’.