Startup IPOs A Goldmine For Indian Investors, Albeit At Realistic Valuations

There has been an ongoing debate within India recently owing to the pricing of new-age technology companies listed on the Indian stock exchanges falling disastrously from their peaks. 

New-age Indian businesses have listed on Indian stock exchanges in some of the largest initial public offerings (IPOs) in the country’s history. These include startups such as Paytm, Nykaa, CarTrade, MapmyIndia, EaseMyTrip, Delhivery, Fino Payments Bank, IndiaMART, Nazara Technologies, Policybazaar, and Zomato.

Nevertheless, with a few exceptions, the shares of the majority of these new-age digital businesses have been under pressure, and most of them are now selling at a large discount to their IPO price.

Consider Paytm, which has fallen by more than 75% from its listing price, or Zomato, which is down 50%!

Due to this, startup IPOs are no longer seen favourably by investors, and investor confidence has been undermined.

This has also raised some voices against allowing these loss-making companies to list via an IPO on the Indian stock exchanges.

Equity Is The Real Gold For All ages, Not Only Data!

I would like to point out to the naysayers and the doomsday predictors,  “Ownership of companies is the most valuable commodity of today’s times!”  

Capital valuations run on multiples of action on the profit and loss side (Revenue, EBITDA, Net Profit) and hence provide superior returns as compared to returns made via profits alone. Also, tech companies are very scalable and capture market share fast, thereby giving a huge upside on capital invested in no time.

There is enough liquidity in the world to covet the stock of companies with a large market share, even if they take longer to recover from losses! Following the 2008 financial crisis, the United States alone printed $25 Tn, which is now sloshing around in the global ecosystem, creating asset-class bubbles. 

This is in addition to the European Union (EU) and Japan, both of which have printed massive amounts of money. Investors appear to prefer holding equity in companies with a large market share, even if they are losing money for a long time. 

Consider MakeMyTrip. Listed on the NASDAQ in 2010, it enjoys a high share price while continuing to lose money, owing to its 50% share of the Indian online travel market across all verticals! Is it any surprise that MakeMyTrip does not raise prices in response to the price-sensitive Indian customer, instead focusing on market share?

Is ‘Flipping’ A Good Option For Indian Tech Companies?

Not long ago, some leading lights in the Indian startup world bemoaned the fact that many Indian startups were ‘flipping’. They were transferring ownership to foreign structures or establishing holding companies in Singapore, the United States, and the United Kingdom. All in search of better liquidity windows available in these overseas locations. 

Flipping India-incorporated startups to the US was referred to as ‘institutionalised wealth transfer’ and exploitation of Indian intellectual property (IP). This is because ownership of the startup, the IP, and the data were all shifted overseas. Other operations, however, continued as before. Products were manufactured in India using Indian labour and sold to customers in India as before.

Sanjeev Bikhchandani of InfoEdge even predicted a market cap loss of more than INR 17 Lakh Cr at the time, saying, “These companies will operate in India and access the market.” However, they will not be Indian companies. A domicile shift and transfer of IP and data to an overseas company is a permanent loss. As a company grows, so does this loss. Remember that HCL and Infosys were startups in the early ’80s. Imagine what would have happened if they had flipped overseas when they were young. This is a matter of strategic significance for India”

Flipping has meant that the benefit of capital appreciation and value unlocking through the balance sheet route has primarily gone to foreign investors based in Singapore, Hong Kong, UAE, US and UK. 

PhonePe, a unit of Flipkart, showed the way recently, by ‘reverse-flipping’ from Singapore to India, with an eye on an Indian listing!

SEBI Allowed Loss-Making New-Age Tech Companies To List On Indian Stock Exchanges 

Subsequently, the Securities and Exchange Board of India (SEBI) amended its rules. The previous rules mandated that companies should have a track record of three years of profits to list on the Indian stock exchanges. This led to 11 new-age technology startup IPOs on the Indian stock exchanges

Loss-making companies, such as Zomato and Paytm are now listed on the Indian stock exchange. They entice investors by promising a bright future, which must typically be supported by rising top-line growth and sustained profitability.

Funding Winter

However, it should come as no surprise that the reported closure of nearly 30 businesses sponsored by either venture capitalist (VC) firms or angel investors since the beginning of the year has sounded the alarm for entrepreneurship enthusiasts across the country. 

Investors are wary of startup IPOs due to the challenges that the Indian startup ecosystem has faced since the beginning of 2022. This includes unfavourable macroeconomic conditions, high financial burn, a funding winter, unfavourable media coverage, and a lack of understanding of the startup business model.

How The China & US Relationship Can Serve As The Path Ahead For India

Indian and Chinese tech startup ecosystems have some fundamental differences. The main one is that China forbids US FAANGs (US tech behemoths Facebook, Amazon, Apple, Netflix, and Google, with only Apple given some leeway in exchange for tough conditions) from setting up shop in China. Instead, it nurtured its own tech companies, which now dominate their respective markets (Alibaba, Tencent, Meituan, Xiaomi, and so on). However, India has allowed these US technology companies to establish monopolies in the Indian market. 

These Chinese tech behemoths serve many purposes, including keeping the Chinese customer’s tech business and the Chinese market in Chinese hands. The data of Chinese citizens stay outside the bounds of western countries, and this provides huge succour to the Communist Party of China. Most importantly, ownership of Chinese businesses remains primarily in Chinese hands, as does the benefit of capital returns!

And the results are for everyone to see. The Chinese investors have made tremendous returns on shares of these companies with the total market capitalisation being in excess of $8 Tn on the Shanghai Stock Exchange alone!  

What Did The US Do In The Face Of Buoyant Chinese Shares?

For the US, its casino system of NASDAQ and NYSE provides a window of cycling the huge dollar liquidity and services-driven nature of its economy. How could it be left behind in capturing the upside in the shares of the world’s second-largest economy, China?

Faced with difficulties such as the opaque nature of financial records of Chinese companies and the hyper-sensitivity of the Communist Party of China in allowing data, information and ownership of Chinese companies in foreign hands (China denied access to the US’s Public Company Accounting Oversight Board (PCAOB), citing state secret concerns among others), the US created specific structures for Chinese companies. This allowed these companies to list on US exchanges without getting their accounts audited in the US! 

This meant that in many cases, there was no compliance with reporting standards and shady accounting was used to trade these stocks! Only recently after the Luckin Coffee debacle, has this clause been overturned! 

One other innovation was ‘variable interest entity (VIE)’ structures which are akin to saying “We know the ownership resides within China’s jurisdiction but we believe it is in the Cayman islands”!

This is similar to US investors investing in China by purchasing Chinese Real Estate Bonds. The bond market’s equivalent is the ‘Keepwell obligation,’ which is nothing more than the borrower’s word of promise! This is a loose version of the ‘Corporate Guarantee’ or the ‘Letter of Comfort’.

There are 264 public companies headquartered in mainland China or Hong Kong that trade on the New York Stock Exchange, NYSE American, and NASDAQ, the three largest U.S. exchanges.

These actions by the US clearly show that ownership of tech companies demonstrating hyper-growth is coveted handsomely by the US and developed economies! Market share is the reality on Main Street which Wall Street covets, especially for large companies! 

India Is The New China! 

It is predicted that the Indian GDP will go from $3.5 Tn to $8-10 Tn within the next eight years! 

Let’s not throw out the baby with the bathwater!

It is obvious that if India were to go back and prohibit new-age tech companies from listing on Indian stock exchanges, the world would not wait for a second longer to provide sufficient incentives to create ownership of these businesses in their hands! It would be a big loss for the Indian investor! Does India want that?

How Indian Tech Startups Can Get Easy Access To The Indian Stock Exchanges

Indian tech startups should be listed on Indian stock exchanges, even if they are losing money!

However, things can be done intelligently on the valuation side!

Since many of these startups were in the hands of private investors, valuations soared and were not subject to market scrutiny. However, when they trade below the listing price, they cause the most harm to retail investors because institutional investors usually exit in a timely manner.

Few Measures Come To Correct The Situation

• Unit Economics is the North Star: First, determine the quality of the losses and make it compulsory to declare it in the RHP (Red Herring Prospectus). 

If the startup’s loss is due to it being in investment mode and is demonstrating meaningful monetisation of its market share, then the startup’s business model differs from that of an entity like WeWork, whose business model is inherently loss-making. (Locate the costliest place in the city, lease it for 10-15 years at high rentals and create costly 7-star infrastructure but the end-consumer is the gig economy person, who is in and out of jobs most of the time!)  

• Provide disclosures and compliances in the RHP for the valuation based on comparative multiples of the tech companies which recently listed on Indian stock exchanges: Given that the price discovery of previously listed tech startups occurred over the course of a year due to the fact that they were a new phenomenon for Indian stock exchanges,

This will provide valuable insight into how much valuation range is the Investor sitting on the Indian stock exchange willing to pay. 

• To avoid situations where these companies run out of cash: Provide regular disclosures of their cash burn and cash holding positions along with other financials. For instance, their net cash-to-cash burn ratio.

Indian startups are the new gold standard and the Indian investor should ride this journey to the maximum in the coming golden decade for India!

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