India’s unicorns find exit doors blocked
9 min read . Updated: 15 Sep 2019, 11:32 PM ISTThe hype is gone with the dramatic fall in valuations of WeWork and Uber. How would that impact India’s startups?
Bengaluru: WeWork, a fast-growing startup that has smartly dressed up the business of subleasing office space, is expected to list its shares in the following months. Earlier this month, various publications reported that WeWork may seek less than half of the $47-billion valuation it fetched in January in a private fundraising round. On Friday, Reuters reported that WeWork may consider a valuation as low as $10 billion, nearly a fifth of its present worth. Doubts are increasing whether the initial public offering (IPO) will happen on schedule.
In May, Uber Technologies Inc., which was then the world’s most valuable internet startup, listed its shares in the US. It was one of the most highly anticipated IPOs in recent years. Soon, it turned out to be a bitter disappointment for the pioneering transportation startup. By the end of trading on 10 May, the market debut for Uber, its shares slid by nearly 8%. The stock has plunged another 22% since. Even Lyft Inc., a smaller rival of Uber in the US, has seen its shares fall after its March IPO.
These events, in particular the Uber IPO, could mark a turning point in the startup universe. Globally, it appears the hype is evaporating in the venture investing environment. Some say the era of huge private market valuations and limitless funding of losses is coming to an end.
This may be consequential for many Indian unicorns—firms with valuations of a $1 billion-plus—that have pursued a similar growth-at-all-cost strategy, and which hope to go public over the next few years.
Ever since Flipkart’s record-breaking sale in 2018, investors here have been speculating about the next Indian startup that could secure a big exit. However, as things stand, there are few signs that another Indian unicorn can deliver a successful exit, either through a sale or a public listing, any time soon. Investors have pushed up valuations of many Indian internet companies in the hope that public markets too will ignore their losses and assign a high price to their market share gains. After the disappointing Uber IPO and the expected slump in WeWork’s valuation, it looks like that hope may have been misplaced.
The post-Flipkart world
In May 2018, Walmart agreed to buy a 77% stake in Flipkart, valuing the online retailer at $21 billion, in what was the first exit of more than $1 billion in the Indian startup space. The sale dwarfed the previous biggest exit, the $400-million buyout of Freecharge by Snapdeal in April 2015.
Over the past 20 months the number of unicorns has nearly doubled, reflecting the surge in investor appetite for large, fast-growing internet assets. But the most valuable unicorns left—Paytm, Oyo, Ola, Byju’s, Swiggy and Zomato—are all faced with long-term challenges that make an IPO seem unlikely. And their lofty valuations indicate that there are few suitors who can afford to buy them.
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For instance, Paytm is struggling to maintain its market leadership as rivals Google Pay and PhonePe, owned by Walmart, spend hundreds of millions of dollars to increase their share of digital payments. Its bottom line doesn’t make for a pretty picture either. One97Communications Ltd, Paytm’s parent firm, reported a loss of ₹4,217.2 crore for the year ended 31 March, up from ₹1,604.34 crore in the previous year, Mint reported on 9 September. The company’s revenues rose just 8.2% to ₹3,579.67 crore in FY19. Paytm Mall, the company’s commerce business, has failed to make a dent in the dominance of Flipkart and Amazon. It is expected to have a fringe presence in the e-commerce market despite its $150-million fundraise from eBay in July.
Food delivery startups Swiggy and Zomato are locked in an expensive market share battle that shows no signs of letting up and that has caused significantly higher losses at the two companies. The growth in Ola’s core cabs business has shown a sharp decline while two of its other businesses such as food delivery and payments haven’t taken off yet. Oyo has taken off on an unprecedented expansion spree globally that will require heavy investments for many years to come. Some critics have also pointed out that Oyo is essentially a hotel firm rather than a so-called internet company, which are typically assigned higher valuations than their more traditional counterparts. In any case, Oyo is yet to prove that its business model can become profitable, even in its older markets such as India.
The other hope of the internet ecosystem is Flipkart itself. When Walmart bought Flipkart, it announced that it will seek an IPO for Flipkart at some point. But given that Flipkart is expected to continue investing billions of dollars in expanding its business, investors said it would be difficult for the company to attain profitability in the near future. Flipkart’s quest to list its shares will also be made tough by the expected entry of Reliance Industries Ltd as a major presence in e-commerce.
“The consumer internet unicorns still don’t have great unit economics so an IPO by any of them looks highly unlikely for the next two to three years," said Anand Lunia, founding partner at India Quotient, a venture capital firm.
The Uber fallout
Apart from their own problems, what currently makes the listing prospects of Indian internet startups appear dim is that globally investors have begun to question the wisdom of the growth-at-all-costs approach after the poor market debut of Uber. Uber, with its historic fund-raising spree in the past decade, had ushered in the trend of startups staying private for long periods instead of seeking IPOs. Now that its much-awaited IPO has flopped, the allure of companies that grow fast but show high losses may diminish over the coming years.
“The Uber IPO and the upcoming WeWork IPO demonstrate that there’s a meaningful disconnect between private and public valuations, particularly for high growth consumer internet firms that continue to burn a lot of cash as they invest for growth," said Ashish Sharma, chief executive officer (CEO) at InnoVen Capital India, a venture debt fund. “Unlike a few years ago, we now have many public valuation benchmarks for large tech firms across ride hailing, food delivery etc, which will influence how private valuations move in these spaces. While it’s too early to pass a judgment on iconic companies like Uber and they may very well surprise investors on the upside over time, one thing is however clear that public market investors have moderate appetite for high cash burn businesses with an uncertain path to profitability."
Uber as well as WeWork count SoftBank as their largest investor. These two are among the first outcomes of SoftBank’s plan to bet on outsized amounts on mature tech startups. SoftBank had invested nearly $20 billion in Uber and WeWork together from its $100 billion Vision Fund. The Japanese investor announced another $100 billion fund in July.
SoftBank is also a large investor in three of the most valuable Indian unicorns, Paytm, Oyo and Ola. For now, SoftBank’s appetite for writing big cheques in India remains as strong as ever. But if more SoftBank-portfolio companies struggle after a listing, the Japanese investor could be forced to reconsider its aggressive strategy. “SoftBank has been the primary driver of the valuation of consumer internet companies," a local venture capitalist said, on condition of anonymity. “If their portfolio companies don’t see successful exits then that will have a cascading effect on the entire consumer internet space."
Whether or not winter comes to pass for consumer internet firms, the best bet for a big startup IPO from India could turn out to be Freshworks, the software product startup formerly known as Freshdesk. Mint learns that Freshworks will start preparing for an IPO in the US before the end of this year. Last year, Freshworks had hired Suresh Seshadri from AppDynamics, a US software startup that was bought by Cisco for $3.7 billion in January 2017 just as it was about to list its shares.
Freshworks has already begun hiring other, junior executives with the objective of preparing for an IPO, two people familiar with the matter said. The company may invite pitches from investment banks to run the IPO before year end, they said.
The company last raised $100 million in August 2018 at a valuation of about $1.5 billion from Sequoia Capital, Accel Partners and CapitalG. Freshworks hasn’t disclosed its financials but software product firms typically require less external funding and are said to have profitable business models. A Freshworks spokesperson said, “We are focused on driving growth in new markets, and strengthening our position in existing markets. We will consider all investment options, including an IPO if it proves opportune for the business."
Apart from Freshworks, another unicorn, Delhivery, a logistics provider, had considered exploring an IPO. But after raising $350 million from SoftBank, the company put its listing plan on hold.
Investors said that outside the unicorn startups, smaller companies that have raised venture capital but are not internet-only firms may have a better chance of pulling off IPOs in the near future.
“As far as IPOs go, rather than internet startups, you will see other venture-funded companies in financial services and consumer spaces that have a higher chance of going public," said Niren Shah, managing director at Norwest Venture Partners India. “These companies are not as large as the consumer internet unicorns but they generate real earnings, which is a must if you’re going public."
Even among internet-only firms, it is the smaller startups, whose business models are less shaky, which seem better-placed to pursue IPOs. In June, IndiaMART InterMESH Ltd, a marketplace for small and medium businesses, listed its shares on the National Stock Exchange.
Secondary route
To be sure, the lack of IPOs doesn’t mean that investors will be starved of liquidity. Before the Flipkart sale, exits had anyway increased, mostly via secondary share sales. These transactions, worth thousands of crores of rupees, helped VCs return cash to limited partners and raise new funds. VC investors netted about $2.8 billion in 2017, up from $1.8 billion in 2016, according to data supplied by Venture Intelligence. Exits may exceed $4 billion this year. About half of this number has already been realized at Oyo. In July, Ritesh Agarwal, CEO of Oyo, announced that he will invest $2 billion in the company, mostly by buying back shares from the company’s early investors Lightspeed Venture Partners and Sequoia India.
While the Oyo deal was unusually large and its size is expected to be an outlier, secondary share sales will continue to be the main source of liquidity for investors. Additionally, small to medium-sized buyouts may increase as large companies like Reliance, Naspers and Walmart seek to increase their footprint.
“There’s very healthy demand from private equity and other late-stage investors for consumer internet startups," said Vinod Murali, managing partner of Alteria Capital, a venture debt fund. “They will buy shares from early investors in the unicorns and other fast-growing companies. A majority of exits will happen through this route rather than IPOs or buyouts for the foreseeable future."
