PremiumBENGALURU : Paytm permanently changed the way Indians recharge their phones and pay their bills. And the story of its founder Vijay Shekhar Sharma, a quintessential small-town boy who dreamt big and doggedly persisted with his dream, is truly an inspiring one.
While Paytm’s growth since demonetization—mostly as a payments company—has been exponential, the company did make mistakes. Some of the pivots were opportunistic and smart; others came across as reckless and brash. The sort one makes when sitting on a huge pile of cash.
Its foray into e-commerce via Paytm Mall was a case of reckless diversification. No one ever believed that Paytm had a sniffing chance of making a success of its e-commerce gamble. While Sharma was busy building Paytm Mall, PhonePe and Google Pay were building alternate payment solutions that would pose a serious threat to the core business of Paytm.
Overtime, Paytm became ‘everything for everyone’. It earned several labels, from being a wallet company and mobile commerce firm to being a payments bank and India’s largest fintech player.
Paytm’s ‘go big or home’ philosophy helped it capitalize on opportunities, but also led it astray at some of the defining moments in its journey, the 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 the IPO–neither too low to leave significant value on the table nor too high to disappoint retail investors. In its desire to be seen as the biggest IPO ever, the company erred on both the offer size and price.
Global brokerage firm Macquarie Research’s coverage of the company sums up the problem: “Paytm has a history of spinning off several business verticals without achieving market leadership or profitability. Paytm has been a cash burning machine, spinning off several business lines with no visibility on achieving profitability. Despite factoring in an aggressive ~50% CAGR increase over the next five years in non-payment business revenues led by distribution business, we expect Paytm to generate positive free cash flow only by FY30E."
In contrast, the business models of companies such as Zomato and Nykaa are relatively easy to understand. While Zomato may be a loss-making company, its path to profitability, and the levers available to get there are clear. Paytm’s business model, and its path to profitability are difficult to comprehend. Hence, the investor wariness is quite understandable. Paytm’s reception at the bourses exposes the dichotomy between customer love for a product and the investor dislike for the stock.
Cheap money fuelled by the Fed’s zero interest rate policy has created an unprecedented frenzy and FOMO (fear of missing out) resulting in a stampede for Indian technology IPOs.
The spate of IPOs, including those planned, has triggered several questions. Do retail investors have the sophistication to understand the complexities of investing in loss making companies? Can they evaluate businesses that are expected to rely on unprofitable growth for some years before they can hope to make money? Do analysts and brokerages have the ability to accurately forecast future scenarios and compute the right share price for these companies? Are sophisticated institutional investors exiting the gate after dumping their stock on unwary retail investors? Is this optimism and bull-run expected to continue, or was 2021 an exceptional year because of the pandemic induced abundance of cheap money? Finally, who would be left holding the can when the tide turns and cheap money disappears?
The correction in the shares of Paytm after it listed helps us think through some of the answers, and the lessons it holds for every stakeholder, from retail investors to analysts and even the Securities and Exchange Board of India (Sebi), the regulatory body for the country’s securities and commodity market.
(On Wednesday though, shares of Paytm rallied 17.27% to end the day at ₹1,753.15.)
But, before we delve into the answers, it will be interesting to trace and understand some of the changes sweeping the startup landscape across the world.
The ways of private capital
Companies that went public in the last 10 years across different ecosystems have remained private for longer than companies that went public in prior periods. Even when the time to list has been the same, there has been an exponential increase in the market cap at the time of IPO. Take the example of Infosys. The IT services exporter took 12 years to go public. At the time of its IPO in 1993, it was a sub $100 million company. On the other hand, Zomato took almost the same time to list (13 years) but its market cap on listing was 130 times that of Infosys.
This is a trend that is likely to continue, one that points to two interesting and perhaps obvious changes that have quietly crept into the way new age businesses are built. First, business models in prior periods were more linear and tended to become profitable within a much shorter runway and second, they did not consume excessive capital. Both these indicate that the newer business models are far more complex and audacious.
Over the years, private capital markets have evolved to fund ideas that needs a lot more capital and time to demonstrate proof of concept. While the obvious implication of this is that retail investors don’t get to participate in a company’s value creation process and upside until very late, this is not necessarily a bad thing. Retail investors are best left to participate at a stage when the story behind how and whether a company makes money becomes more evident to a less savvy mind.
What private capital has accomplished in the last decade with such panache is the acceleration of systemic trends by spotting—and massively funding—startups that get an early scent on new inflection points.
The pandemic upended several businesses, but also established new trends and accelerated a few others. Probably, 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 scaled at the same pace as American startups even though the Chinese market has been nascent in comparison. He concludes that the only logical inference is that in a vigorous fast-track setting, competitive free-market dynamics are sufficiently potent for systematic trends to emerge relatively quickly. This is as true for India as it was for China.
One could argue that private capital’s willingness to fund audacious ideas by betting big on inflection points that were faintly visible on the horizon, and not obvious to many, is the 21st century’s financial markets innovation. None of the companies that made their stock market debut in the last one month could have been created without the unprecedented and massive participation of private capital. This was possible because the yardstick used by private capital for evaluating the market opportunity and value creation is very different from the one used by public markets.
Private capital tends to take a much more long-term perspective, so much so that the intermediate stages that a company has to go through to get to the long-term end state could be disconcerting to the faint hearted.
Private capital uses an approach weighted more in favour of momentum and trends rather than the traditional fundamentals. In the process, they help create companies that cannot otherwise be created in a public market setting. And as a consequence, a few companies operating at the confluence of a mega trend, a large addressable market, and ambitious founders have received a disproportionate share of all venture capital money in recent years.
Much of this money has been used to change consumer behaviour and drive consolidation through mergers and acquisitions. However, at times, excessive capital also led to spending frenzies that were compounded by serious issues of corporate governance. Along the way, there were some casualties. But, that’s the very nature of the startup beast.
As per a CB Insights research report, published in September 2018, and titled “Venture capital funnel shows odds of becoming a unicorn are about 1%", less than half the startups that raised a seed round went on to raise a second round of funding. Every round sees fewer companies advance towards new infusions of capital and only 15% of the companies in the cohort they researched went on to raise a fourth round of funding, which typically corresponds to a Series C. Finally, less than 1% of these companies went on to become unicorns. This is a steep decline by any stretch. By this stage, most startups of any cohort would have ended up in the graveyard or would have been acquired.
These findings were put together by following a cohort of over 1,100 startups from the moment they raised their first seed investment. The sombre statistics offer another good reason to celebrate the success of startups that are now listing.
The takeaways
The questions raised earlier on, I am sure, were anticipated and considered by Sebi before they introduced regulatory changes making it easy for Indian startups to list on the domestic stock exchanges. There are pros and cons of allowing loss making companies with no clear visibility on profitability to list. Sebi, in its wisdom, figured out that the pros outweighed the cons and a change in guidelines was called for.
Sebi may now be tempted, or even forced, to introduce additional checks and balances based on some of the lessons thrown up by the string of tech IPOs. However, the fact is that everything that is ongoing, including losses suffered by enthusiastic retail investors, is an essential part of maturing financial markets.
Analysts and market participants will soon understand how new-age companies with complicated business models are to be evaluated and valued. The markets, particularly the institutional investors participating in these IPOs, will learn quickly even though they might be victims in the short-term of a self-inflicted bout of irrational exuberance.
Retail investors, too, may lose money initially but that should not tempt Sebi to create unreasonable restrictions and guardrails. Retail investors should ideally stay away from investing in businesses they don’t easily understand and should instead stick to traditional approaches of either value or growth investing in mature companies. Alternately, if they are very keen to participate in potential upsides of new age companies, they could invest modest amounts—based on their risk appetite—after reading reliable research reports by trusted analysts or brokerage houses.
It is evident that analysts and brokerages, too, have begun to understand these businesses and have put out thoughtful and well researched recommendations. International brokerages have learnt from covering similar companies in other geographies and have brought those learnings to their coverage of Indian startups. The coverages across different startups that have listed recently are fairly nuanced and reflect their understanding of complex business models. Macquarie Research is a case in point.
The last wave of first-generation entrepreneurship created companies such as Infosys and TCS. Both are $100 billion dollar companies by valuation now. It took Infosys 28 years to get from $100 million to a $100 billion. Together, the IT outsourcing companies are expected be a $350 billion (by revenue) industry by 2025. It will now be exciting to see the next wave of entrepreneurship reaching the finish line and this wave is expected to be far more massive than the previous one. Unlikely, the current wave will end anytime soon.
While we imbibe the lessons from Paytm’s IPO rout, it is also high time we celebrate all the entrepreneurs and the other stakeholders who have patiently and doggedly built these amazing companies. They have weathered countless ups and downs. Near death moments, even. The businesses, the brands they created have transformed and simplified our lives beyond imagination. Going ahead, the impact on the economy will be deep. These businesses can potentially transform the lives of more than 500 million Indians.
TN Hari is head HR at BigBasket and co-author of the book ‘From Pony To Unicorn: Scaling a Start-Up Sustainably.’
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