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OPINION: Internet IPOs—the next gold rush or fool’s gold?

Even Amazon, the biggest disruptor, went through a 90% correction post its listing

ipo Internet-based business models will be consumers’ delight, but that may not be the case for their investors | Shutterstock

The Sensex has touched lifetime highs even amid the COVID pandemic and a struggling economy. And unsurprisingly, it’s raining IPOs, making the most of bullish market sentiments. 

High profile IPOs like Zomato, Nykaa, Policybazaar, Pharmeasy, and Paytm are likely to be in the offing. Thanks to the rise of the internet and mobile phones, these names are now big business empires and will soon offer you a chance to participate in their stocks. 

But, should you?

Show me the money

Let’s take the case of Zomato. A household name, it got further boost amid the pandemic. With an almost duopoly (along with Swiggy), asset light and a debt-free business, it has all possible tailwinds in its favour in a growing market like India. 

However, what gets missed amid the promising big picture is that it is still making losses. Until FY20, Zomato lost an average of Rs 31 per order.  Let that sink in. 

Amid the pandemic, when local supply chains and restaurants were shut, the company cut back discounts and payments to its delivery partners. That helped it turnaround its per order economics in FY21.

Yet, the bottomline and cash flows continue to bleed, courtesy the advertising, branding, and costs associated with maintaining a tech and delivery platform. Don’t be surprised if losses further swell once the economy opens up and local competition is back in the game. 

Big opportunity, bigger competition, price wars, cash burn, and a long road to growth (if at all)—that’s the lot of many new age business models that are planning IPOs. 

Consider Paytm.  Demonetisation was a shot in the arm for the business, making it an overnight phenomenon. However, it is getting competitive with the likes of Google Pay, Phone Pe, WhatsApp Pay, in addition to rising UPI transactions. In FY21, a rare year when ATMs didn’t see long queues amid the pandemic, Paytm reported a drop in revenue, and a staggering loss.  

It is planning to raise Rs 218 billion through the IPO. This implies a valuation of Rs 1.2-1.8 trillion, making it bigger than many Sensex companies with proven business models. But, are these valuations justified and sustainable?

The forever optimists 

On the other hand, arguments are galore in favour of the companies—these are new age business models, scale matters, and profits will follow. Some say there is more to businesses than profits; why else would the savvy investors bet their money on them? 

Then there is the argument that the market works on future prospects where historical performance is an irrelevant metric for futuristic businesses. Comparisons with Amazon, which started off as a loss-making entity is another favourite. Some think IPOs are the only ways for Indian investors to play along the multiple megatrends of fintech, e-commerce, edutech and bet on the internet and technology space. Missing them will come with a big opportunity cost. 

Reality check

Big disruptors are not monopolies. These highly fragile companies are fighting price wars, and prone to disruption themselves. Scaling up is their only hope, and burning more cash is the only way. Don’t be surprised if the market matures before some of these companies taste profits. Eventually, the winner will take it all, and there will be no room for a third or, for that matter, even a second player. 

Private players are in a different game. They bet on multiple ventures, knowing a lot of them will never survive, and count on probabilities. IPOs are their exit route. They have deeper insights into these businesses, and are selling to you at a price much higher than what they paid to enter. What are the odds that this transaction will be in your favour? 

These businesses will remain consumers’ delight, but that may not be the case for their investors.  Valuations will always be about discounted value of future cash flows. With everything priced to perfection, and no clarity on profits, the risk reward ratio is unlikely to be in your favour. 

If you dig deeper, there are enough megatrends shaping up in time tested and profitable businesses with better probabilities of delivering good returns. You don’t read and hear much about these because they often don’t make good stories.  

As for listing gains, that is speculation, not investment rationale. People win lotteries, too. Good luck to you if that’s the game you want to play. 

There is only one Amazon. For every Amazon, there are thousands of tech firms that made big promises amid the dot com bubble, and rest in graveyards now.  Even Amazon went through a 90 per cent correction post its listing. Even if you could withstand volatility, do you have the skill to identify the next Amazon?

Last, if any of the loss-making internet IPOs is going to be future Amazon, rest assured the market will give you enough opportunities to get in. IPOs may not be the best time. So be patient, and choose well. 

The author is senior research analyst at Equitymaster, a capital market research firm.

The opinions expressed in this article are those of the author's and do not purport to reflect the opinions or views of THE WEEK.

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