How are new internet IPO companies doing when it comes to valuation and profitability?


By Sandip K. Khetan and Veenit Surana

In the short term, the market can be a voting machine, meaning it determines which firms are popular and unpopular, and is swayed by investor sentiment. In the long run, it is a weighing machine that determines the essence and potential of a company. This is a one-shot description of how new internet IPO (e-commerce, online, platform) companies are faring in the current market.

Since the last few years, we have focused on ConsumerTech, Edtech, Fintech, SaaS, HealthTech, etc. we see the attraction of PE/VC investments in internet companies like Examples include Delhivery, Zomato, Nykaa (FSN E-Commerce), Byju’s, and PayTM, to name a few. Gaming and artificial intelligence platforms are gaining attention in media and entertainment. In addition to PE/VC, large corporations are now increasingly acquiring start-ups to enhance their e-commerce and technology capabilities, with new capital pools already available alongside venture capital investments.

India’s growth in terms of PE/VC investments has also been significant in the last few years. For the first time, Indian PE/VC investment flows have shown some weakness after being stagnant for almost six months amid the global headwinds of tightening liquidity and rising inflation. PE/VC investments in July 2022 were the lowest in a year in terms of both value and volume. PE/VC investments in July 2022 at USD 3 billion, 69% of the value recorded in July 2021 (USD 9.7 billion) and investments in June 2022 (USD 4.9 billion ) is 40% less. PE-backed IPOs, one of the defining features of PE/VC exits last year, will continue to remain elusive in 2022. With liquidity tightening, uncertainty caused by geo-political events, and a sharp correction in some recently listed startups, sentiment toward IPOs by startups and other companies has moderated somewhat in the early months of 2022.

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The underlying business model is key to better understanding these companies and their growth potential. Some are transformative, while others aim to bring simplicity and efficiency to the way things are currently done and are incrementally innovative. Over the past few years, India has become a competitive platform for such companies, placing India firmly on the global map to generate employment, attract talent, access funding and solve complex problems innovatively at scale.

Part of the equation relates to market fundamentals and investor preferences, and another part relates to the growth potential and maturity of these companies. We have a long runway as we have 100+ Unicorns and some of them are listed. This pipeline includes many companies in the fintech, consumer internet, education, enterprise technology and media and entertainment sectors. The maturity of the startup ecosystem has also changed, as many startups funded by PE and other investor groups are looking for an exit, and many of these businesses have also matured and scaled.

Internet companies are not typical and valuation can be difficult. As investors competed with each other in the process, valuations kept rising. Assessment methodologies have continued to evolve over time. The number of clicks to a website in the dotcom era, etc. were some of the methods that lead to inflated valuations, where the view varies from simply tracking the actual revenue generated from driving visitors to your website. There may be other methods of valuation generated such as total product cost/order cost etc. Assessing the true potential of many of these companies will take time to evolve, let alone the broader social and consumer-centric positive impact. The market also evaluates these companies for the potential they offer in terms of the companies’ future plans, for most of these companies the purpose of the IPOs was acquisition or growth.

One driver for attracting funding for Internet companies compared to traditional businesses is the Internet’s ability to expand rapidly. Traditional businesses will have a tangible product, may require a factory to facilitate production, and may require more capital. On the other hand, Internet companies that connect buyers and sellers/service providers can grow rapidly. This could be a winner-take-all market. Once companies become dominant players, they can work towards profitability.

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On a broader business and investment trend, India is among the fastest growing startup ecosystems in the world. From an investment perspective, investors, both private equity and large funds, are taking a cautious approach by reducing investment costs. Recently, many companies have also been seen reducing the size of their IPOs. There is a shift in behavior between loss-making (internet) companies and investors looking for companies that are potentially profitable (with good cash flow or a clear path to profitability).

An IPO is a private-to-public journey and issuers face a number of challenges, including both regulatory/external challenges and getting their homes to be effective on the IPO journey and underestimating the seriousness involved. Companies with proven business models, higher governance standards and better financial standing are the companies that will find it easier to get listed.

In addition to being cautious when investing and not being fooled by “this time is different”, appreciating a different perspective and supporting new internet companies will lay the foundation for an even more interesting and rewarding outcome.

(Sandip K. Khetan, Partner and Head, Financial Accounting Advisory Services, EY India and Veenit Surana, Partner, Financial Accounting Advisory Services, EY India. The views expressed in the article are those of the author and do not reflect official position or policy. FinancialExpress.com- from.)



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