Dotcom IPOs redux?

The narrative and comments expressed in this article are wholly based on the writer’s own personal views and are not to be construed as representing the views of the firms or institutions which whom the writer is associated with.

The market has gone gaga over?recent and proposed IPOs of dotcoms and huge investor interest is being reported. Being of the old school style of investing (and on the wrong side of 50 to boot!) a few people of my vintage have been expressing reservations about the eye popping valuations for such heavily bleeding businesses with doubtful economics even in the long run.

The context

To begin with, it is important to note that over the past few years, growth has been at a premium in an increasingly recessionary world. It is also seen that yields are at near zero and in fact negative in some developed countries. It is also known that there is a huge overhang of global liquidity searching for some or any kind of growth market. Therefore it is no surprise that huge consumer markets like India, with seemingly endless potential to exploit and digitally well equipped to decimate the traditional offline industries, have become the hot beds of such experimentation for global capital chasing any positive return!

Thus, over this same period that e-commerce ventures have taken off in emerging countries like India – again riding on huge capital flows from these global pools of liquidity – and channelized by high risk appetite global VC majors. ?Unlike the tech VCs of yore who bet on disruptive product innovations to create new products of value and even new categories of products / services, many of the present Venture capital funded business models seem to mostly chase market dominance in existing categories.

With market share and revenue growth at any cost (discount) being the only major objectives, these ventures quickly raised humongous money from global VCs which kept funding losses over a “Series” of capital raising . Also in many cases the businesses (with few honorable exceptions) themselves seemed to have doubtful unit economics.

How else could this play out? - as neither the VC investors nor the young entrepreneurs represent patient capital – the objective was all about value creation at the shortest period of time followed by a block buster exit (giving rise to terms such as unicorn, soonicorn, baby corn et al). Such ventures became almost monopolistic or oligopolistic either gobbling up smaller ventures or just finishing them off ?as not many competing funds have the wherewithal to fight a bruising battle of funding losses for market share.

IPO as end game

But once the valuations increased to unicorn levels and beyond, and so did the number of VC series funding rounds, it became apparent that somebody has to finally hold the bag as the rounds and sizes have become very large and so have the appetite of these loss making ventures to guzzle capital!

Ergo the next step in build-up of such bubbles, entry of the public markets as last refuge for such deals! The large mutual funds that are managed by marquee names and channelize millions of small shareholders wealth,?were also searching for ways and means to generate return in an increasingly competitive and growth averse markets – for these institutions such Unicorns represent a huge opportunity – large IPO deal sizes, almost guaranteed multiple times oversubscription and tendency to appreciate immediately after IPOs given the huge shareholder frenzy as well as with more than 90% financing of high net worth investors by large NBFCs. Also, very conveniently last year,?Indian capital market regulators too relaxed hitherto strict norms on profit making track record so as to facilitate such loss making ventures offerings.

Such is the nature of the volatile liquidity mixture which is fueling the frenzy for dot com IPOs (bringing back memories of the early years of 21st century for old investors!)

Issues for the public investors

A few questions arise in mind about the future of such offerings:

·??????Given the fact that the DRHPs seem to clearly mention that such ventures are unlikely to make profits any soon – it begs the question, how would these loss making giants finance any future requirements? It will have to be through rights or follow on IPOs – what are the chances that any of these super VCs (who are taking such big exits) will re-enter them in public market at better valuations!!

·??????Would the banks/ rating firms?revisit prudent cash flow based funding norms to enable such loss making businesses to raise debt?

·??????Again the private investing world provided lot of protective options for the few sophisticated investors in terms of valuation structuring , convertible instruments like CCPS, Liquidity preference, anti-dilution,?etc for control, valuation and exit management – none of these avenues exist for the public markets investors for future funding.

·??????Against a background that the promoters have only promised more losses in future, how exactly are the institutional shareholders or other corporate governance torch bearers going to question the management on “value destruction” – how would you even measure it, given revenue can always be bought at higher losses / dilution?

·??????Will good old P/E become ?passe' and Market Cap/Revenue become the norm in Indian markets ?– and if a few of these blockbuster IPOs of dot coms happen and eventually (given their sheer size) they enter the indices, what happens to old measures like index P/E ? ( Ironically this may attract more funds towards such stocks). Also ?how would you compare these stocks vis a vis say, a more sedate but hugely profitable IT services business?

·??????It is also a matter of concern that bulk of such humongous “value creations” accrue to the benefit of large global VC and hedge funds (admittedly early risk takers) who now seem to have a set formula - as a powerful and elite group?invest a few hundred million - and take a billion out leaving Indian institutions, MF and retail investors holding the bag at IPO. Since a handful of these global elite firms dominate fund raising as well as the large deal markets they are able to perpetuate a view, that?huge operating losses should be worn as?badges of honor!

·??????This party will continue in the near future as the global investing world is awash with?liquidity?with a near negative interest rate environment and hardly any growth avenues outside emerging markets. The day the tide (in terms of capital inflows) changes for India will be the day of reckoning for residual value in such companies if any left.

·??????From the private world (which at least have sophisticated investors), this pernicious valuation environment is now spilling over to the more gullible Indian retail investors?and funds in public markets and there is a real danger that posterity ( read domestic investors) may end up paying for these misadventures.

It will be interesting to see how the regulators, large public market investors groups and proxy firms react to these developments and if they can come out with sound investor protection and market stability enhancing measures. If not, the Indian listed markets just might find it difficult to handle this hot new potato!