#2: Analysing loss-making companies' IPO

2021 has been a year for IPOs. And a giant one at that. In fact, the largest IPO in Indian stock market history is scheduled for launch this year. No brownie points for correct guesses - it’s from One97 Communications Limited (the parent company for the Paytm brand). They have already filed the papers (DRHP) with regulator SEBI for approval.

However, that is not the only trend for this year’s IPO. A much greater rage is about the IPOs from loss-making companies. As I write, three such large companies already await IPO approval from SEBI - PB Fintech Limited (brands PolicyBazaar and PaisaBazaar), One97 Communications Limited (brand Paytm), and FSN E-Commerce Ventures Limited (brand Nykaa). (Okay, Nykaa has already posted some profits for the most recent financial year, but you get the idea.)

Indian stock investors have been mostly analyzing profit-making companies up until this point. They discount future profits to determine the ‘ideal price’ for a stock. If the stock is trading lower than this value, they buy; if higher, they sell. Investing was simple.

Now, they are staring at this new rush of companies where not only the business models are hard to understand, also there are no profit expectations for the foreseeable future. How to value these companies?

Of course there are some investors who take part in all the frenzy for the listing gains, believing that the greater fool theory would work in their favour (which basically means that the bubble isn’t expected to burst before they book profits). And then there are others who are investing out of the FOMO syndrome (where the fear of missing out is so great, that all logic goes down the drain hole).

But then there are others, who believe in the old wisdom for stock investing -

The price at which you buy is more important than what you buy.

For them, we lay certain factors they can look at while analyzing these stocks:

1. The winner takes it all.

   Remember Yahoo? Only Google survived the search engines market, while Yahoo! vanished from the scene. More often than not, this is the norm for big tech. The winner takes it all.

   How do you apply this to investing? Well, look for early indicators of a market leader in the making. Factors to look out for include - current market share, technological innovation, customer stickiness, availability of funds for expansion, to name a few.

   Note that I did not list ‘brand’ as a factor. It’s because it is not. In highly dynamic areas such as tech startups, brand images change with customer perception faster than we think. Remember how Blackberry was all the rage until the likes of Apple and Samsung revolutionized smartphone technology?

   So, look out for early winners.

   

2. Cross-selling opportunities.

   More often than not, startups are found building a brand with one idea but pivoting to an entirely new area before they monetize. Zomato began as a restaurants-listing platform where users could post and read reviews, yet it eventually turned to food delivery for monetization.

   When analyzing a futuristic company for investment, understand that its current business model may ultimately pivot to something entirely different. Will the management and their operations allow the company to grab such opportunities with both hands when they come up?

3. Efficiency and scale.

   One of the easiest ways of analysis could be to understand whether the digital business is a more efficient and scalable version of a brick-and-mortar business? If yes, chances are that it will see success (other factors to be considered).

   Amazon, Uber, and Netflix come to mind here.

4. Tipping points.

   Digital businesses usually see exponential growth at certain tipping points. For Paytm it was demonetization, for food delivery it was Covid-induced lockdowns, and for edtech it was school shutdowns.

   

   There’s not much you can analyze here, as these events are hard to forecast. What can be done is that you stay up-to-date with the latest happenings and be an early identifier when any such opportunity comes up. (Thinkvest by Advance Thinktank is helping you do just that 😉)

5. Financial checks.

   Certain financial trends can come in handy - are the net losses reducing, does the promotional expenditure reduce while revenue increases, what is the revenue per user, trend line for the customer acquisition cost.

When analyzing any investment, remember to choose discretion over valour. Returns are made with discipline, not with following trends. Leave trend-jacking for Instagram followers, if you are looking for real wealth.

Also, even if the tech IPOs resemble the dot com bubble of the late 1990s do not forget that when the dot-com bubble burst, certain IT companies with sound business models became more valuable than before.

Bottom line: Invest wise, earn handsomely. That’s all for today.

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Surbhi Singhal is a Chartered Accountant and a Company Secretary; and the founder of Advance Thinktank. The company specializes in preparing custom research reports regarding investment opportunities in India, tailored to the client's needs.