Loss-making Zomato IPO’s oversubscription contributed by qualified institutional buyers' (QIB) and retail category's vehement response and that of Paytm's soon-to-be mage debut of Rs 16,000 crore in the last 10 years since the 2010 issue by the Coal India has led to the discussion of the emerging criteria of startup valuation .
Are the traditional valuation methods of earning, EBITDA or P/E multiple no longer considered?
Experts, especially after Zomato's public issue, have explained the importance of valuation and advised investors to take care of certain parameters before making any substantial investment, which brings us to the question— is profitability insignificant in the valuation of a startup? Do loss-making startups have a better chance of sustenance after their public floating and remain high-valued?
One of the core goals of business sustenance for startups is their eventual scalability (of course, a sound idea precedes every requirement of sustenance) over the growth, implying growing revenue at a rapid rate over costs rather than increasing revenue and resources.
Zomato not alone
In the last five years, India has witnessed the rise of loss-making yet high valued startups, such as Paytm, Oyo, Ola, Policybazaar, Mobikwik, Nykaa, Delhivery, Indiamart, Easymytrip and Zomato, while the trend was initiated by the InfoEdge, Indian first internet firm.
Like Zomato, these ventures are also going for their public floating, likely in this year itself, debuting as listings of loss-making companies.
The subscription result of Zomato especially that its 20 per cent of applications were done by another startup stock broking firm Zerodha speaks volumes on the changing business climate for startups in India. .
As Nithin Kamath the founder of Zerodha mentioned, "Zomato IPO would pave way for other Indian start-ups to go for IPOs in Indian markets, as Indian markets are the best platform for all the stakeholders i.e., company, investors and customers."
Losses to continue
Interestingly, none of these startups, despite their listing as a loss-making company in the Indian public market, intends to earn an immediate profit— for instance, Zomato, in its regulatory filings with SEBI , has disclosed it would be many years before it declares any profit. Other instances of high-valued Indian startups include Swiggy and Flipkart. Swiggy accounted for a loss of INR 397.30 crore in FY18 from INR 137 crore in 2016, but its valuation increased manifold to INR 8660.4 crore.
Similarly, the Indian e-commerce giant Flipkart reported its loss of INR 545 crore in FY16, which went up to INR 2064.80 in FY18; however, Walmart acquired its 77% stake in 2018 valued it at $21 billion.
Valuation metrics for startup
So, coming to the first question on the declining importance of profitability for valuation of Indian startups— well, the valuation index for startups— a temporary entity scientifically solving people’s needs— is different from the valuation of an established business.
For valuation, the question lies in the contribution of the startup IPO, here Zomato, in the unit economics and its competitive advantage shortly, along with the above metrics. It seems that the metrics for startups are different from the usual price-to-earnings ratio, net profit; EBITDA; discounted cash flows, etc. metrics.
Startups are valued based on their user base— both captured and uncaptured, repeat user rate, customer acquisition costs and customer spend, investments to create new revenue streams and vertical credit tech to lead the next growth wave. .
Simply put, these loss-making startups are redefining the valuation metrics followed up until now in India through “inverse proportionality”. Valuations are typically a function of projected revenue, based on assumptions that unit economics will work out once the competition is killed. Nonetheless, not in all cases, competition can be diminished, as can be understood from PayTm’s case.
Paytm intends to achieve $2.5-3 billion as IPO and is expected to improve unit economics by experts through a break-even in 12 to 18 months.
Thus, it is forecasted to continue as India’s largest payment and fintech ecosystem, despite strong competition from similar entities like Google Pay, Amazon Pay, BHIM, PhonePe and WhatsApp’s payments challenging its monopoly and will have a total throughput of $52 billion in FY21— a 33% increase year-on-year.
Different metrics implications
Financial experts’ reasoned these changing yardsticks for valuation with the assumption of Indian companies that they will drive out competition. Therefore, two or three strong companies would survive and make profits. That is the hope driving valuations.
Moreover, there is an assumption on losses, which if, lower, is seen in a very positive light.
Consequently, a significant portion of the funds that a company raises continues to be allocated for loss funding, achieving scale, customer acquisition and driving out competition. Investors like SoftBank and Naspers opine that in the business models that continue to evolve, like food delivery, valuations are only based on negotiations based on the Company’s constant growth concerning new service lines and, therefore, needs more funds. .
The Amazon example
A successful loss-making startup can be seen through the case of Amazon, which went for public floating in 1997 with a loss of $31 million.
However, in 2001, it recorded its first profit as IPO, and by 2021-22 it is predicted to create a wealth of $1.6 trillion for its shareholders. Nonetheless, as private and deep-pocketed investors are driving valuations, sustainable price discovery, which comes into play at the pre-and post-IPO stages, is not happening, as observed in industrialised nations like the US.
Consequently, high-valued companies are forced to slash their public offering valuation, as happened with We Work’s parent We Company. The startup slashed the valuation of its public offering to nearly $20 billion, less than half the $47 billion valuations it attained in a private funding round in 2019.
Besides, the overly high valuation of ventures, as happened with Zomato with 25x FY21 EV/Sales compared to an average of 9.6x for global peers and 11.6x for Indian QSRs, might put both investors and the companies at risk, since “valuing such early-stage businesses on plain vanilla financial matrix might not give the right picture and may look distorted.”
As some mega IPOs in the past, like homegrown SBI Card, GIC Re, NIA and ICICI Prudential, could not deliver listing gains despite all the excitement for one reason or the other.
Similarly, on the international front, Quibi, Loon, Katerra, Essential Products are some of the startup failures acquiring more than $100 million funding due to aggressive sales tactics, longer and riskier commercial viability than predicted, and profits not meeting the vision.
Therefore, valuations of a startup, along with the optimistic assumptions investors and the companies make about their growth and wealth generation in the near future, should also be based on the product, market size, team background, strategic relationship /networking and existing investors background to avoid substantial cash burn and devaluation.
About the Author: Saurobh Barick is Registered Valuer & Director-Finshore Management services Limited
Disclaimer: The views expressed are solely of the authors and ETCFO.com does not necessarily subscribe to it. ETCFO.com shall not be responsible for any damage caused to any person/organisation directly or indirectly.
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