S02E27

Parsing India’s Tech IPOs

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In this special episode we take a look at India’s IPO boom with Gopal Jain, the co-founder of private equity firm Gaja Capital; Karthik Reddy, the co-founder of Blume Ventures and Madhav Chanchani, the Editor-in-Chief of TheCaptable.

Welcome to a special episode of The Orbit Shift podcast powered by Freshworks. We’ve been bringing you practical insights from founders, experts, and investors to help you scale your startups. From today, we are adding a new series to our show. In this special series, we’ll pick up a hot topic from the world of startups and help you parse it with the help of top experts. In today’s episode, we take a look at India’s IPO boom with Gopal Jain, the co-founder of private equity firm Gaja Capital; Karthik Reddy, the co-founder of Blume Ventures and Madhav Chanchani, the Editor-in-Chief of TheCaptable. We’ll try to answer questions such as why now and how will this play out?

More than half a dozen Indian tech companies including Zomato, Paytm, Flipkart, InMobi, Nykaa, and PolicyBazaar have said that they are likely to go public this year. This is obviously a big milestone for India’s tech ecosystem, which has seen very few public offerings in the past. What has changed, and why are Indian companies talking about going for an IPO now? Gopal Jain explains the macroeconomic conditions that make the markets ripe for an IPO.

Gopal Jain: For the last 12 months, we are living in a momentum-driven world. In financial markets, we’ve seen huge asset price inflation. The sign of our times is what’s happening in cryptocurrency markets where it’s difficult to figure out whether their currencies or assets have value. Then one can rationalize the valuation of many high-growth companies, technology companies as well. There has been an unprecedented amount of fiscal stimulus in the form of welfare spending and subsidization by governments, especially in large economies in the west. But in periods like this, people tend to save rather than spend. So this huge amount of fiscal stimulus has created an unprecedented volume of savings. The U.S. is rumored to be sitting on $3 trillion of financial savings. This financial savings pool is driving asset price inflation across the board. This partly explains the mean commodity phenomenon, the cryptocurrency phenomenon, the NFT phenomenon, where notional assets have value. In every such cycle, notional assets gain value. With low interest rates, which increase the present value of future cash flows, asset prices are on the rise. These two factors will also cause this market to turn as the economy gains momentum and this excessive pool of financial savings will start getting affected. Because people will start consuming and they’ll start converting financial savings into consumption. Now governments around the world are saying that they don’t care about inflation. But this cannot continue forever. We will soon have a situation where monetary policy will have to work to bring down inflation. When it is clear that this inflation is coming from excessive savings and low-interest rates, then interest rates will start going up, as the financial savings pool starts getting depleted because people start consuming. These fundamental factors will combine to make stocks look even more expensive than what they are today.

Madhav, what’s your take on this? Why are the markets hot now?

Madhav Chanchani: The Indian stock markets have doubled in terms of market capitalization and in terms of where the Sensex and NSE were before the lockdown last year. The markets are excited at the same time with the COVID 19 pandemic, there has also been a significant shift towards digital consumption. All our conversations are happening on the digital platform, work is completely shifted digitally. So if investors are looking to invest in this trend, there are hardly any companies that you will find listed in India. Only 1.4% of the aggregate market capitalization of India’s stock exchange is digital companies if you exclude services companies like Infosys and TCS. So there are only a few like Infoedge and IndiaMART. That number stands at 25% in U.S. and 17-18% in China. So obviously, there is a lot of appetite to invest in these new economy companies and digital businesses. Given the fact that the adoption of such platforms has become more organic, discounts have come down. So a lot of these companies have seen their losses significantly come down. But has that translated in terms of growth? That’s something we’ll have to watch as we come out of this pandemic.

Karthik, as an investor who’s been backing early-stage companies since 2010, what are the changes that you’re seeing now in the markets?

Karthik Reddy: So there’s been an understanding that you can’t take a loss-making company to the public markets. What was not read between the lines is that the regulator is willing to listen to reason. However, it felt like that’s too much work. Why bother when you can just go get that capital in the private market? Nothing wrong with it. But you can’t say that you will never solve the problem. So in everyone has been working with the regulator. So all those efforts have come to fruition at this juncture.

Two market forces are also working in our favor. First, companies such as ReNew Power, have started finding ways for natural reasons to list on overseas exchanges. Other Indian companies have domiciled in the US and have a clearer path to go to Nasdaq and other exchanges there. Second, American investors have started identifying Indian assets to go public using the Special Purpose Acquisition Company (SPAC) route. It’s still not very foolproof in terms of tax treatment but it’s an option.

So in India, there are three things that are happening: One, there is a regulatory push saying, don’t wait for American regulation to figure out whether they can buy an Indian company or American risk-taking of that nature, just allow us to directly list overseas. But it’s confusing because of tax implications. And we’ve still not crossed the final hurdle, though they will draft guidelines on that front. So we can’t wait for that perfect moment. And thankfully, the Indian markets have opened up. The main bourses have opened up with their ability to absorb this risk. Zomato and PolicyBazaar already visibility in the market. Now they’re taking the courageous next step. Then others are planning to take that next step and whether it takes six months, eight months, 12 months, 18 months, it doesn’t matter. There is an assembly line of companies that are willing to go to the regulator and say this is our business model, this is our last recorded valuation, this should be restricted to individual investors, retail investors in the Indian markets, who do not understand this risk and they shouldn’t participate, but institutional investors are savvy. They can assess us and they should be able to buy into these companies. So the regulator is okay as long as they believe that the person making the decision is highly informed. And so they have been making these concessions where retail participation is close to zero and institutional buyers can buy these stocks even in the main bourse. That’s a big change. Last point is there is something called an institutional trading platform, which was the proxy for our inability to go public on the main bourse, and it will show its capacity to absorb $100-$200 million companies also in the future. So not SME exchange, which was $10, $20, $30 million, not the main bourse, which needs to probably be half a billion or bigger, but companies which can go to the market with 100 or 200 crores of revenue, and list in the institutional trading platform where retail is not even allowed as you go to Japan, you go to the U.S. or the U.K. There are three-four exchanges for this reason because all of this cannot be absorbed by one exchange. And that moment is waiting to happen in India. But there is a boatload of work from the boardrooms and the CEOs to be in a position to take advantage of these opportunities.

So the market is really ripe and the timing is just right. And that’s an opportunity to go public. A couple of years ago, everybody was saying that these companies can remain private for longer. Why go public when they can stay private? What has changed?

Karthik Reddy: The timing matters. You should be smart about it and choose when to list as opposed to list at the mercy of your capital requirements. Just because that market has matured a little and can support that kind of growth for a little longer, it does not mean that you couldn’t have done it in the purview of the public eye. The benefits far outweigh the so-called risks of being watched with a quarterly lens by the public markets and analysts, which has been the historical debate why we subject to quarterly pressure when we’re building very, very long-term goals. But tell me how is that a defendable argument when you have companies like Tesla, SpaceX, etc., being public for a decade? How can there be more uncertainty in a business model than some legendary companies of that nature, compared to what we are doing in commerce or SaaS today, and then say that some of the markets are dumb enough not to understand what risk we’re taking? That has been my biggest opposition to this idea that private is better than public. I’m actually a fundamental believer that cumulatively put together, public markets are smarter than private markets.

We had MakeMyTrip go public in 2010. Infoedge listed before that. In 2013, we had Just Dial and in 2019, IndiaMART went public. So just a handful of them really. Traditionally, very few VC-backed tech companies have gone public in India. What does this mean for India’s venture capital ecosystem?

Karthik Reddy: The biggest criticism around our industry has been that you’ve delivered nothing back on a predictable basis. You can make an excuse in the first three years, six years, eight years that the cycle is playing out. And then one private company saying it is fine, 10 saying it is fine, 100 private companies saying it is fine at the company level. But at the fund level or at the VC level at the platform level, not knowing when you will actually be able to generate liquidity systematically for money that you took 10 years ago, is borderline unacceptable to LPs overseas. And they are the ones funding this growth and this boom — 90% of the capital is still from them. So the last thing you want to leave from a sentiment perspective is it’s a one-way street. So anybody who has returned money has been lauded in the country. However, when you go look at the track records, these are one-hit wonders in a particular fund cycle or vintage. If you, therefore, have to solve for that, you’re arguably better off not waiting at the mercy of whether only a SoftBank or Tiger or somebody else can pick up the company but try to go public earlier than later. This is good education for us to know what to expect when it comes to end-state value creation. Let’s say in my portfolio as well we have Purple and Turtlemint. If Nykaa and Policybazaar go public, suddenly there is a valuation benchmark that will rub off onto your companies as well.

Madhav, you have been tracking the private equity and venture capital market for many years now. Tell us what your take is.

Madhav Chanchani: IPO is the big event that the Indian venture capital ecosystem has been waiting for a long time. Returns through IPOs will be pivotal for the startup ecosystem because that is one mode of return, which investors feel they can control. Because secondaries happen when there is a booming market and secondaries cannot be the primary source of exits. M&As are a game of chance till the last minute. In mature startup ecosystems, like the U.S., 80%-70% of the exits happen through IPO. The year 2018 was a really great year for venture capital exits primarily due to the Flipkart exit which accounted for $13 billion to $14 billion of money going back to the investors. But after that exits for the last two years, 2019 and 2020 have been successively falling. In 2018, it was around $17-$18 billion. But in 2019, this number fell to $4 billion to $5 billion. And in 2020, this number fell to around $1-$1.5 billion. So if there is a steady stream of IPOs, there could be a steady stream of exits for venture capital investors. There is a lot riding on some of the first few IPOs that are expected to come out.

This is great news for private equity companies as well. Gopal, how do you view this development?

Gopal Jain: Over the last 10 or 12 years, we’ve taken nearly six of our companies public. So there is no dearth of venture capital and private equity-backed IPOs in India. In fact, since 2013, private equity-backed IPOs have been preferred by the market. And the reason for that is governance. The private equity backed companies tend to have better governance. So now the question is: are venture-backed technology companies going public? In technology, there are profitable companies that have gone public. If you are referring to non-profitable or financially immature companies that are going public, well, they must pay extra attention as to how will they become sustainable.

Are the tech companies ready to meet the scrutiny and requirements of the public market?

Madhav Chanchani: One advantage that a lot of the venture-backed companies as compared to traditional companies have is that they always have a board of directors which is filled with the representatives of the investment firms that have backed the company. Typically Indian promoter-led companies will have directors who are part of their families. That is different for startups because, from the start, they have been answerable to their investors and the board of directors. Obviously, the point that you have mentioned is a question that we are looking for an answer to now because a lot of these companies need to put in systems that they should be able to get on the quarterly analysts call and give the answers to the concern of common shareholders and smaller investors as well.

While companies have to build up their systems and processes to meet the demands of the public markets, some of them have already been doing that for several years.

Karthik Reddy: If you think about it, PolicyBazaar and Zomato, have been getting a lot of scrutiny by the public markets as Infoedge line items for five years now. In fact, the valuations are baked into the Infoedge price today. So what’s the fear? And that’s why I’m not surprised they’re amongst the first two, because they’ve been guided and mentored by the best in the business for the last decade. That path to prepare for that scrutiny has to happen irrespectively. Will somebody buy a $5 billion asset without going through all of that scrutiny? I’m not judging the timing and saying they should do it in 2021, 2022, or 2023. But the path to going there and being under scrutiny is inevitable. The acquisition comes through scrutiny. The liquidity even comes through that same public market scrutiny and your eventual value wealth creation is arguably higher in the public domain than in the private domain in absolute dollar terms.

This is probably going to be the beginning of several IPOs to come and eventually the markets will need more than $10 billion to absorb these companies. Do you think the losses are going to be a problem?

Madhav Chanchani: So it’s not the first time that there is a listing of a loss-making company in India. If you saw there was an IPO of this company called Burger King at the end of last year and the IPO has been a great success. It got listed at Rs 60 per share, but its share price currently trades at around Rs 160 even though it lost more money in 2021 than the previous year. That was a much, much smaller IPO of around $120-$130 million. So that is where the Indian venture capital investors and the startup ecosystem is watching if there is a big enough appetite in the Indian market.

Gopal, without naming names, which companies do you think will do well?

Gopal Jain: I guess the best prospects for IPOs are from those companies that are mature to do an IPO because of where their businesses are and not necessarily just because of where the financial markets are. There are many companies that will be able to go public because financial markets are hot and there are some companies that will go public because they are mature and their financial and business models have reached a stage where the public at large can buy into these businesses. The ones that have mature financial and business models will have the best prospects and will be the most insulated from the volatility in financial markets. My sense is they’re also the ones that will perform the best over a period of time. Companies that depend on capital raising to sustain themselves are inherently at risk. To quote Buffett, when the tide runs out we’ll know who’s swimming with what degree of clothing. Imagine there is a company with a relatively immature financial model and a business model which is loss-making and therefore, it needs to raise capital periodically to sustain itself. What happens when financial markets turn around? What if you are an investor in a company that is loss-making and needs to raise money when the markets are down?

One of the challenges that loss-making companies in India are going to face is the lack of depth in India’s debt markets.

Gopal Jain: So the ability of loss-making companies to go public in the U.S., for example, is predicated on the depth and strength of debt markets. Debt markets supply the capital that these companies need after they go public because there is a very active junk-rated bond market in the U.S. So in India, we must recognize that our debt markets don’t have depth. There isn’t an active junk-rated bond market here. So in India, it’s even more important that we don’t look at markets through the lens of the last 12 months. We look at markets through the lens of the last many years. In India, it’s even more important for companies to ask themselves that are financially mature? Are we going public because our business models are mature enough, and not because the markets can afford us an opportunity?

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Featured image by Hans Eiskonen on Unsplash

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