Aage bhi jaane na tu, peeche bhi jaane na tu,
Jo bhi hai bas yehi ek pal hai
During Moneycontrol’s Muhurat Roundtable, Devina Mehra, chairperson of First Global, recalled this Sahir Ludhianvi classic from the Hindi film Waqt to describe her sentiment towards the Paytm initial public offering (IPO).
Last Thursday, as the stock debuted with a 26 percent fall, the aura around India’s digital payments pioneer began to fade. This Monday, the share price fell another 12 percent and all hell is breaking loose, or so it seems. Questions around the regulatory landscape for pricing IPOs and on various other points are being raised by investors and media alike, conveniently ignoring the role of greed and irresponsible investing.
Paytm is the second IPO in the internet space to decline on debut. Last week, Fino Payments Bank, too, had a tepid listing and is quoting 20 percent lower than its issue price.
If the negative sentiment dims funding prospects for other fintechs, Helios Capital’s Samir Arora’s prediction at the Moneycontrol Muhurat Roundtable may well come true—he said some fintechs will blow up before they go public.
Overall, there has been exuberance around the internet space, with IPOs being launched at bizarre valuations, far out of range in terms of earnings multiples, or any multiple. Indeed, the high valuations of technology-enabled companies have both puzzled and fascinated investors scouting for the next Amazon or Google of the Indian market.
Zomato which listed in July 2021, is now trading around Rs 149, more than double its IPO price of Rs 76 and up 18 percent from the Day 1 closing price of Rs 126. Earlier this month, Nykaa operator FSN E-Commerce Ventures’ debut was a fantastic success, and the stock is now trading at a nearly 87 percent premium over its issue price of Rs 1,125, although down 4 percent from its Day 1 closing. Ditto for Policybazaar (PB Fintech), which debuted last week. As against the IPO price of Rs 980, the stock now trades at Rs 1,227.
Despite those bumper listings, the value destruction on Paytm’s listing has hurt sentiment. Both investors and the media are crying foul over the pricing of the issue. While their outburst is in defence of gullible small investors, the value destruction has landed a bigger blow to institutional investors who willingly accepted the deal despite the tremendous risk because of both the business model and valuation. In Paytm’s case, at least, their opportunism seems to have backfired.
Interestingly, it was the pre-IPO anchor round that was oversubscribed 10x by 74 investors with the biggest cheques cut by marquee names such as Blackrock, Canadian Pension Plan Investment Board, Abu Dhabi Investment Authority, City of New York, Standard Life Aberdeen, Vanguard, Fidelity, UBS…. Local mutual funds were more guarded.
Another point to note is that the retail portion barely got sold. And the muted response to the issue overall was a tell-tale sign that investors were unimpressed by the Paytm story. The large issue size only compounded the problem with a supply glut that created the conditions for a precipitous fall, sooner than some of the institutional investors would have anticipated.
Evidently, it was not the fundamentals of the company but the success of previous issues that probably strengthened the confidence in the play.
However, there was one critical difference between the internet stocks that have done well on the bourses and Paytm. Nykaa, Zomato and Policybazaar had all shown clear leadership in their chosen business segments, so analysts were willing to count on the profit that is assumed to naturally accrue to them, even far into the future. Nykaa’s proof of success in its main business segment also ensured that the promise of new categories could be sold down to the next set of investors, laying the ground for stretch valuations.
Paytm has a problem in that its business model is still both unclear and unproven. And competition is set to intensifying in the payments business, Paytm’s main plank from where all other businesses must flow, with Jio Pay likely to enter the fray.
Not surprising, when a business model is not going as planned and billions have been committed to the venture, the only game in town is to find greater fools. From investors’ perspective, the unproven business model added a layer of risk that perhaps made them wary about the issue but not enough to prevent them from participating, given the allure of a likely quick buck.
When you haven’t a clue about valuations, the least investors can do is to take refuge in the “right business”—although history has shown that if the price is wrong, the investment can’t be right. For example, Reliance Power, where the business was only on paper, ended up destroying nearly 80 percent value in just about a year in February 2009. Even Infosys that had a fabulous business model the market was totally sold on before the crash in January 2000, eroded 70 percent value in little over a year.
Now, after the 35 percent fall in Paytm, investors are still viewing this as a Paytm problem. It is, indeed, but investors are still unwilling to recognise the bubble in internet companies. The overwhelming question now seems to be how much more Paytm can fall. After all, an entry price 35 percent lower than that paid by institutional investors seems like a bargain. For retail investors, it may feel like a coup.
But that’s the catch.
Putting a floor price on Paytm or, for that matter, a cap on other successful internet IPOs will not be devoid of anchoring bias. That is, we are going to be victims of a cognitive bias that relies heavily on the first piece of information, which is the IPO price itself. The right way then would be to start with a clean slate and evaluate what the business could be worth. So far, no meaningful research seems to have emerged on this because analysts themselves, by and large, are at best price-chasers.
As for Paytm, at this point, investors should keep in mind that the Rs 8,000-odd crore that was subscribed to by anchor investors is still locked in for one month. So, it is fair to assume that there will be sustained selling pressure going forward.
Second, people are also asking if the management and bankers should have left more money on the table when fixing the price. One common grouse is that private investors are taking away the cream and there is hardly anything left for public shareholders. It’s important to recognise that venture and private equity investments are a different ballgame. The risk profile of the startup/company, including mortality risk, is supposed to be minimal if not eliminated completely by the time it hits the public market. To that extent, the return to public shareholders on an individual stock can’t be compared to those made by the private market as the return on successful exits has to cover failed bets.
But what is truly befuddling is the huge leap in public market valuation compared to the last round of private market valuation, just months ahead of the IPO. These numbers are revealing.
Granted that the pandemic fast-forwarded digital adoption and accelerated growth for this segment, but can that really explain $1.4 billion valuation rising to $7.4 billion from January 2021 to October 2021? That is how high Nykaa’s valuation has scaled.
Policybazaar raised capital at $2.4 billion as early as March 2021 and went for an IPO at $6.15 billion seven months later. Zomato, which raised capital in February 2021 at $5.4 billion, went for an IPO at $8.6 billion in four months flat. Ignoring the high base, Paytm actually looks timid on this count—it went for an IPO at $20 billion, while it did raise funds at $15 billion the same time last year.
The flip side of this argument is who is to decide the right value. Tesla went up nearly 10x in the public market in 2020, so why can’t the value of a private company go up as much?
Disturbing as this may sound, this is really how the market works. No regulator can really try to regulate stock prices or valuation. Even if the regulator takes it upon itself to question the spike in valuation, investment bankers will always find a way around to justify it.
There is no point blaming investment bankers either because they are hired by the issuers and not investors. There is a clear conflict of interest, thus, between what bankers push for, which is to get the best valuation possible, versus handing out a bargain to new investors.
If companies that hardly make a profit pay bankers what could be their profit for a few years, you know they better make super-good deals.
Warren Buffett explained eloquently in Berkshire Hathaway’s 2014 annual meeting why it is hard for investors to make money in IPOs—it’s because sellers pick the time they want to sell shares, which is usually not favourable for investors. Second, these are negotiated deals where you can’t hope to get bargains. The example Buffett gave was that of a homeowner in Omaha trying to sell his house. He will never sell the house at a value significantly lower than the price at which a comparable neighbouring house was sold. But at the same time, if the house were owned by a large number of small owners each owning a small percentage of the house, they will more likely sell down at whatever price. Simply put, the auction market (secondary market) offers much better deals than negotiated deals with a single party.
The simplest answer to this conflict of interest between bankers and investors, and misaligned incentives, is to abandon the IPO process and adopt direct listing. The successful listing of Spotify and many others in the US may be the way forward, but that is a story for another day.
In the current regime, the best option available to investors to express displeasure is to not participate in an overpriced issue. But then, that is where greed takes over.
At some level, occasionally, a Paytm is good for the market as it acts as a leveller, reminding people that they should care more about fear of loss than the fear of missing out.