Moneycontrol Pro Panorama | Angels are rushing to the exit, what should 'fools' do?

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Dear Reader, 

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The tide is flowing out and it’s not a pretty picture. Every week brings news of marquee shareholders striking bulk deals to exit from startups that were listed a year ago, after the lock-in on their holdings expired. Softbank has sold a 4.5 percent stake in Paytm for Rs 1631 crore, bringing its stake down to 12.95 percent. That leaves open the possibility of more stake sales in the coming weeks. Another bulk deal candidate was Nykaa, in which Citigroup, acting on behalf of TPG, was offering shares worth Rs 1000 crore for sale. Citi had struck deals in Nykaa last week too. While shares of both companies have not reacted adversely, many listed startups have seen their values crash in recent months.
These early institutional shareholders rushing for the exit can mean a few things. The more worrying view, from the point of public shareholders, is that they no longer believe in holding these shares for the long term. Sure, the lock-in prevented them from selling out earlier but if they believed there was still value in the stock, why sell at all now? This adds to the worry that public shareholders have about whether these startups are overvalued. Since they have a business model that chases growth and market domination and bolts on new businesses to keep the growth engine humming, profits and cash flows are not prioritized.

But that was when capital was available for the asking. The withdrawal of liquidity globally has reset investor expectations. Although, global markets may have recovered on hopes that the US Fed’s rate hikes are approaching peak levels soon, investors are not going to be as loose-fisted with their money.

Incrementalism was a chief driving force of investor behaviour​, writes economist and Columbia Business School professor Abby Joseph Cohen in the Financial Times (free to read for Pro subscribers). She writes how incrementalism meant that asset classes that did well continued to do so, valuation models mattered less and investors sheltered under winning strategies. Passive funds did well, for instance. But that has ended, she writes, as rapidly rising rates upended fund manager assumptions and the midterm results mean more trouble may lie ahead. Do read.
But the less threatening conclusion for investors could also be that shares are moving from itchy hands to more secure ones. The sellers are in troubles of their own and may be exiting to cover losses incurred elsewhere or to raise funds to meet redemption pressure. The global rout in some parts of the market, particularly tech and crypto, may also be adding to the pressure. For instance, Softbank incurred a solid $100 million write-down of its investment in FTX, while Temsaek incurred a $275 million write-down. An FT report also pointed out that Softbank founder Masayoshi Son personally owes $4.7 billion to the company, because of growing losses on its technology bets.

Thus, a benign view could be that once these share sales are concluded, a new set of shareholders with a longer term holding period will provide stability to valuations. While that may be so, it’s equally likely that, unlike the long rope given to privately-held startups, these new investors will nudge founders to steer the business towards sustainable performance, with a focus on profitability and cash flows. Already, listed startups are making noises echoing this thought. But will they be able to change their stripes altogether? And, shorn of their hunger for growth, won’t they begin to resemble the old economy companies and therefore, deserving of a reality check on valuations? Given a choice between flaming out by burning cash and surviving a funding crunch, they will choose the latter. Once the funding winter ends, they may revert to their old ways.
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Ravi AnanthanarayananMoneycontrol Pro