OPINION Why the LensKart IPO pricing is pure art... and artfulness

Gravity works just one way. So, the key in IPO pricing is to anchor valuation such that any level below that appears a coup.

There is an inner game to IPO pricing that almost nobody understands, including the guys doing the IPO pricing.

In fact, even I did not understand this up until 2022, despite having been a Category 1 Merchant Banker for 30 years, which shows you how loose merchant banking licensing standards are.

The story starts with the IPO of Paytm, the fintech run by Vijay Shekhar Sharma, which has been a great story of a man starting out extremely small and building something quite astonishingly big, in market capitalisation terms, for sure. Now, the company went public at a IPO market capitalisation of around Rs 1.4 lakh crore.

What exactly was the business of the company that merited this valuation (implying market cap and not these fossilized ratios like P/E ratio, et al)? As far as I could figure out, it had ‘Paytm’ stickers all over India, even in the smallest of shops, with millions of shopkeepers using it to receive payments. There was high brand recall, especially because of that manna from heaven moment called demonetization, which lit up the fortunes of the company. All of this translated into an IPO market capitalisation of Rs 1.4 lakh crore.

Thereafter, as Shakespeare once wrote, "To thine own self be true, and it shall follow as the night, the day", the Paytm stock - deep down in its sinfully avaricious little heart - knew that it had no, absolutely no business being at that valuation. And, with perfect mea culpa that would have shamed Ramalinga Raju, it sank to a market cap of around Rs 20,000 crore in the months and years that ensued.

In the same, by now sepia-tinted era of Indian ‘tech companies’ (India has a different definition of what constitutes tech as compared to the rest of the world) came Nykaa, Zomato, Policy Bazaar, CarTrade, etc.

Nykaa convinced us that selling lipstick via an app was worth Rs 50,000-70,000 crore, all with profits less than what Infosys makes in around 3 seconds. Zomato had us lapping up its offering at a market capitalisation of Rs 60,000 crore. Policy Bazaar had us drooling over its Rs 45,000-50,000 crore IPO valuation, and CarTrade appeared to pretty much give it all away for a mere Rs 7400 crore for an unbeatable, unassailable moat - a website, an app and a WhatsApp channel selling used cars.

The rest of the story is well known but also well-forgotten, as all stock market lessons are. All the above-mentioned stocks cratered between 40-80 percent. Believers in India's ‘tech plays’ became scarcer than AQI 20 days in Delhi as sceptics sneered.  The ‘I told you so’ rotated wildly all over India's polluted social media that would put Yamuna to shame.

But everybody was missing the point, and there was indeed a point that nobody with an investing IQ of over 30 should have missed. This point crept up on me, not while doing some deep investment thinking (I do no such thing, at least not these days). It came to me through the dashing utterances of somebody I respect a lot, on that nostalgically dirty street called Lansdowne in Calcutta, having a ‘Kalkatta Navratan Keemam Paan’.

That chap patiently explained to me why and how Paytm was now a screaming buy at around Rs 350 (down more percentages than my calculator allowed). In a nutshell, his skinny was this: “Look, everybody lapped it up at a market capitalisation of Rs 1.4 lakh crore. It is down 80 percent from there. It simply cannot go down any lower." He went on about the fundamentals and Paytm stickers that even the Lansdowne paan dukaan sported.

My eyes had glazed over, and my brain was already onto the greatest self-made IPO pricing schema (sounds suspiciously close to ‘scam’ but that's pretty much what it is) of all time.

Since it's almost certain that nobody reading this article has ever done any great invention or discovery, allow me the indulgence of telling you how it feels when you stumble upon a great anomaly of nature, something akin to the ‘anomalous expansion of water’.

It was like the keemam in the paan had catalysed a burst of deep wisdom in my anterior cingulate gyrus, inside of my parenchyma, that I wasn't even vaguely aware of.

Suddenly, everything made sense just like it did to Hercule Poirot in The Murder of Roger Ackroyd.

It was something called ‘Anchoring Bias’. Again, no connection to ‘anchor’ book allocation although I think there is a connection after all.

Since Daniel Kahnemann is dead, buried and plenty cried over, let's not disturb his soul for this kindergarten level bias. This is simply about pitching something so high that every other price below that seems like a bargain.

This was used by Sapru in ‘Deewar’, selling Amitabh an overpriced skyscraper. But Amitabh knew all about that caper (or at least, Vijay did).

So, what all the dirty half-a-dozen names mentioned in the first half of this piece did was that they simply had us good by creating an anchoring bias. Whether they did it knowingly or unknowingly shall remain a mystery bigger than who stabbed Saif Ali Khan.

The process was/is as follows:

Retail investors in India were told these are ‘tech companies’, and that tech is generally loss or near-loss making, so please don't be silly, obtuse, amateurish in applying smokestack valuation metrics.

Marketing was into overdrive, TV channels were going blue in the face, talking about the increasing ‘maturity’ and ‘risk appetite’ of the Indian retail investors. If this was maturity, I would rather be retarded.

The IPOs sailed through, after which the sails on these boats collapsed and the boats sank 50-80 percent.

But here is where the sheer evil genius of the anchoring bias schema shows up in all its glowering glory. Once these stocks tanked, they suddenly became ‘great value’, and that they simply ‘can't go lower’ etc. Indeed, all of this is very logical. After all, (unleveraged) stocks typically do not fall more than 80 percent, and if they do, they go to zero because of fraud. So, almost any, sufficiently large stock (exactly where anchoring bias works best) with even basics of some legit business will simply not go below an 80 percent decline from its peak prices, at least, not durably.

You see, most people investing in stock markets are less than super geniuses, but don't take my word for it. Even an Old Man from Omaha said something to this effect once. Or maybe, they start out super geniuses and then stock market alchemy turns them into idiots.

Whatever sequence the path to idiocy follows, the fact is that almost nobody will stop and ask the one minimalistic question - “Sure, this stock which IPO-ed at Rs 1 lakh crore is now (just) Rs 25,000 crore. But... wait... isn't this itself a massive market capitalisation for this kind of business and fundamentals? I mean... Paytm is still at 20x revenue for what's becoming less fintech (whatever that is), and more vanilla brokerage and NBFC... isn't Paytm 's intrinsic value less than even this 80 percent lower price?”

Nykaa is still ~10x sales (let's not get into the P/E discussion) for an online fashion retailer, innovatively diversifying into physical retail...P/B is still 15x revenue, CarTrade is still 12x revenue (after trading at 30x revenue at its peak). So, aren't we just getting ‘anchored’ to a high IPO valuation and calculating ‘value’ based on gross initial overvaluation?

This reductive query that nobody raises goes to the prostrate of the matter - people with biases vastly outnumber people without biases by a ratio of 100-0. And that's what this IPO pricing scheme or scam understands viscerally. Just get an IPO done at a crazy valuation... India has enough Crazy Caged Capital willing to roll the dice... and then, when the stock tanks it will become, relatively ‘deep value’ as the conversation at Lansdowne had revealed. Never mind what its real intrinsic value ought to be.

The keemam had really started to kick in. Think of another scenario. Suppose Paytm had gone public at a much saner 10x sales (it's all relative, all right?), if Nykaa had IPOed at 5x sales as a god-fearing retailer should... Would they have traded up, ever, to 50-25x sales post listing? Not a chance.

The thing is that markets are a fascinating study in comparative degrees of lunacy. If you sell irrationality first, then resetting and selling rationality later is a piece of cake. But try selling rationality first - 5-10x sales in the examples above – and you have immediately and indelibly anchored the public mind to rationality so solidly that it won't ever pay you the irrationality of 25-50x sales.

Gravity works just one way. So, the key in IPO pricing is to anchor valuation such that any level below that appears a coup. Hence, Paytm, Zomato, Nykaa, all became (relative) bargains simply because intrinsically, they knew that if they ever sold stock at believable valuations then they'd have shut themselves out from the Alladin treasures of unbelievable valuations.

There was simply no easy way for Paytm to have gotten to Rs 1.5 lakh crore m-cap, if it had IPOed at Rs 20,000 cr market capitalisation. At least, not quickly enough. Nykaa would never have gotten to its current Rs 75,000 crore m-cap if it had IPOed at a fair value Rs 10,000 crore market capitalisation. It takes years for a new listing to go up to 7-10x, and most importantly, it requires sustained business performance. Doing the opposite way is a well-lubricated ace in the hole.

Sisyphus knew this. Rolling a boulder uphill is impossible. (Fun fact. Read about Sisyphus. He was a crook!) But more importantly, it is silly, outdated, inconvenient and completely unnecessary.

Take a chopper to Everest. Roll the boulder downhill, from Everest's 28,000 feet. When it metaphorically reaches Jungfrau, at 13,000 feet, it will stop because most large stock market boulders don't roll all the way down to the sea level.

Back to LensKart, then. What they are doing is starring in a gripping new season of ‘Anchoring Bias’. Get the IPO done, even if it means striking Faustian bargains. The stock may tank, (No pun on Shark Tank here) but it can't and won't tank to Rs 3000 crore.

At Rs 10,000-20,000 crore m-cap for it, another conversation at another paan dukaan will take place. "Surely, it can't go lower..." It's all about optical bargains (pun un-intended again though it should have been intended, it's that good), you see.

(Shankar Sharma writes as Le Grand Fromage. He is a veteran investor and Founder of Gquant FinXRay, an AI firm.)

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