The fundamental investment premise of internet businesses is that they will use technology and network effects to build something that will deliver high growth for a long period of time and be profitable. When listing rules were eased last year to enable Indian internet businesses to offer their shares to the public, investors bought into this premise in a big way. Less than a year since the first listing, amid a skittish market, those internet stocks are out of demand. And that premise, under scrutiny.
In a stock market that has moved in a 20% band in the past year, internet businesses that listed during this period are nursing significantly higher depreciation in value. All five prominent internet businesses—Zomato, Paytm, Nykaa, PolicyBazaar and CarTrade—are down between 35% and 68% from their listing-day highs. And Nykaa apart, the other four are also trading below their issue price.
Looking ahead raises a fundamental question: how are those businesses faring on that premise of growth and profitability? In the long run, that will determine their ability to claw back and rebuild shareholder value. The expectation of internet businesses on the ascent is doubling revenues within two to three years. Doubling revenues in two years calls for quarter-on-quarter growth of about 9%. Doubling in three years will take a growth rate of 6%.
Since their public listing, these internet businesses have declared two to three quarters of financial results. The growth picture is uneven, with quarters of high growth alternating with moderate growth. That’s true for CarTrade, Paytm and Zomato, each of which is facing limits to growth in its primary business.
Beyond the core
Such growth pangs are compelling these companies to look beyond their core business. Paytm is eyeing a bigger financial services presence: it has scaled up personal loans and is preparing for general insurance. Zomato has invested substantially in quick commerce, with $225 million in 2021 in Blinkit (previously, Grofers), Shiprocket and Magicpin. Such investments will delay profitability. It remains to be seen whether these new business lines can match their core businesses in performance.
In this transition, capital is one resource they won’t be short of. Most such businesses had abundant private capital. The public issues have added to their reserves, and will help them stay in expansion mode.
For example, in the last three years, Paytm has averaged net cash from operations of negative ₹1,775 crore. This has to be covered by capital. At current usage levels, Paytm has a capital runaway of about six years, Zomato of about 11 years.
At some point, these new investments have to pay back. These internet businesses also have to eventually move to profitability. At present, barring Nykaa, the others are not profitable at a net level. They are also depleting their capital reserves, rather than building them, as sturdy, mature and profitable businesses tend to do. That makes them difficult to evaluate. Further, on the risk-return matrix, internet businesses are a high-risk, high-return proposition.
In this current cycle, retail investors have found themselves at the receiving end of these nuances. Amid the sharp fall in share prices, the consolidated holding of retail investors has increased in Paytm, Zomato and Ease My Trip. Given the movement in share prices, this means retail investors have been buying at higher levels, and have seen value erosion. In Nykaa and PolicyBazaar, their holding has declined, though only marginally. It has also declined in CarTrade, but this was also the internet business where their holding was the highest.
Part of the attraction of internet businesses going public was the opportunity to invest in businesses for the future. Investors knew these businesses first as users. But usage and an investment case are different. That variance is currently playing out globally, offering a cautionary tale for retail investors.
One example is an exchange-traded fund (ETF) in the US called Renaissance IPO ETF, which offers a mutual fund-like exposure to the “most significant newly public US listed companies”. In the past three years, it has added to its portfolio internet businesses like Pinterest, Zoom, Slack, DoorDash, Robinhood, Lyft, Bumble and Asana. In 12 months after the pandemic broke, this ETF appreciated 2.5 times. In the past six months, it is down 55%, on high volumes, which points to incoming investors catching the wrong end of the investment cycle. Internet businesses remain a double-edged sword.
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