The fundamental investment premise of Internet businesses is that they will use technology and network effects to create something that will provide high growth and be profitable over a long period of time. When listing rules were eased last year to enable Indian Internet businesses to offer their shares to the public, investors bought into the complex in a big way. In the midst of a weak market, less than a year after the first listing, those Internet stocks are out of demand. And that base, under investigation.
In a stock market that has moved in the 20% band over the past year, listed Internet businesses are seeing a significantly higher depreciation in value during this period. All five major internet businesses—Zomato, Paytm, Nykaa, PolicyBazaar and CarTrade—are down between 35% and 68% from their listing-day highs. And apart from Nykaa, the other four are also trading below their issue price.
Looking ahead raises a fundamental question: How are those businesses progressing on that basis of growth and profitability? In the long run, this will determine their ability to recover and rebuild shareholder value. Internet business is expected to grow, doubling revenue within two to three years. Doubling revenue in two years requires quarter-over-quarter growth of about 9%. Doubling in three years would result in a growth rate of 6%.
Since their public listing, these Internet businesses have announced two to three quarters of financial results. The growth picture is uneven, with quarters of high growth alternating with moderate growth. This is true for CarTrade, Paytm and Zomato, each of which is facing growth constraints in their primary business.
beyond the core
The pain of such growth is forcing these companies to look beyond their core business. Paytm is eyeing a huge financial services presence: it has expanded personal loans and is preparing for general insurance. Zomato has made substantial investments in Accelerated Commerce with $225 million in Blinkit (previously, Grofers), Shiprocket and Magicpin in 2021. 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 the one resource they will never lack. Most of such businesses had abundant private capital. Public issues have added to their reserves, and will help them remain in expansion mode.
For example, in the last three years, Paytm has averaged the net cash from operations of negative 1,775 crores. It has to be covered by capital. At current usage levels, Paytm has around six years of capital, Zomato has around 11 years.
wrong legs
At some point, these new investments will have to be paid back. These internet businesses also have to eventually move towards profitability. At the moment, except Nykaa, others are not profitable at the net level. They are reducing instead of building up their capital reserves due to strong, mature and profitable business tendencies. This makes them difficult to evaluate. Furthermore, on the risk-return matrix, Internet businesses are a high-risk, high-return proposition.
In this current cycle, retail investors have found themselves on the receiving end of these nuances. Retail investors consolidated stake in Paytm, Zomato and EaseMyTrip rose amid sharp fall in share prices. Given the volatility in share prices, this means that retail investors are buying higher, and have seen a decline in value. In Nykaa and PolicyBazaar, their share has declined, though only marginally. CarTrade also declined, but it was also the Internet business where they held the highest stake.
IPO Reforms
Part of the allure of Internet businesses going public was the opportunity to invest in businesses for the future. Investors knew these businesses as the first users. But the case of use and investment is different. This divergence is currently trending globally, offering a cautionary tale for retail investors.
An example is an exchange-traded fund (ETF) in the US called the Renaissance IPO ETF, which provides mutual fund-like exposure to “the most important new public US listed companies”. Over the past three years, it has expanded its portfolio Internet businesses such as Pinterest, Zoom, Slack, DoorDash, Robinhood, Lyft, Bumble, and Asana. In the 12 months following the pandemic, this ETF appreciated 2.5x. Over the past six months, it is down 55% in high volumes, pointing to impending investors catching the wrong end of the investment cycle. Internet business is a double-edged sword.
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