Over-valued unicorns in a distressed economy

News: India’s largest IPO (Paytm) made a disastrous stock market debut and ended its first trading day at a discount of 27% to the issue price. Questions are, hence, being raised on the valuation of the firm and the IPO.

Paytm, along with an educational technology start-up, are being viewed as one of the ‘shining beacons’ among a growing list of unicorns in India.

But the not so enthusiastic response towards the giant IPO casts doubts about the valuations of unicorns in India.

What are the reasons for the remarkable growth of Unicorns in India?

In recent years, the growth of unicorns in India is remarkable, covering diverse sectors. Digital payment in FinTech sector and educational sector has achieved unprecedented growth. The reasons are:

Market opportunity due to a growing smartphone user base: The country has around 640 million Internet users, of which 550 million are smartphone users. Rising Internet penetration and growth of digital payments are also crucial factors.

Impact of the Pandemic: it has been a blessing in disguise for EdTech firms. Many are forced to shift to e-education.

The expectation that startups have the ability to sustain an initial level of hyper growth: because start-ups with limited resources aim at technology disruption.

Why Paytm’s IPO didn’t go well?

Paytm that came out with the giant IPO was considered by many as a technology disruptor and game changer which created hype and overvaluation. However, it failed to sustain the hype because of the following reasons

Core business model is not unique: Paytm doesn’t do anything different from its competitors’. For example, it is losing market share as more and more people are opting for UPI-based payments to directly transfer money from their bank accounts, instead of wallets.

Funding losses: The structure of the group has an inherent weakness. There are 39 subsidiaries and over half of these put together contribute to a mere 5% of its revenues.

What is wrong with India’s overhyped unicorns?

Too many acquisitions: Many firms are doing multiple acquisitions. For eg: The Edtech startup (whose name is not mentioned in the article) acquired nine other firms in one year. Too many acquisitions with big ambitions to grow inorganically puts pressure on the balance sheet in the years to come, as some new acquisitions are likely to fail.

Overestimation of demand projections: Data by the Centre for Monitoring Indian Economy (CMIE) points that there are just about 23 million households which earn more than ₹5 lakh per year i.e., less than ₹42,000 a month, which is about 7% of all Indian families. If firms want to go beyond this 7% of households, they have to offer bigger discounts, burning more cash in the process.

Saturation point reached: The current state of Indian economy and employment situation are in a misery. Due to this, tech companies are already reaching the saturation point of their real customer-base i.e. consumers who can afford to consume without discounts.

Hence, India is witnessing new unicorns emerging every month, which are products of inflated valuations to tap more funds to burn more cash. These valuations are solely on the basis of future earnings, with virtually no profits to show in the present.

Source: This post is based on the article “Over-valued unicorns in a distressed economy” published in The Hindu on 24^th November 2021.