How to value new-age IPOs

The new-age IPO party seems to have ended. The ₹18,000-crore Paytm IPO—which beat Coal India to become India’s largest so far—turned out to be a party pooper. The stock fell about 37% in two days against its IPO price. Its debacle shows how sentiment-driven investing does not work. It has to be backed by solid research. The new-age digital IPOs will keep coming. The ones by Mobikwik, Oyo, and Delhivery are in the pipeline. As loss-making new-age companies enter Dalal Street, conventional ways of evaluating IPOs will not work. You have to rely on different metrics.

“In the absence of profits or positive cashflows, new valuation parameters are being discovered and bandied about. In each business, different valuation parameters may be relevant or applicable such as expected growth in cash flow or operating profit,” says Deepak Jasani, head of retail research at HDFC Securities.

We suggest you some:

1) Business model

The first and the foremost is the business model. You must understand exactly what the start-up is doing and if it is relevant to make a disruption in the segment it operates. You should also see if the business model will stay relevant in the years to come. Gopal Agrawal, MD & head, investment banking, Edelweiss Financial Services highlights three parameters in this context –

i) Competitive positioning, a unique business model with the company being either the segment leader or among the top three

ii) Past track record, current size and scale, future business scalability and potential growth

iii) Path to profitability

2) Capex/opex

Although new-age companies typically have an asset-light model, their operating expenditure is quite high, due to their need for spending money on technology upgradation, research and development, hiring employees and ad-spends. Call it capex or opex, the viable start-ups will be the ones that are reducing their capital or operating expenditure.

3) Financials

Since most digital IPOs are loss-making, you cannot run conventional valuation or profitability metrics. There are other financial checks that you can run. You should see if the company has been narrowing its losses over the years; if it is generating operating profits if not net profits, and if its revenues have been growing.

“New-age IPOs have good revenue growth but still incur losses due to their substantial spending towards advertisement, promotions and employees, etc. These companies cannot be valued by traditional methods and investors should look with a different perspective like understanding the sector, strategy and future growth prospects,” says Ajit Mishra, VP, research, Religare Broking Ltd.

“Also, they should analyse market share (gaining or losing) and check their financial trend for cues on narrowing losses as that would encourage investment,” he adds.

4) Type of the IPO

Investors should see if the fresh IPO coming in is an offer for sale (OFS) or is generating fresh equity. Fresh issuance is better than OFS, as in latter, the existing investors sell their shares. “The split of the issue, that is, fresh issue and OFS could also impact the future price behaviour. In case a very large proportion of the issue size consists of OFS, then it may not be a good sign,” says Jasani of HDFC Securities

5) Equity dilution

One also needs to see how much equity dilution has happened in the IPO in question. The start-ups getting listed in the stock market should be self-sustaining, instead of raising fresh capital repeatedly. Thus, the founders diluting their equity stakes excessively may not be a good sign.

“Dilution reduces the value of an individual investment. However, if new shares are issued to boost revenue, capacity addition and debt repayment, etc., it is positive,” says Mishra of Religare Broking.

Thus, the higher dilution will not necessarily be a negative sign. Check the reason for equity dilution before you take a call on avoiding or subscribing to the issue.

Agrawal of Edelweiss Financial Services advises checking the names of existing investors who are exiting in the IPO. “How much and in what proportions the promoters and existing investors are diluting their holdings are some equally important factors to be considered.”

What lies ahead

Paytm’s lacklustre listing has triggered a reality check of the sort in the IPO market. The sell-off has affected stocks of recently listed start-ups such as Policybazaar, Zomato, and Nykaa. If a new-age IPO coming in is richly valued as Paytm was, investors would do well to give it a pass. Invest in it only if you have a conviction in its business model and future potential.

“Retail investors do not have the wherewithal to value the new age IPOs. Based on their limited knowledge and the relevance of the companies in their practical use, they can allocate small amounts in some of these IPOs and if their conviction about the medium-term prospects is not high, they may keep a stop loss in terms of absolute loss per IPO,” suggests Jasani.

He sees future IPOs to price themselves modestly. “IPO investors have been allotted shares at a much higher price than the last round of funding by PE/VC investors. So, IPO investors are taking much higher risks than the so-called aggressive investors (PE/VC). This movement in the post-listing price could result in future valuations by new-age companies being more modest. Though retail memory is short, the IPOs expected in the next few months will attempt to leave something on the table for investors."