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Is India's Start-up Boom Ending?

Nov 24, 2015

In this issue:
» Government's sectoral intervention to help stressed banking sector?
» Reduction in tax rates to benefit all sectors?
» ...and more!
00:00
Devanshu Sampat, Research analyst

'Did you hear about the TinyOwl fiasco?' asked my friend when we met at our local coffee shop this past Sunday. Our discussion had turned towards start-ups.

'Yes', I replied. I had read all about it. The food delivery start-up TinyOwl fired about 300 employees earlier this month. And all hell broke loose! The staff refused to leave the building. They held the senior management hostage for two days. The police were called in to calm things down.

During our discussion, it occurred to me that I should connect the dots a little for the benefit of the 5 Minute WrapUp readers. I believe this is just the tip of the iceberg. Deeper problems lie beneath the surface.

First things first. The start-up boom in India is a wonderful development both socially and economically. Young people have learned the world of business firsthand. Instead of looking for jobs, they have created them.

A successful start-up has unlimited potential. In terms of wealth creation, no asset can deliver better returns than one you create yourself from scratch. It is little wonder that India's youth, disillusioned with the job opportunities available to them, have taken to entrepreneurship in a big way.

Now let's look at the other side of the coin. Starting a company is high-risk endeavour. The chances of failure are far higher than success. If a young person quits his well paying job, starts his own company, and does not succeed, then the world will not look quite so bright to him. Indian society is not very accepting of failure.

It's important to keep in mind that India does not have a social security net. Going back to a job is also not easy. Indian software firms do not welcome back with open arms those who left to strike out on their own and did not succeed.

No matter what the newspapers might say, Mumbai, Bengaluru, Delhi, Noida, Pune, Hyderabad, or Chennai are not comparable to Silicon Valley. And probably never will be. The favourable ecosystem for start-ups found on the US west coast, does not exist anywhere in India.

None of these issues mattered when funds were easy to come by. Fuelled by zero interest rates in the developed world, foreign money has flowed to India in search for good returns. Naturally, as start-ups offer the biggest upside potential, they got tons of money. We see this reflected in the insane valuations many of them command.

Make no mistake; the flow of easy money is what has kept the boom going for so long. Unfortunately, young Indian entrepreneurs are now learning what Silicon Valley has known ever since the dotcom bubble burst. When the money stops flowing in, your business had better be profitable. If not, it will disappear very soon.

This is something that makes people uncomfortable. But there's no escaping reality. This is capitalism at work. Venture capitalists (VCs) who funded the start-ups are very demanding. If targets are not achieved, they will look to exit. This pressure forced TinyOwl to lay off so many employees. But it's not an isolated case. There are many others; Zomato and Housing.com are cases in point.

The start-up valuation bubble has peaked and has now begun to deflate. If the US Fed begins to hike interest rates next month, this process will accelerate. Many start-ups will fall by the wayside by the time the dust has settled. It won't be pretty. There will be many more tears and much more anger than what we have read about thus far.

But hopefully, from the ashes will emerge the next generation of start-ups who would have learned the lessons needed for a better chance of success.

What do you think? Is India's start-up bubble about to burst? Let us know your comments or share your views in the Equitymaster Club.


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02:25 Chart of the day

That the public sector banks' (PSBs) asset quality is very poor is a well-known fact. Amongst the key sectors that are causing trouble for banks include infrastructure (specifically power generation), and iron & steel. Today's chart of the day indicates the share of the sectors that are causing trouble to the banking system.

Which Sectors are a Menace to Indian Banks?

As per the Hindu Business Line, five sectors - mining, iron and steel, textiles, infrastructure and aviation - constitute about a fourth of the total advances of scheduled banks. However, when it comes to stressed advances, these sectors have a share of a little more than half. Infrastructure and iron & steel in itself have a share of about 80% of the total stressed loans.

Ratings agency ICRA is of the view that the NPA situation expected to improve in the short to medium term; the agency lowered its NPA projections to 5% to 5.5% from 5.3% to 5.9% earlier for the ongoing fiscal. Key reasons for lowering the same include the trend in refinancing/ restructuring as well as the slower pace of fresh NPAs in the first half of the current fiscal. On the other hand, the Finance Minister recently stated that the government is considering sectoral interventions to stressed assets from sectors such as steel and aluminum. What this means is that the government will address the key problems in each sector to help improve the asset quality. One key step that the ministry has seemingly taken is providing the banks' senior personnel more authority and autonomy. Giving more teeth to the bankers to tackle willful defaulters and take control of the companies will also help arrest the problem of bad loans to some extent.

03.45

In this year's budget, the Finance Minister announced a gradual decline in corporate tax rates to 25% from current levels of 30%. At the same time, the corporate tax exemptions would be phased out as well. The government recently released its draft roadmap for phasing out corporate tax exemptions in the next two years. As reported by the Mint, this move is likely to impact investments in SEZs, research and development as well as impact the sectors which have a saving due to tax sops and incentives.

An interesting piece of information reported by the business daily is that the effective tax rates of the large companies (with profit before tax (PBT) of Rs 5 bn plus) is about 21% while that of companies with PBT of less than Rs 10 m is 26%. What this indicates is that the tax planning and saving is way more widespread amongst the larger firms, and that the change in the structure is likely to impact only the larger firms.

The chart below gives an indication of some of the sectors' effective tax rates.

Will Lower Tax Rates Hamper These Sectors?

This becomes an important matter to look at we believe, as companies saving on tax are likely to see their profitability levels go hay wire going forward. Investors would do well do keep this in mind when trying to gauge and study historical data points of businesses that they would be interested to invest in. It would make sense for them to make adjustments to historical numbers to get an idea of how the dynamics could change going forward.

04.45

Indian markets were trading flat with the BSE-Sensex trading up by about 19 points, at the time of writing. Stocks from the mid and smallcap were in demand today with the BSE-Mid cap and BSE-Small cap indices trading up by 0.4% and 0.5% respectively. While oil & gas space stocks were in favour, those from the capital goods and auto spaces were least preferred.

04.55 Today's investment mantra

"The best thing that happens to us is when a great company gets into temporary trouble... We want to buy them when they're on the operating table" - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Devanshu Sampat (Research Analyst).

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4 Responses to "Is India's Start-up Boom Ending?"

Prashanth R

Dec 19, 2015

Good in-depth insight. Well described. Yes its imperative to take a step at a time ,youngsters armed with a college education should learn business set ups before they venture on their own .Patience is the key and greed to be successful in no time is the attribute of immaturity,overconfidence and being over ambitious. Chew only what you can swallow is the take from such stories.

Like 

DM Padher

Nov 27, 2015

Sir Ji,
The liked the words - From the ashes will emerge the next generation of start-ups who would have learned the lessons needed for a better chance of success.
I am sure this will happen.

Regards,

DM Padher

Like 

Arun

Nov 24, 2015

Thanks for the good observation.
What was running in my mind and what Mr.Mohandas Pai (90% of startups will fail) concurred with yours.
I still feel our colleges (including IIT/IIM) have not raised their standards to a very good/high level to teach entrepreneurship and also how to plan successfully and face eventuality when crisis arises.
The old adage of going step by step rising is one thing the younger generation should not forget

Like 

Yogish Kaushik

Nov 24, 2015

Well articulated point of view. While it is true that capital inflow may change with the increase in rates by the US Fed, investors are usually focused on the medium to long term. When ever there is a throttling of funds, the better managed startups and those that have better ideas will survive. What gets eliminated is where the wheat gets separated from the chaff. Although painful for the incumbents, it is good for the ecosystem. The remaining /new funds will go to the more deserving, which is what should happen in a market driven economy, thereby strengthening the firms which are better.

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