- By Tanushree Banerjee
So should you be readying funds to apply to every startup IPO that seeks listing on the exchanges? More importantly, can you evaluate these IPOs like any other?
Google or Facebook in the making?
The easiest way to evaluate if a business idea is feasible and can create value for shareholders is to look at similar entities listed elsewhere globally. Now, here you would be making a cardinal mistake if you expect the ecommerce ventures to have Google or Facebook like success in the stock markets. Not just is their business model very different from ecommerce entities. But both have income and profitability patterns that are starkly different from ecommerce ventures. Instead a company like Amazon would be a comparable benchmark. And Amazon itself, despite being the largest and one of the most successful ecommerce companies globally, has created little wealth for shareholders so long. With thin profit margins the company hardly enjoys the kind of investing appetite that Google and Facebook do.
Scarcity premium - How much is too much to pay?
Newly listed ventures with unique business models often attract what is called 'scarcity premium' in valuations. This is because investors hoping to cash in on the exponential growth in the one-of- its -kind business get greedy. And in the absence of competition do not find sufficient benchmarks for the valuation.
So it was not without reason that companies like Facebook and Twitter, amongst the first social media companies to get listed, saw valuations soar to unreasonable levels during their IPO itself.
The first pure play ecommerce firms to get listed in India could also see a similar rush of investor appetite. Ones that have had private equity (PE) firms pay astronomical valuations will have all the more reason to justify the premium. However, as a retail investor, you do not have the kind of risk appetite that PE firms do. Hence there is a need to rationalize the valuations that you would want to pay.
What is in it for you - the shareholder?
The way to figure out how much to pay for a stock is to take a look at what is in it for you, the shareholder. Not just new companies but even ones that have been around for decades, like ones in aviation sector, sometime fail to create shareholder wealth. The billion dollars in sales is therefore not a good yardstick for shareholder returns. Instead the profit margins and return ratios (like return on capital employed) will give a better sense of what is in it for you. Companies like Amazon and even Flipkart back home have yet to prove their investment worthiness with a healthy bottomline.
When to invest?
The initial public offerings of most ecommerce firms are likely to be the first exit route for the PE firms that have so far supplied them billions in funding. Therefore notwithstanding their fundamental strength, the ecommerce IPOs are likely to be priced at significant premium to sweeten the deal for PE investors. Hence for you, the retail investor, the IPOs may be a good starting point to start tracking the performance of ecommerce companies. But do resist the temptation to invest in over hyped IPOs.
Tanushree Banerjee (Research Analyst) is the Co-Head of Research at Equitymaster. She is also the Managing Editor of the recommendation services, StockSelect and The India Letter. To write to Tanushree, please click here.