How 2 Chinese Investors Made More than US$1 bn in Paytm

Ghazal Alagh is a famous Shark Tank India celebrity and owner of Mamaearth.

She recently said that some companies she had invested in, had terrible products.

That's not surprising. While finalising deals, the sharks have very little knowledge about the venture, the entrepreneurs, and the products. Along with some data, it's the kind of pitch that influences the deal and the valuations.

It's amazing the kind of valuation entrepreneurs ask for on the show. In some cases, they come up with a multiple of the valuation from the previous round.

Equally amusing is the bargaining that happens on the show. It could put to shame the bargaining that happens in bhaazi bajaars.

Shark Tank India is wonderful show. It makes us aware of the business world.

And if you think about it, it's not much different from what happens during IPOs. This is especially the case for loss making new age companies.

The narrative drives the valuations along with the craze for the IPO. It's mostly at a steep premium to the valuation in prior funding rounds.

The business model and even the products and services are untested. The public doesn't know much about the management.

It's only after investing money and seeing it getting burnt, the public realises that narrative can drive only offer price. Ultimately, the valuations will align with the fundamentals.

This reality is finally dawning on the investing public in case of new age IPOs in India. The hype is cooling off. The stocks have seen sharp corrections.

And the biggest of these disappointments has been Paytm.

With a muted listing and subsequent fall in Paytm stock price, investors are wary of anything that gets sold in the name of technology or a new age business model.

Even the regulator is waking up to the need of having some justification for the offer price, in loss making companies.

As per a recent consultation paper, such companies planning to get listed may have to make disclosures related to valuations in past transactions/fundraising by issuer company. This along with financials and key performance indicators shared with any pre-IPO investors the three years prior to the IPO.

If implemented, this would be a great move. It will strengthen your chance to make VC like gains from disruptive, even loss making new age companies.

Consider Paytm. At the time of IPO, the firm was valued at US$20 bn. By the way, it's worth mentioning here that Mr Vijay Shekhar Sharma considered it 'cheap'. I wonder what he feels now, having lost over a crore every single day since listing?

But did you know that despite its disastrous performance, China's Alibaba and its affiliate, Ant Financial, made nearly US$1 bn in the IPO?

That's right. They did this by selling a 6% stake.

A bit of digging into fund raising history reveals interesting media reports. In multiple rounds the same year, they had valued firm at US$800 m and just a few months later, at US$3.4 bn.

Paytm has never made profits. Yet, even after the crash, it's trading at more than double of that valuation.

So how did these two Chinese investors end up making so much money?

Or if I have to broaden the scope of this discussion, what's the secret of VCs? How do they assess the potential of loss making businesses and end up making huge wealth.

How VCs Analyse Investments

Last week, I shared the reason you need a different lens to assess platform companies. They're the representative model of new age businesses.

I wrote about how to get a sense if a platform company could create huge long term wealth for investors if it's loss making.

It all starts with Total Addressable Market (TAM).It's a critical starting point to understand the upside potential of any business model.

I promised to share more with you on this. So let's move on to some user based metrics.

Remember the distinguishing feature of platform is the network effect.

Once a platform achieves a critical mass of users or transactions, the growth feeds itself...and profits grow exponentially

VCs enter the company prior to that inflection point. At that time, there is uncertainty about the business. Thus, valuations are relatively cheaper. This is what Alibaba and Ant Financial did when they picked up a stake in Paytm.

At this stage, tracking the trend of active users and other user related data points offers a lot more insight than the profit and loss statement. The idea is to not get fixated on absolute numbers but to look for progress being made in the right direction.

It also helps to know if the platform is popular only among existing users or if it's able to attract new users as well. Growth in new users is another critical parameter to track.

The growth in new users is valued more if a platform is able to retain them as well. Platform businesses track this through the retention ratio. It's a measure of customer loyalty.

It can be calculated as follows...

Retention Ratio = (Customers at the Beginning of the Year - Customers at the end of the Year) / Customers at the Beginning of the Year

Another metric used to assess loyalty is the churn ratio. A higher retention ratio and a low churn ratio is what you should be looking for in a platform business.

Apart from loyalty, predictability of revenues from users, growth in revenue per user and customer acquisition cost (CAC) are some of the critical parameters to look at.

The CAC can be represented as sales and marketing costs divided by total number of acquired customers for a period. This is where most of the burn happens, until a critical mass is achieved.

This may flow through financials as losses but should be seen as an investment. The value of this investment depends on what value can be extracted by the platform over the lifetime of the user.

And this brings me to the next platform terminology - LTV or lifetime value.

LTV is the money a platform generates from a user till the time he stops using the platform or until the platform loses him to competition.

For example, in the case of a food tech business this will be average order value x number of orders x retention period.

LTV depends on user experience and company's ability to use data science to understand customer behaviour and optimise it.

Then there's unit economics. This is measured per customer as the LTV of a customer divided by the CAC.

It can also be used to measure a business model's revenues and costs in relation to a single item sold i.e. a unit.

Take Ola for example. It could compare revenue and costs per ride offered. For Zomato, unit economics is defined per order.

Another interesting thing to look at is the ratio of fixed costs over variable costs.

A very high ratio means break will take a long time but once the business scales up, the growth could be exponential and profitable. A high ratio also creates entry barriers and some early mover advantages.

For well-established conventional businesses, capital allocation is critical to judge management quality. And this is equally critical in platform businesses as well.

You see, most early stage platforms lose money. Some are good losers and others while others lose it the bad way. Money could be burnt to acquire new users and to retain them.

Between two platforms, all else being equal, choose the one that spends on acquiring customers versus the one that spends on retaining existing users.

When you compare platforms here's the most important thing to keep in mind.

Not all platforms are equal. A transaction platform (such as Ola/Uber) will be different from a subscription platform (such as Netflix or Matrimony). Both will be different from an advertising platform such as YouTube.

I recommend this video that I recorded a few days ago for more...

Most of these metrics are quantitative in nature.

Numbers help in getting a sense of the opportunity. But they can only take you so far. And it's critical you do not miss the bigger picture. This is not just in terms of opportunity size, but potential risks as well.

Most will survive only if they be the biggest or operate in a duopoly. Apart from competition, you should be mindful of regulatory risks as well. This was a big reason for the huge value destruction in Chinese tech platforms.

I hope this editorial has given you a good head start to assess the potential of platform businesses.

If you're interested to know more about the best Indian stocks in the tech and disruption space, I invite you to join me and my colleague, Tanushree Banerjee on Monday, 28 February for a very online special summit.

We will share with you the details of making VC-like returns in the stock market.

Warm regards,


Richa Agarwal
Editor and Research Analyst, Hidden Treasure

PS: If you would like to make VC-like returns in the stock market, you must attend our free online event on Monday. Book your free seat here.