This is why you should stay away from stocks like Nykaa

Nov 18, 2021

To fundamental analysts like me, the equity markets are becoming a strange place to work in.

The market's obsession for loss making companies is a puzzle which always eludes me. The love for these companies is based purely on a goldilocks scenario playing out.

After all, how else would you justify a FY41 valuation.

As a Chartered Accountant and a fundamental analyst, I have learnt to value companies based on their intrinsic value and the concept of margin of safety. I find it very difficult to model new age tech companies.

The moto has become: Higher the loss, higher the optimism about the prospects of the company.

Last week, when food aggregator Zomato reported its second quarter results, the headlines read 'Zomato loss widens to Rs 4.3 bn as delivery costs go up'.

Increased loss in a normal world would mean bad news, but Zomato's stock was up by 5% the next day.

The stock market can't seem to get over the VC mentality it seems.

Every few years, the markets are obsessed with an acronym, thereby letting it build stories and narratives around them.

During the early part of the decade, the acronym was 'solar' and 'renewables'. The stock market was obsessed with companies which had anything to do with renewables.

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We all know how that ended.

The acronym now has changed to 'Platform' in the tech space. The pre-requisite is that the word 'Platform' should be somehow linked to the company.

Now I do believe many of the companies in technology and new age ecommerce business have solid business models. But what scares me is the euphoria and the valuations around them.

Seeing the meteoric rise in the stock prices of these ecommerce and platform companies in an extremely short span of time, I am reminded of what my father taught me as a kid.

'In life, what goes up extremely fast, will come down even faster'.

The law of reverting to the mean somehow always works in the stock market.

When I look at how fast the stock prices of these platform companies go up on listing day and the euphoria around them, it gives me a 'too good to be true' feeling.

Let us take an example of the most talked about the tech platforms like Zomato, Nykaa, Car trade, and PB Fintech (Policy Bazaar). All hit the secondary market recently.

A quick wrap of these businesses

Every platform company has a different business model. This is in terms of customer base, ticket size, penetration, etc. So it's naive to paint the all platform companies with the same brush.

Some business models are strong. Others have flaws.

Some companies might turn profitable soon. Others might perish.

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The business models of Nykaa and PB Fintech are solid and scalable.

My focus in this piece is on the valuations and the uncertainty around it, not the business model per se.

How did we get here? - Greater Fool theory

The investments by private equity players kept funding losses during the initial phase.

Now it's perfectly normal for companies to have losses during their initial years of operations. But I fail to understand the fact that every time a loss making start up gets an additional round of funding, the valuations keep on rising.

This is exactly 'The Greater Fool Theory' where private equity players eventually make money because there will be 'someone' who will buy from them at a higher price.

In stock market terms, that 'someone' is the retail investor and the exit route is generally during the IPO.

Just look at the timeline of the Zomato IPO.

4 months before the IPO, Zomato was valued at US$5.4 bn (15 times EV/Sales of FY20).

The IPO Valuation of Zomato was US$9 bn (29 times EV/Sales FY21).

That is 75% jump in valuations in just 4 months

What changed in 4 months? Nothing.

Now let us look at Sapphire Foods IPO. The chain operates Pizza Hut, KFC, and Taco Bell in India.

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Here is the chronology of events...

March 2021 - Rights issue to promoter at Rs 187 per share.

August 2021 - 9.2 m shares issued to promoters at Rs 505 per share.

November 2021 - IPO is pure Offer for Sale (no proceeds went to the company). Promoters are selling 6.5 m shares at Rs 1,180.

That is 9 times increase in valuation of Sapphire Foods in just 9 months.

Before subscribing to the IPO, the question to be asked was...

Why are the promoters partly exiting their holdings if they were so confident of future growth?

This is exactly the greater fool theory playing out. The smart money i.e. the promoters and PE funds are exiting after making 10-20 times returns in a few years.

Food for Thought

We have come across many reports valuing these new age tech companies 30 years down the line and assigning a fair price based on those assumptions.

Let me give you an example of what happened to Infosys during 1999-2000.

Infosys was the leader in the software sector and a favorite of investors in 1999. It was growing its revenues at 100% for quite some time.

The stock price shot up from Rs 2,000 in January 1999 to around Rs 24,000 in March 2000. However, by September 2000, the stock was down to Rs 7,000.

Nothing had gone drastically wrong with the company since March 2000 when the stock was at its peak.

It's just that the valuation of the stock was unsustainable.

Infosys at its peak price of Rs 24,000 in early 2000 had a market cap of Rs 850 bn. The market justified it because the company was growing at 100% every year.

In financial year FY20, Infosys reported a revenue of Rs 8.8 bn.

If revenues grow at even 50-55% CAGR over the next 10 years, almost half the 1999 growth rate, Infosys will report revenues of Rs 704 bn.

Infosys was valued at a market cap to sales multiple of 100 times in 1999. If we take the same multiple to value Infosys today, Infosys would be valued at US$1.6 tn.

The GDP of the USA was US$9.2 tn in 2000.

So, the valuations were implying Infosys was 17% of GDP of the largest country in the world.

That can't be true.

Infosys is among the best IT companies in India and the world. The institution which Mr. NR Murthy has built has changed the face of Indian IT sector.

However, if you would have bought the stock Infosys at the astronomical valuations in 2000, you would have lost money in the medium term and made very average returns on a long term.

Besides, Infosys was a profit-making company. The new-age tech startups are loss making. They have been programmed to burn cash doled out by private equity funds.

I started with how strange the market is. Let me leave you with an example...

Tata Steel's net profit was Rs 125,000 m for the last quarter. On the other hand, Nykaa's net profit was Rs 120 m for the last quarter.

The marketcap of Tata Steel is Rs 1.5 tn. The marketcap of Nykaa is Rs 1 tn.

Now you know why I won't be investing in Nykaa. What about you?

Warm regards,

Aditya Vora
Aditya Vora
Research Analyst, Hidden Treasure

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5 Responses to "This is why you should stay away from stocks like Nykaa"


Nov 19, 2021

Nice article Aditya. Clearly the great and greater fools are at play.

Also, the narrative around new-age businesses that cannot be valued through the prism of traditional business models rings hollow. At the end of the day, you exist for a profit, no matter what you do. The VCs and smart early-stage investors found a golden opportunity to cash out and let retail investors realize their folly a few years from now.

The Paytm IPO tanking is their first wakeup call. But again the naysayers will jump in saying that the business models are different and market share is paramount. When folks open their eyes with businesses reverting to mean, there will many stocks going deep into the red, the fancy business models notwithstanding. Then all hell will break lose and people will start to blame the govt, RBI, and SEBI, for no fault of theirs. :-)


Like (1)


Nov 18, 2021

Great informative analysis by Mr Vora. Example of Infosys of Fy00-01 was excellent to understand the market's frenzy, from time to time. This time frenzy is for startup, fintechs and tech based businesses. Good Research and good foresight. I truly appreciate Equitymaster in bringing fore so hidden insights about the actual thing and the froth of hysteria of the market. Great team of analysts of Equitymaster.

Like (1)

Harit Shah

Nov 18, 2021

There is an error in the write up. It says revenue of Infosys in FY20 was Rs 8.8 bn. I guess it should be in FY2000 - forgot to add 2 zeroes! Secondly, regards new age companies, yes, if we view these firms through traditional valuation metrics, then they may seem puzzling to fundamental analysts like us. However, we should note that these new businesses are operating in a new high growth industry, where gaining market share is paramount. Thus, such cos typically have high sales and marketing spends, etc, due to which they are reporting losses.

We should note that it has been a while since these cos have traded at so called high multiples, it is not as if this has been a one quarter phenomenon. New age tech cos are not a bubble, the industry (be it the market for Zomato, Policybazaar or Nykaa) is very much real and growing, and leaders will command multiples that may seem difficult to justify if viewed through traditional metrics and valuation lens. We should not be arrogant and make statements like "Tata Steel profit is XYZ and Nykaa profit is ABC and yet market cap is DEF". These are totally unrelated and different businesses, and cannot be used as a yardstick for deciding whether or not to invest in Nykaa.

A totally new approach and mindset is needed to understand how to value such new ago cos, be it Nykaa or Zomato. We cannot just say they are making losses and thus, they should not get XYZ market cap. We need to show some humility and accept that perhaps our approach is incorrect.



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Nov 18, 2021

The Greator Fool Theory of recently IPOs very well explained. Its warning signal for investor for applying over valued IPO.

Like (1)

Shamzal Parab

Nov 18, 2021

Dear Mr Vora,

I appreciate your thorough analysis of IPOs and the true valuation of those new companies. It is indeed very well written article. However, one thing I fail to understand that why this article after IPOs were launched and not before. I am also a CA and I could easily umderstand the over valuation of many IPOs but not everyone can read through. Also, many IPOs though were over valued still were listed at heavy premium. That listed pricing lead to more grid and high excectation amoung the Investors. Also, why Stock Exchange can't put higher limit on offer price protecting the interest of the investors based on the current financial state of the company?
Please write more such articles.
Best regards,

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