»Profit Hunter by Equitymaster

On This Day - 15 JULY 2021
Zomato: Worth a Bite?

13,214% return.

That's the number which flashes on your screen when you do a simple google search on 'Infosys share performance since listing'.

However the relevant question for me is this...

How many people could abandon their traditional thought process of investing in old economy stocks and bet on a group of young friends who quit their jobs to start a software company?

Words like 'Software', 'Outsourcing' was alien language to a majority of the baniya's on Dalal Street who were obsessed with old economy companies like cement manufacturers and textile companies in the 90s.

The traditional old economy valuation methods were incapable of valuing a company in a new industry.

To add to this, the fear in the Indian stock market during 1993 was at its peak as Bombay was hit with multiple bomb blasts.

The result?

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Infosys IPO was undersubscribed. Morgan Stanley had to bail them out by picking a 13% stake at Rs 95/share. It's only in hindsight that words like multibagger and wealth creator were associated with Infosys.

Why am I telling you this today?

This story is so close to my heart because Infosys changed my family's fortunes.

Back those days, my father, a practising Chartered Accountant, was always inclined to make a career in the stock market. However, the investing environment during the early part of 1990's was uncertain.

Today, there is massive data and research available to everyone. It wasn't the case then.

He saw an opportunity.

Being a Chartered Accountant, reading balance sheets was his forte. However, he had to tweak his skills from a post mortem analysis required in auditing, to a diagnosis based approach.

Just like many people, he overlooked Infosys as a 'fad' or a passing trend. This led to him building an old economy portfolio.

In fact, till 1994, the narrative was that Infosys was too expensive. After all, it traded at PE multiple of 100.

However, as fate would have it, a casual interaction with a friend who resided in Bangalore and knew the management, changed his views completely. The departure from typical valuation metrics to industry opportunity was the deciding factor.

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After months of reading about the sector and the companies in it, he finally developed the conviction to invest. He was convinced in Indian Information Technology and Infosys as a company.

In stock market, conviction is one thing but taking a sizeable bet on a conviction is vital.

He sold his entire portfolio of old economy stocks and invested in IT stocks. These stocks accounted for 80% of his portfolio during 1995-2000.

As they say, the rest is history.

These days, a lot is being spoken about valuing the so call 'new generation business' which have been in existence for barely a decade.

The street is divided on what valuation methods to assign to them. They have carved out an industry in itself - Platform Business.

Take Zomato for example. Its IPO is currently open for subscription.

The management of Zomato acknowledges the fact that discounts are an important part of the business strategy and is likely to continue.

The naysayers have their arguments ready. How can a loss-making business with no time line for profit, be valued?

Also isn't it magical that Zomato's valuations have gone up 75% in 4 months from US$5.2 bn to US$9 bn i.e. the IPO valuation.

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Let's look at the food delivery space...

This sector has been in existence for less than a decade. The opportunity here is massive but unknown. Covid has accelerated the industry's growth by at least 2-3 years.

With smart phones and internet penetration becoming 'necessities' the potential for food delivery business like Zomato and Swiggy to penetrate to rural India is massive.

Their ability to raise money so easily is a luxury which traditional business don't have.

Also, being a tech platform business, the scope of acquiring unrelated business and scaling them up presents additional opportunities.

So does this resemble the Infosys story?

In terms of the opportunity you bet it does.

IT sector back then was a completely new animal for investors. The opportunity was massive but unknown.

Very few people could have predicted the dominance of Indian IT companies in the global landscape.

The cost advantage which IT companies leveraged to grow can be compared to the ease of financing from VCs and private placements which these platform companies are blessed with.

So what do I think?

While the size of the opportunity for tech platform resembles the IT revolution, the most important element is missing - Profits.

Majority of IT companies were growing at a rapid pace but they had profitable growth.

Tech platforms however are loss making.

The loss is being funded by venture capitalists and private equity players. The hope is, going forward, they will go the Amazon way.

It took Amazon 10 years to generate its first profit.

Amazon kept growing in size both horizontally and vertically. It entered unrelated business and dominated them.

The challenge for Zomato and other new generation businesses is to do the same.

Warm regards,

Aditya Vora
Aditya Vora
Financial Writer

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