28/11/2019
Some of the World’s top investors don’t find it difficult to justify investing in loss-making businesses. Is it a fact that we are unable to figure out what really they can see? Or they are also betting on the probability?
This has been one of the trending discussion in the investment communities since last couple of years as India has seen some blockbuster investments and exits at a valuation that raised many eyebrows.
Recently Paytm raised $1 billion from new and existing investors, which lifted Paytm’s valuation to $16 billion, from the $15 billion it was valued at in August.
Till now the company’s revolutionary operations strategy and huge brand recall do not seem to have benefitted its balance sheet. Paytm has continued this unfortunate streak, widening its losses by 162% in the financial year 2019. According to a media report, Paytm’s consolidated net loss was INR 4,217 Cr for FY19, as compared to INR 1,604 Cr net loss in FY18.
In FY19, Flipkart India Private Limited, the wholesale entity of Walmart-backed homegrown e-commerce firm Flipkart, has widened its losses by 85.91 per cent at Rs 3,836 crore.
Before raising a question mark on this, we have to remember that each investor has its own strategy and they are better equipped than us to take more informed investment decision. Of course one can’t deny that even the best mind can hit the wrong button or even the best decision can go wrong with changing market dynamics.
To be precise, the ultimate goal of every investment is to realize its return on investment. And there are only two ways:
1. Take back from the internal resources of the business (buy back, dividend, leverage recapitalization)
2. Take back from external cash flow (trade sale/M&A, IPO, secondary buyout)
The first way is too distance to achieve if the company is burning more cash than the cash inflow.
And the second case is only possible up to the time the valuation is stretched higher than the original investment, and the business is able to attract a new financial/strategic investors at that valuation.
Perhaps the only reason why investors are willing to put their money into unprofitable companies, is the rapid growth of the tech sector that created a hype in valuation. Since many shareholders value growth and tend to be more comfortable even if firms aren’t making huge margins.
But valuation can’t be stretched beyond a point with negative cash flows from business operation. At the moment, risks are magnified by inflated expectations along with the widely overpriced Internet and technology deals. And if you are a lucky one you can find a deep-pocketed investor for your exit (for example Flipkart), but luck may not favour each and every time for every investor, as sitting on a ballooned size valuation means viable exit opportunities are scarce. For example take the case of WeWork IPO. The Masayoshi Son-led group, which runs the $100-billion Softbank Vision Fund, has also come under criticism after the botched IPO plans of WeWork, which led to a $4.6 billion loss for SoftBank. WeWork is not the only tech investment that is not working for Son. High-profile investments in Uber, Slack, Guardant Health, Wag, Plenty and Fair are all performing poorly.
Some professionals are contrarian to the modern tech valuation thoughts, and believe that the traditional measures to judge a business (such as RoE, RoCE, Revenue as well as Margin Expansion, Increase in market pe*******on and so on..) have still not lost its ground and can help to protect one from risky investment decisions. If within in a reasonably time say 3-5 years a start-up is unable break-even, than it’s time to think about the corrective action, and if the negative bottom line widening year by year beyond this time, it’s time to think about the sustainability of the business.
The best strategy for any investor should be “An exit with a loss is not desired, it is in fact avoided, but when inevitable, it is best done as early as possible.”
Your valuable thought and comment on this is welcome….
