How should investors approach IPOs of loss making companies?
With Zomato IPO getting a stupendous response and many more digital IPOs like Paytm, Nykaa and MobiKwik on the anvil; there is a big question. How do investors assess the prospects and value of loss-making IPOs in primary markets.
Right place at the right time
This aspect is oft ignored, but digital businesses have tipping points. Paytm, gained from demonetization and a shift to digital money. Zomato and Swiggy, sold the convenience factor during lock- downs. For Byjus and Vedantu, it was their unmatched potential to deliver quality education under the most trying circumstances. For any of the digital IPOs, look for this tipping point. To make profits, the digital play must be in the right place and also the right time.
Focus on digital dividends
For digital businesses, digital dividends normally come from the network effect. Here is how it works. For a Zomato or a Paytm, a surge in customers attracts more vendors to register with the portal and that logically gives a much wider choice to customers and attracts more customers to its fold. This is the time when digital companies can grow their profits and valuations manifold. Network effects were first seen in telecom and now digital players are witnessing the same, when supply and demand gets into a virtuous cycle. That is the second aspect for you to focus in digital IPOs.
Basic financial tests
To be fair, traditional parameters used to evaluate IPOs like PECV and P/E ratio will not work. One financial test you can apply is whether the losses of the business are narrowing at an operating level. The second parameter that you can apply is if the peak promotion spend is done and dusted and the digital play can get publicity benefits with sharply lower promotion expenses. The third parameter that you can look at is the global benchmarks. The beauty of the ecommerce plays is that global metrics like EV/EBITDA or Price / Sales are more or less comparable. That allows Indian investors in such digital IPOs to apply global benchmarks for evaluation.
Discretion is better than valor
We come to the million-dollar question; should retail investors buy digital loss- making IPOs. There is no harm if the company is in a sweet spot, can create network effects and basic financial metrics are favorable. The momentum is in favor of digital stocks and if the basic boxes are ticked, you can surely invest. However, investors must keep 3 things in mind. Firstly, don’t go overboard and allocate all your IPO capital to digital plays. Secondly, allocate IPO capital in the IPO as well as post listing, so that you can also gain from any listing day blues. Lastly, ensure it fits into your financial plan. If you are satisfied, just go ahead and buy these digital IPOs!