Public Market Conundrum

The startup ecosystem is ushering in a new era of "tech-empowered India.” It is becoming more prominent and vital, and there is an opportunity for all investors to make outsized returns in the long term. Historically, private market investors such as global institutional investors, family offices, and HNIs have invested in tech startups, mainly through venture capital funds. The last 3 to 5 years saw a growing interest in investing directly or through co-investment/syndicates alongside PE/VC funds. And now, the ecosystem is evolving further when the public market investors enter these scaled-up tech companies through IPOs / secondary markets.

With more capital flows and exits, more wealth creation will happen in the ecosystem, which has more than 84,000 startups today. India has been in the throes of a boom in tech sector IPOs in the last two years. However, these most touted scaled-up startups, like Paytm, Nykaa, PB, or Zomato, have taken a beating through the massive sell-offs by private market investors. Although PE and VC investments come with an expiration date because of the finite fund lives of these institutions, they sell down their holdings slowly after companies go public.In fact, in some cases, they also hold stakes in companies a decade after their IPO. The long goodbyes show other investors the scope of an upside in these share prices.

But the current happenings in the Indian capital markets are somewhat different. For example, when the lock-in for Zomatos’s pre-IPO investors expired in July 2022, it sparked an offloading spree, and private market investors such as Moore and Tiger Global exited, resulting in tanking of its shares by 41% in that week. This is a shock to investors as Moore participated in Series G of the company in January 2022, only five months before the company went public. Moore’s investment loss due to this sell-off was about INR 4 crore.

But Zomato was not the only one getting hammered with these ‘rapid’ block deals by PE/VC investors. Similar activities were seen in Policybazaar (PB Fintech) listed in November last year. It saw a significant sell-off recently when Tiger Global sold its stocks, resulting in a decline of over 73% in the stock price. Similarly, in the case of Paytm, Softbank divested a 4.5% stake post-expiry of lock-in in November this year. In the case of Nykaa, a profitable startup unlike the rest, entities like Lighthouse India Fund III, Segantii India Mauritius, and TPG Capital were major private investors who offloaded stakes. Several other investors who participated late in these tech startups have already exited post-IPO for a loss.

If the private market investors, who have been insiders to these companies, are selling, then who is buying these shares? Interestingly, it’s the public market investors. Public investor holdings in these tech stocks have increased significantly. Paytm has seen massive bets by retail investors, with a ~6.37% retail stake in the company. Domestic mutual funds, meanwhile, have also raised their stake in Paytm. Bluechip investors, including Berkshire Hathaway Inc., Morgan Stanley Asia Singapore, and BofA Securities, have been buyers of Paytm shares. Zomato and Nykaa also saw a lot of interest from public investors. Franklin Templeton, Motilal Oswal AMC, Kotak Mutual Fund, and HDFC Mutual Fund all made stakes in Zomato. Nykaa saw bulk buy-outs from investors such as Aditya Birla Sun Life Mutual Fund, Morgan Stanley Asia Singapore, and Axis Mutual Fund, to name a few. So, now the question arises, what’s driving this appetite of public investors for these loss-making tech company stocks?

One can think of a few probable reasons. Firstly, they might be facing an anchor bias. A public market investor looks at the IPO price of these stocks and gets anchored to it. The stock currently is available at a steep discount to the IPO price and thus seems to hold a lot of promise. Another reason driving this investor behavior could be the “scarcity premium” for these scaled-up innovative startup business models. Take, for instance, Nykaa or PolicyBazaar, who have disrupted traditional businesses in the fashion and beauty or insurance space. Moreover, investors could be foraying into these stocks due to the ’FOMO’ (Fear of Missing Out) effect, i.e. they have seen massive value creation happen in the private markets in these business models and do not want to be left out to secure handsome gains. Also, there is this temptation for a public market investor to average out their cost of acquisition.

Is this an ideal time for public market investors to dabble in these stocks? Typically, the public market investor playbook involves betting on business model certainty, profitability, predictability of growth stories, and free cash flow generators. Most of these stocks aren’t profitable yet and have laid out their path to profitability, so it is essential to evaluate the risk involved in these stocks. Also, pre-IPO shareholders looking for a way out as soon as possible should be a caution signal to newer public market investors. The hype in these tech company stocks has been a classic example of the market and liquidity cycle. We all know that eventually, profitability and free cash flows will rein in the survivors. Time will tell who knows more, the insider private market investors exiting these stocks or the newer public market investors relying on the management guidance and company prospects.