Reset.com: An Early Stumble for India’s Digital Bull Run

Year 2022 has begun with an intent on washing away the sins of the dazzling post-Covid-19 bull run. While major market indices such as the Dow Jones or the Nifty have barely flinched so far, the pain is searing in the digital end of the spectrum where the biggest valuation excesses exist. This reset had to happen; only the trigger was in question. The US Federal Reserve has provided the market with an excuse to blow away the accumulated froth and bring these high-flyers down to earth. India has merely mirrored the trend.

The bloodbath brings back memories of the brutal technology meltdown at the turn of the century. Post-Covid-19 poster boys such as Zoom Video and PayPal have lost over 70 per cent of their market value, Netflix and the mighty Meta-Facebook have halved and even Tesla is down a third from its peak. It’s a carnage.

Back home, the recently listed digital unicorns which investors couldn’t get enough of just last year, are in the middle of a grand walloping. Zomato and Nykaa have halved from their peaks, as has Policybazaar, while Paytm is the leader of the fall with a 60 per cent crash. Many old-timers in the market are probably having a good laugh as these newbies and their admirers get their comeuppance.

Such crashes are always a good time for reflection. And on doing that, one is struck by how eerily similar the pattern of this digital boom-bust is to the previous one. As they say—the more things change, the more they remain the same. If it was the ludicrous PE to Growth or PEG ratio in 2000, this time it was the Price to Sales ratio for digital stocks. The same investment bankers who pimped IPOs like Reliance Power to the gullible public, paraded these digital beauties before eager youngsters with no experience of market cycles. And brokerages, with a few exceptions, put out glowing ‘buy’ reports with price targets well ahead of the peak prices from which these stocks crashed. The same cheerleaders, doing the thing they always do—fan the flames of greed and madness.

The promoters of these digital unicorns shouldn’t get a free pass either. Often, it was a case of them playing a game of collusion with private equity investors to raise capital at ever increasing valuations before providing them an exit with the IPO. Retail investors need to be very watchful about this trend. In a bygone era, a business would have to prove itself, turn profitable and then come to the IPO market to raise capital for growth. The game has changed. Easy access to private equity capital has ensured that the real jump in valuation is captured by these early investors and the general public is suckered in at the last stage to buy an unprofitable entity at a grossly inflated valuation. Is it any surprise then that these stocks are crashing? It was so predictable that very few serious professional investors would have bought any of these names post listing.

The first warning sign should have come from the advent of the Price to Sales ratio, propagated widely in the US to value NASDAQ stocks. This is such a bogus metric, disheeding the most basic tenet of investing—a stock ultimately derives its value from profits—that an unravelling was always on the cards. In India, one of the promoters of a unicorn, now down 55 per cent and well below its issue price, spoke so dismissively of the need to generate profits, that discerning investors should have run for cover straightaway.

The one good thing is that the flames of this bubble were not fanned even further before the crash came. That would have led to even greater pain. The other, that many of these franchises will soon be available at interesting price points. It is always important to separate a business from its market value. The value may be conferred by the market based on many erroneous factors but the business itself remains fundamentally what it is. Not made better by the stock price, or worse.

For example, Nykaa is an excellent franchise, but the price was wrong. It isn’t one of those companies which disregards profits, in fact quite the opposite. Therefore, it will probably be the first digital stock to bottom out, once the dust settles on the reset. Zomato too is a top class platform, again with a mindless valuation. Now hacked down to size, maybe with some to go. Policybazaar is a good model but has to descend from its—don’t ask me about profits—high horse and smell the coffee. And Paytm has to realise that it is all very fine to compare itself with a Bajaj Finance but an ambition is not a proven business model. The yawning chasm between the two is the one into which the stock has plunged. But it would be unfortunate if this crash turns investors durably away from digital stocks. That would be a colossal mistake as in the next decade, many of these enterprises will become giants. Hopefully profitable ones.

Resets, while painful, are wonderful things. They show up economic actors in their true colours, though investor memory tends to be remarkably shallow. They teach young promoters lessons about playing the long game and whittle away excesses, leaving the market stronger for the next leg. So, despair not, India’s digital bull run has just started. This is an early stumble which we will recover from, and build on, to emerge the most vibrant of digital ecosystems in the world. Don’t confuse a reset for an obituary.