VR Logo

A hot IPO

No matter how you look at it, it makes little sense for investors to take the Zomato IPO seriously

A hot IPO

Once upon a time (actually, as recently as 2015), there was a rule in this country that to collect money from the public in an IPO, a company had to have a track record of being profitable. One result of this rule was that loss-making companies were conducting their IPOs in foreign equity markets. Apparently, this inability of Indian investors to invest in loss-making companies was a great handicap and so this rule was amended. As a result, you, the Indian equity investor, now have the freedom to invest in companies that have never made a profit in the past, are not making a profit in the present and may never make a profit in the future.

The Zomato IPO is a perfect example of these strange phenomena but there will be many more. You can read our detailed analysis here. Now and in the future, there will be plenty of IPOs of such companies and for reasons that you surely understand, they will be the ones that will be declared by a lot of wise people to be the 'hottest.' I make this prediction with complete confidence, even though I have no idea whatsoever what exactly 'hottest' means in the context of the business and financial prospects of a company. The ability to make predictions about things one has no idea about has become highly valuable. However, one thing that I have been able to figure out in recent days after reading many articles in the media is that 'hottest', whatever it means in finance, is an adequate substitute for being profitable. In fact, it may even be better. Much better. I find it absolutely alarming that articles about the Zomato IPO in the financial media are going on and on about Zomato's hotness while paying no attention to the company's lack of any viable path to profitability.

It would appear that being the 'hottest' ensures higher valuations in an IPO than merely being profitable does. I'm not joking nor am I being satirical. Seriously. The logic is actually very clear. The past and the present are reality. The future is a story. It's hard to make the past or the present any hotter than they are. The numbers are there for anyone to see. However, the future can be made to sound as hot as possible. Since it's just a story anyway, its hotness just depends on your audacity as a storyteller.

I'm not saying, even for a moment, that no one should invest in these kinds of businesses. This kind of investing - pouring in money into speculative businesses that can nominally pretend to be startups - has its place in the world. However, that place should logically be filled by angel investors and venture capitalists. In that world, the ability to absorb risks, as well as influence and guide businesses, creates a very different situation. For individual retail investors, the story is different. It hardly needs to be pointed out that investing in startups will be a very different business than the kind of equity investing that even a seasoned investor might be used to. There won't be any conventional track record of profitability, nor will any normal methods of equity research or analysis be of much use.

Investors need to understand that startups are not permanently immune to the normal laws of business, nor are richer investors immune to getting swept along by stories of imminent world domination that startups like to spin. Almost without exception, all Indian startups who have captured any market share have done so on the strength of unsustainable cash burn. This is considered normal for all tech startups, but there is a difference. When Google was burning money back in 1999-2001, it was using the cash in building its technology and its infrastructure. Facebook did the same at an equivalent stage and also created a powerful network effect. This was even true for Amazon at one stage. In contrast, much of the startup scene in India today seems to consist of businesses that are sustaining themselves by basically giving away money to customers.

Anyhow, as an individual investor, what other people do should not matter to you. There are always people who get taken in by stories. You don't have infinite money and you don't have to chase every single opportunity. Profitability, growth, value and other conventional measures of business have served sensible investors well and will continue to do so for all times to come.

If, on the other hand, you plan to sell and run on the day that the IPO lists, then sure, go ahead and focus on the hotness.