An impossible IPO problem | Value Research Is there a reasonable way of pricing the IPOs of profitless companies?
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An impossible IPO problem

Is there a reasonable way of pricing the IPOs of profitless companies?

NATC. It's a nice new acronym that has been invented and now even has the official blessings of SEBI, which has used it in a consultation paper on 'Disclosures for Basis of Issue Price section in the Offer Document' in IPOs. It means 'new age technology company', which unfortunately, has no precise meaning that can be pinned down. A far better acronym would be CTHNMAPAPNS. This stands for 'company that has never made a profit and probably never shall' and unlike the vague hand-waving 'new age technology company', it has a precise meaning that conveys something useful to the investor. In fact, it encompasses the single most useful fact about an IPO company that an investor should be concerned with.

So in this column let us discuss CTHNMAPAPNS. The need for the SEBI consultation paper arises out of this fact, that these companies have never made a profit. All the existing mechanisms for figuring out what the appropriate stock price of a company should be are finally based on how much money does the company make. From that, you can make a reasonable bet on how much money it will make in the future and what is the likelihood that this future bet will work out.

Really, of all the reams of conventional analyses that you can do on a company that is about to go public - or are already public - works for a company that has never made a profit. Note that I'm saying 'never' made a profit. There are plenty of conventional companies that occasionally slip into the red but those are not difficult to evaluate. When the word 'never' comes into the picture then that becomes a special case. In fact, there's an even more special case - that of companies in businesses in which no one has ever made a profit anywhere in the world.

This differentiation is important. For example, there are chronically loss-making e-commerce companies or delivery companies in India. However, when you look around the world, there are many companies in these businesses that are profitable. That validates the business and gives investors some kind of a benchmark. However, when it comes to a business like that of Ola or Zomato or Paytm, this does not work. No one in the world has ever become profitable in such businesses.

The SEBI consultation paper discusses the issues and then arrives upon some proposals that it puts up for public discussion. The proposals are centred around 'key performance indicators' (KPI) of the business. Conceptually, the issuing company will have to reveal past KPIs that have been used with pre-IPO investors to set valuation. It will have to set clearly defined KPIs that are a justification for the issue price. These KPIs will be certified or audited by statutory auditors. There will be a comparison of KPIs with Indian listed peer companies or foreign listed peer companies, and the comparison of KPIs over time will have to be explained.

It sounds reasonable, if it can be worked and regulated - which is a gigantic if. The centrepiece of these measures is that companies will reveal past KPI-related communications and discussions that they had with VCs and funds. Essentially, we are relying here on companies honestly revealing private information from the past. That too, not verifiable financial information but things that may have been just discussions. Will this work? I'll leave that question hanging there in the air. You're welcome to try and answer it for yourself if you have any interest in investing in CTHNMAPAPNS.

Basically, pricing such companies for an IPO in India is a hard, maybe impossible problem. The conflict of interest between the existing shareholders and the investment bankers on one side and the investing public on the other hand is too great and verifiable information is too sparse. This kind of investing should be done by professionals who are in the business and who can sit across a table and negotiate hard. Ordinary retail investors who are offered a take-it-or-leave-it deal in an IPO should basically just leave it. There are many other fish in the sea.

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