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Bengaluru: Indian unicorns, or startups with a valuation of at least $1 billion, are defying the conventional logic of valuations being based on future earnings. As their losses widen, private investors are rewarding them with even higher valuations.

In fiscal 2016, for instance, when Paytm parent One97 Communications Ltd posted a loss of 1,497 crore, it was valued at 30,747 crore or about $5 billion. Three years later, its losses have nearly tripled, with a consolidated loss of 4,217.20 crore for the year ended 31 March. In the same period, the Noida-based firm’s valuation tripled to $15 billion.

Similarly, online food delivery startup Swiggy posted a loss of 137 crore in FY16. At that time, its valuation was about 1,307.30 crore or nearly $250 million. In FY18, its loss almost tripled to 397.30 crore but valuation zoomed to 8,660.40 crore or $1.4 billion. Likewise, homegrown e-commerce giant Flipkart’s losses went from 545 crore in FY16 to 2,064.80 crore in FY18. Despite this, Walmart valued the company at $21 billion when it acquired 77% stake in it last year.

Experts are calling this trend “inverse proportionality". Valuations are typically a function of projected revenue, based on assumptions that unit economics will work out once competition is killed. The problem, experts pointed out, is that in most cases, the competition does not die. On the contrary, as in Paytm’s case, several rival services such as Google Pay, Amazon Pay, BHIM, PhonePe and WhatsApp’s payments are now challenging its near-monopoly.

“In India, companies are in cash-burning stages in the hope that they will be able to drive out competition. Two or three strong companies would survive and make profits. That’s the hope driving valuations," said Santosh N., managing director of valuation service provider Duff and Phelps. “There is an assumption on losses and if the losses are lower than that, then it’s seen in a very positive light." He added that a significant portion of the funds that a company raises continues to be allocated for loss funding, achieving scale, customer acquisition and driving out competition.

Investors such as SoftBank and Naspers are not too worried about cash burn and are willing to fund losses as long as growth continues. “In business models that are still evolving in India (such as food delivery or ride sharing), there is no science to deriving valuations—it’s about negotiations. Companies are showing they are becoming bigger than before, adding new service lines, hence need cash to burn," said Santosh.

Losses widen at India's biggest startups, but their valuations are rising higher
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Losses widen at India's biggest startups, but their valuations are rising higher

As private and deep-pocketed investors are driving valuations, sustainable price discovery, which comes into play at the pre- and post-IPO stages, is not happening, a development now visible in the US.Office space rental company WeWork’s parent, We Company, for example, is looking to slash the valuation of its public offering to nearly $20 billion, less than half the $47 billion valuation it attained in a private funding round earlier this year.

The valuation drop, which happened amid lukewarm reception from investors, has spooked the company’s largest shareholder, SoftBank, so much so that it now wants the company to shelve its IPO plans, according to several media reports. Ride-hailing giant Uber was valued at as much as $120 billion in a large private funding round last year. In May, in its debut trading it was valued at $76 billion on the back of the stock price.

With several Indian unicorns such as Oyo, Paytm and Flipkart planning to go public, can things be different from what they are in the US?

Experts are cautious. “Investors are pricing companies, not valuing them. Pricing is what one is willing to pay, valuation is about the inherent value of the business," said Santosh, adding that an IPO in India is not the best option. “M&A (merger and acquisition) is the most preferred, particularly for those firms who are below the $10 billion valuation bracket. They can get acquired."

For now, valuations appear set to continue their northward trajectory. This will go on only as long as there are super optimistic investment firms, believes Vivek Durai, founder of business information platform Paper.vc.

“Despite recent IPO failures, irrationality still persists in late-stage investments because private investment options still look attractive and opportunistic compared to today’s public markets," Durai said. “Savvy firms know to get in and out at the right time. But there will be many losers when the music stops."

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