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Friday, 19 Nov 2021
A newsletter that demystifies complex economic jargon and explains how it impacts your everyday life
By Vivek Kaul

Tip Tip…What’s Common Between Unicorn IPOs and Akshay Kumar?

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One of the unintended consequences of the rise of the multiplex and the so-called gentry that watches movies in them, and the rise of the internet, has been the death of the Hindi film rain song.

From Padmini’s ang lag jaa baalma in Mera Naam Joker to Zeenat Aman’s teri do takiya di naurki re mera laakhon ka sawan jaaye in Roti, Kapda aur Makaan to Smita Patil’s aaj rappat jaaye to humme na utheyo in Namak Halal, the rain song was an integral part of Hindi cinema, over the years.

But once the male gaze had access to the internet and almost no censors, for more or less free of cost, it made no sense to pay ticket prices for a rain song. And given that, Katrina Kaif’s recent rain song tip tip barsa paani in Sooryavanshi came as a surprise. Of course, the song was a redoing of the original tip tip barsa paani from the 1994 release Mohra (which in turn was a copy of the Nusrat Fateh Ali Khan’s dum mast kalandar mast).


The opinion on the new tip tip barsa paani is divided. The current generation likes the new version, leaving the people who grew up in the 1990s, thinking, why do this. In my opinion, the new version adds to the long list of Hindi film songs that Tanishk Bagchi has managed to massacre. But then that’s my opinion. As the great Anand Bakshi once wrote, ye public hai ye sab jaanti hai (This is the public, it knows everything).

Actor Akshay Kumar, who was in both versions of the song, tweeted: “I would’ve definitely been disappointed if any other actor would’ve recreated Tip Tip Barsa Paani, a song which has been synonymous with me and my career.”

To this, someone with the Twitter handle @Goddamittt replied: “Sir, with due respect, no one remembers that you were also there in that song.”

The point I wanted to make is that like tip tip barsa paani wasn’t about Akshay Kumar, the recent unicorn IPOs aren’t about earnings or, specifically, earnings the way they are being projected, to justify the prices at which the shares are being traded. But, before explaining this, let’s take a slight detour.

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Discounted cash flow

If we look at investing as a science, then the price of a stock at any point in time should equal the discounted value of its expected future earnings.

What does this mean in simple English? The main aim of any business is to generate a profit. When the profit is divided by the number of shares that the company has issued, it gives us the earnings per share. An analyst trying to value a stock tries to project the earnings per share for the stock over the next few years, and then the present value of the forecasted earnings per share is calculated or what is referred to as the discounted value of the expected future earnings. This is done because there is a time value of money due to inflation.

Hence, Rs 100 today is worth much more than Rs 100 two years down the line. So, the present value of the expected future earnings needs to be calculated. Once this is done, the value we get is theoretically the right price of the stock. But, of course, there is a difference between practice and theory, and the twain rarely meet.

The discounted cash flow method on its own sounds like science and precision; nonetheless, it comes with its share of ifs and buts.

First, to predict future earnings, the business should be mature enough and have reasonable predictability for analysts to project future earnings.

Second, there is no guarantee on how the economy will perform in the years to come, and that’s a possibility that needs to be kept in mind. Third, most Indian unicorns are in the platform business. This is something that is evolving, and so are the metrics needed to understand it.

Why did we take this detour?

In the recent past, a spate of unicorn IPOs hit the stock market. Unicorns are startups with a valuation of greater than $1 billion.

Stock market analysts need to write reports explaining whether an IPO is worth subscribing to or not. They do so using their tried and tested discounted cash flow method. The trouble is that most unicorns that have listed or want to list are losing money or barely making any, and there is very little predictability to their earnings.

In this situation, using the discounted cash flow method to forecast future earnings becomes an exercise in false precision.

Recently, the very high IPO price of a unicorn was justified by projecting earnings up until 2041. I mean, it’s difficult projecting earnings over two years; how can one possibly project earnings over two decades. It also begs the question as to why these IPOs are so expensively priced if there are no or little profits.

Venture capitalists and their search for return

The fact that unicorns are already valued more than $1 billion before they go public is because venture capitalists have invested in them. Hence, the price at which the IPOs are sold needs to be higher than the highest price at which they have invested in these companies.

Since 2008, the Western central banks have printed a lot of money to drive down interest rates and boost economic growth. The lower interest rates have sent investors all across the world in search of a higher return. Some of the money has found its way into Indian startups through VCs. But, of course, the competition among different VCs not to lose out on what may eventually turn out to be a good deal, has led them to invest in startups at higher and higher prices, turning many into unicorns. And once that happened, the IPOs were bound to come at even higher prices.

Now that’s one reason.

The second reason is network externality. In the book Exponential—How Accelerating Technology is Leaving Us Behind and What to Do About It, Azeem Azhar uses the example of fax machines to explain network externality. Azhar’s parents ran a small accounting firm in London. In 1986, they bought a fax machine to communicate with their customers.

It wasn’t used much in the first few months, but by 1987 it was being used quite a lot. As Azhar writes: “Every month, another client or two bought a fax machine: they weren’t just faxing my parents, but also suppliers and customers – who were themselves increasingly buying fax machines…When only one person has a fax machine, it is effectively useless; when thousands have one, suddenly it comes in handy.” So every new purchase of a fax machine made the network even more valuable.

And that’s a network externality for you. The telephone is by far its best example. The more people who used the telephone, the more the number of people who wanted to own one. There are other great examples as well. Most people use WhatsApp because everyone else uses WhatsApp. Despite the recent resentment around WhatsApp’s privacy policy, most people continue using it.

Even Wikipedia is a great example of network externality. Given that most people use Wikipedia whenever they want to understand something quickly, it attracts the most contributors who write these posts. Or TikTok, for that matter, because enough people and more were watching videos on it, it made sense for the content creators to post their videos on the platform until it got banned in India.

The new network externality

In the 20th century, network externality was dependent on the physical expansion of business and companies going through the “cumbersome process of supplying every new customer with a phone, or a fax machine, or some other device”.

That is not a problem today, as customers already have access to something that didn’t exist for a large part of the 20th century, at least not in the public domain: the internet. And the fact that many people are connected to it through the smartphone.

As Azhar writes: “The connections that support the network effect are already there… This has created room for a new type of business. Rather than being suppliers of goods, firms can think of themselves as ‘platforms’ – meaning they connect producers to consumers, without themselves doing much producing (or consuming).”

Take the case of Amazon. It’s largely not in the business of producing goods. But it’s a platform that allows many other businesses to sell goods. And once many buyers decide to buy from Amazon, it makes sense for the sellers to be there as well. Uber and Ola are also platforms. So is Airbnb.

eBay is another good example. As Azhar writes: “eBay… is a space where sellers can meet buyers to sell their own goods, with eBay itself producing and selling nothing.”

The thing here is that platforms have no restriction of physical space. They can’t get too crowded like a physical marketplace. In that sense, they have no limitation of scale and can continue to grow bigger and bigger.

As Raghuram Rajan writes in The Third Pillar: “Once a firm comes to dominate an area… because consumers find it hard to switch away from it because it has their data, the market may come to believe in its continuing dominance. This could make the monopoly self-fulfilling.”

Take the case of Google. It has a lot of our data and gives us extremely customized search results. Moreover, every time a user uses Google, it feeds into its algorithm, making the search engine even more robust.

Or take the case of Netflix. Its popularity has ensured that it has all the data on what people are watching (and not watching). As Azhar writes: “When Netflix gives you a recommendation for a TV show, that recommendation is a result of your viewing habits compared to what other people are watching. Those choices are fed into Netflix’s systems to improve the suggestions you receive.”

This makes things very difficult for a new kid on the block, which doesn’t have your data to start with. This leads to monopolistic tendencies.

This is what many VCs bet on when they pour money into platform businesses, which are unlikely to turn profitable any time soon or perhaps never. They are hoping that the businesses they have bet on will be monopolies or duopolies one day, and then they will rake in the moolah. Of course, they do understand that many of these businesses will go bust, but the bet is that those that do well will cover these losses and bring in more money.

Take the case of Zomato, it has primarily got one competitor, and that is Swiggy. Once an ecosystem around Zomato and Swiggy is built, they are likely to dominate the market. It will not be easy to replicate the systems they have put in place, plus they have all the customer data. A similar logic holds for Nykaa, the Amazon of makeup. This explains the massive valuations despite the lack of current earnings.

The risks

Now just because things sound good in theory doesn’t mean they will work out in practice. Tastes might change. Facebook has experienced this with the younger crowd moving away from what became the platform of their parents. Nonetheless, Facebook bought out WhatsApp and Instagram, the new social media platforms that were becoming popular.

As Azhar writes: “Even as new companies spring up, very large firms are increasingly adept at cementing their own positions in the market. Google bought YouTube in video, DoubleClick in advertising and Android in mobile phones.”

What helps these firms in buying up other firms is their high stock price. As Rajan writes: “The stock market will bid the firm’s share price to stratospheric levels in view of its expected monopoly profits. The firm’s high priced shares will then give it the currency to buy up any threatening competitors.” In that sense, once a company is on its way to becoming a monopoly or a duopoly in the platform business, it is likely to stay that way.

But these businesses have no control over how well the economy will do in the days to come. And that’s a big risk.

India currently has very few women working. As more women work, platforms will benefit. As I had written on 15 October in the newsletter, “Take the case of Zomato or Swiggy… A household with a working woman is likely to see more value in ordering food. There are two reasons for it. One is that a working woman would have less time to cook regularly for her family and hence, is more likely to order (Most men in Indian homes don’t cook). Also, she would have the money to order and wouldn’t have to depend on her spouse or partner.” Or take the case of Nykaa. It will clearly benefit if more and more women take up jobs.

Of course, for this to happen, enough jobs need to be generated for women. This is a big risk over which platforms have no control.

The conclusion

Hence, there is no way of currently knowing whether these IPOs will end up being wealth generators in the long term. They can control a large section of their relevant market, but there is no way of currently knowing whether that market will grow and become big enough in the years to come to justify the current valuations at which the IPOs are being sold. Also, not all VC funded firms make it. Some do fall by the wayside. The dotcom bubble, which burst in early 2000, is an excellent example of that.

This tells us that an informed decision on investing in these stocks, not just in the IPOs, but even after these companies go public, cannot really be made. So, the only way to play this is to look at it as a punt and allocate small amounts towards buying such stocks.

Also, it is important to check the IPO details (assuming you are a serious investor and not someone who just wants some listing day gains). It is but natural that VCs and promoters of these unicorns will want to cash in on the stock market party and unload some of their shares to the retail and the high net worth individuals. And that is currently happening.

As Zerodha co-founder recently told Mint in an interview: “Promoters are selling equity. The early VCs are selling their equity. It becomes even more important to watch what they are doing because this is smart money offloading onto retail investors in India.”

If the insiders are selling out through an IPO, it tells us a thing or two about the confidence they have in the business they are building. Or maybe they are simply trying to hedge a part of the risk they have taken on by selling a portion of their stake early. Like Rohit Shetty did with Sooryavanshi by building in enough set pieces into it, from a new version of tip tip barsa paani to special appearances by Ranveer Singh and Ajay Devgn.


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Written by Vivek Kaul. Edited by Saikat Chatterjee. Produced by Nirmalya Dutta. Send in your feedback to

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