A perspective on investing in new age tech firms – Mint

The number of online buyers is likely to rise to 300-500 million over the next 3-5 years
The emerging internet economy is fundamentally changing the way consumers and businesses interact with each other. It is disrupting traditional businesses and a new crop of digital-native, mobile-first companies is emerging and scaling up at warp speed, enabled by favourable demographics, rising internet penetration and a world-class, frictionless payments ecosystem. Recently, Licious became the first D2C unicorn bypassing the traditional distribution model. We are seeing similar disruptions in healthtech, which is disrupting pharmacy stores/companies while fintech is disrupting traditional banks.
India has a population of 1.4 billion people with almost 750 million 4G connections. However, online buyers/transactors are in the range of 120-150 million only. This is likely to rise to 300-500 million buyers over the next 3-5 years as digital payment penetration rises. This growth will have multiple implications for not only new-age tech companies but also for the disrupted (traditional) companies. It is possible that new-age tech might see faster penetration in India.
There have been high-decibel conversations about the large losses most of these companies are making and whether investors should participate in their equity issuance. The framework of benchmarking a ‘great business’—i.e., superior returns on incremental capital (ROIC), scalability and strong execution and corporate governance—remains the same. Only the tools and techniques change. Near-term losses in the early stage do not necessarily mean losses in the future as well. Conversely, not all businesses that generate profits today will remain profitable forever as some might get disrupted by new-age tech firms. For example, today everyone seems to believe it is a no-brainer to invest in FAANG stocks (Facebook, Amazon, Apple, Netflix, Google). But a majority of those stocks were loss-making when they got listed.
There is an element of underappreciation of the economic model of new-age tech firms. In India, consumer tech firms are in early habit formation stage, which entails extensive investments in developing great tech, building brands, acquiring customers and delivering a great experience to establish long-lasting customer stickiness. Even though such investments are likely to pay off for many years to come, in contrast to traditional companies these investments of the consumer tech firms from an accounting perspective are considered expenses and not assets; hence they report ‘accounting losses’.
While evaluating a new-age tech company, unit economics is a key consideration. It is thus very important to track the ecosystem to gauge the ability for monetization and the potential for recurring usage. An important question to ask here is whether high engagement is leading to habit formation and repeat usage. The output to this framework is the LTV/CAC (expected lifetime value of a customer/cost of customer acquisition) ratio which provides insights into a potential margin trajectory. Along with assessing the TAM (total addressable market size), it provides a good indication of structural profitability and cash flow generation potential and into the eventual RoIC trajectory.
The challenge for an analyst who uses traditional ways of valuing businesses is the negative earnings and the inability to project future cash flows. We have always believed that these historical earning models have flaws and can be misleading. As with our approach for other companies, near-term accounting profits or losses mean very little in our valuation framework; what really matters is the long-term cash flow generation potential and the present value of those cash flows. Therefore, a thoughtful bottom-up consideration of expected future cash flows of each individual company is of paramount importance. Due to their strategic assets like a deep tech stack, well-established brand, large and happy customer base and strong management teams, many consumer tech companies can enter adjacent categories thereby increasing their potential profit pool. Thus, there could be potentially large value creation opportunities in some of these technology-enabled, emerging business models, but envisaging a discontinuous and disruptive future can be a difficult task.
Many professional managers managing capital both in private and public space have employed significant research resources to build a deep understanding of various business models within the consumer tech space across emerging and developed markets. We would continue to focus on companies that have built a competitive advantage in fast growing and large target markets, which have positive unit economics and management teams that are strong on execution as well as governance.
Prateek Pant is CBO at White Oak Capital Management.
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