India Internet Day 2022 Sector Update: Capital-efficient growth is the flavour of the season - JM Financial Institutional Securities
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As Indian capital markets show relative strength with talk of decoupling from the global markets starting to come up, we are also seeing Indian internet ecosystem growing fastest with companies making the strategic choice of growing sustainably along with a clear path to profitability. Unlike some of their counterparts in the developed economies, Indian startup ecosystem has rarely depended on debt capital and has simultaneously been minimally impacted by the rate-hike environment. We hosted the prominent few among these companies at JM Financial India Internet Day 2022 in Singapore and our key takeaway is that these companies have garnered the inherent strength as well as capital to tide through the current lull in large ticket funding rounds. With significant capital raised over the past 12-18 months and a heightened focus on capital efficiency, these companies are positioned to turn profitable within the coming year and are expected to continue alleviating consumer painpoints across their respective categories.
Key Company Takeaways
* Anticipate profitability by CY23: The utmost prominent common theme during the discussions was the profitability guidance. We noted that almost all the hosted companies are tracking their break-even timeline and expect to turn to black sometime in CY23 with most guiding towards Q1CY23 as a profitable quarter. For companies that were investing heavily to sail the COVID tailwinds, they have prioritised the proven business verticals while curtailing further investment into business where unit economics looked challenging. We also noted a tendency to enhance depth rather than breadth by these companies in the current environment.
* Indian companies are resilient to rising interest rates: While the rising interest rate situation has resulted in a risk-off move in asset allocation with investors shunning the loss making companies, Indian companies have still fared better than their international counterparts with some of them having lost over 90%+ of their market capitalisation. Over and above the Indian growth story, another major reason seems to be the minimal debt on the balance sheet of Indian startups.
* Indian digital penetration story and macro environment remain robust: Though the ongoing global environment seems to cloud judgement, the overall digital penetration story in India continues to remain robust. We need to note that India has seen digital distribution precede physical distribution across multiple industries and sectors and that creates an inherent value proposition for Indian startups that are solving for real customer pain-points and are disrupting the middle men. Further, Indian government’s continued focus on digital ecosystem is likely to enable faster penetration and organic customer acquisition for the digital-first players.
* Companies raising equity funds are not optimising valuations: With a large majority of the new age companies still sub-scale, equity capital is still needed for the companies to have a comfortable runway. Despite operational profitability expectations in CY23, the companies would prefer to have access to capital to be prepared for any contingency. We noted that for companies that are undergoing a fundraise process, there is significant flexibility on valuations but they are more focused on getting the right investors that understand their story and also have the ability to back them up during the eventual public listings.
Key Investor Takeaways
* Prefer profitability in existing business operations before diversification: As is evident from company takeaways, profitability is a key focus area. Investors do understand that the profitability can be delivered with the right trends emerging but do want to see the companies creating profit pools in existing business before launching another business that puts further pressure on cashflows.
* Cohesive story enables easy comprehension: While the companies might be solving for disparate customer problems, investors fancy seeing a thread tying up the business model as this makes the story simpler to understand and easy to value. The rationale feels similar to why companies are encouraged to spin-out businesses (different from the core) to create the maximum investor value as investments funds might have a particular thesis to invest in businesses in certain industries and might not give valuation for the remaining businesses.
* Understanding of realistic revenue opportunity is crucial: India certainly has the potential of a huge market for almost any category but there have also been numerous examples of companies and investors that have overestimated the revenue opportunity. Hence, investors want to clearly understand the size of revenue opportunity available to a company both today and in the future. This is applicable across both service and product businesses – how much are the customers willing to pay for a service and how much margin is available in products being sold/bought, irrespective of the size of GMV that might be available.
* Winner takes all or a multi player opportunity?: Investors also seek clarity on industry verticals where the network effects are so strong or the revenue opportunity is so small that the winner takes all the value and there is no benefit of backing the also-rans. This becomes very crucial for the companies that have a larger incumbent as they need to prove that there is opportunity for multiple players in the category
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