Corona-age investing: start ups, shut downs and reboots…

Rapid reading

  • Post corona, the spotlight might shift back to the most basic part of a business model—cash flow
  • Companies that constantly burn cash to grow and depend on heavy leverages are the worst affected ones
  • Risk management is expected to be redefined

….

Grow, grow and grow

Don’t care about the cash flow

Get the glamour

Build the clamour

Snub the losses

Shine the glosses

Get the valuations through the roof

And that’s the business model full-proof

Disruption and start-ups have been the buzzwords for quite some time now. But more often than not it’s been seen that start-ups not only decimate the pricing power of industry but remain loss-making businesses that quote at billion-dollar valuation.

Coronavirus outbreak delivered a mighty blow to many of them and might have changed the rules of the game, perhaps permanently.

In the halcyon times, unicorns raised capital at astronomical valuations. And then the coronavirus came tearing apart the illusionary picture. There’s no dearth of instances where businesses drew ambitious growth plans, Private Equity (PE) funds, banks and other financial institutions funded them only to see themselves getting caught between a rock and a hard place.

Now, heads they lose and tail they don’t win. Writing off capital losses would be painful and pumping more capital to keep the show running will substantially increase the possibility of future losses.

Corona isn’t the real culprit…

It’s being claimed that the coronavirus pandemic has taken a toll on some global giant start-up companies such as WeWork, Oneweb, Lime, and DoorDash, among others. But a deeper investigation suggests that not all was hunky-dory with these companies even before the outbreak of virus brought the globe to its knees.

Oneweb, a London headquartered high profile start up which launched 74 satellites in an attempt to provide high-bandwidth-low-latency internet connectivity, recently filed for bankruptcy.

WeWork was privately valued at over USD 40 billion in 2019 and today (just within a few months it’s on the brink of collapse.

Back home the condition of cash burning businesses and start-ups is no different.

Many experts have been drawing parallels between WeWork and SoftBank-funded, high-profile Unicorn—Oyo. Despite a six fold jump in its losses (Rs 2,385 crore in FY19), Oyo’s valuations doubled between September 2018 and October 2019 from USD 5 billion to USD 10 billion.

As per the media reports, COVID-19 has been a catastrophic event for Oyo, which may force it to do one more big round of capital infusion to stay afloat in the next 12-18 months.

Conventional hotel chains such as Marriott International and Hilton Worldwide—which have much better balance sheets than Oyo—have witnessed a fall of about 40% in their valuations ever since the corona outbreak has disrupted the world. To what extent Oyo’s valuation would be affected, remains crucial to watch.

Change in FDI rules to create hurdles for Indian startups…

To add to worries of other Indian start ups, India recently altered the Foreign Direct Investments (FDI) laws, which now do not permit investments from countries sharing their territorial boarders with India through the automatic route. As clarified by the government, this was a step taken to discourage hostile takeovers under the crisis. However, it may affect all future capital raising plans of India’s iconic e-commerce and technology platforms which are backed chiefly by Chinese investments. According to Economic Times dated April 20, 2020, 50% of India’s topmost downloaded apps in 2018 had sourced funds from China.

Investors and start-ups are awaiting government’s clarification which is expected to come over the next two weeks along with FEMA notification.

Not just start ups, business models of listed companies might be tested as well

What’s true about loss-making, cash-burning start-ups is also true about listed companies that are struggling with fractured balance sheet and unsustainable business models.

Corona inflicted economic slowdown might affect the risk-appetite of not just PE funds and institutional investors but it may also affect conventional creditors such as banks and Non-Banking Financial Institutions (NBFCs). The Yes Bank episode has been an eye-opener for Indian financial institutions.

For instance, despite RBI’s aggressive slashing of the reverse repo rate (which has been a hint to the banks to lend aggressively), banks have been reluctant to lend.  According to RBI, the systematic liquidity surplus for the fortnight ended on April 14th averaged at Rs 4.36 lakh crore. In other words, banks are not keen on lending—and rightly so, considering uncertainty that prevails. RBI’s unprecedented effort might help banks tackle the market risk but they still have to underwrite the credit risk.

It seems that banks are convinced with following the ultra-conservative approach to lending. Cash strapped-highly-leveraged companies might find it difficult to secure bank credit.

In H2FY20, Crisil downgraded 469 companies against 360 upgrades—this ratio was a 3-year low. Outlook remains moderate. According to a study conducted by Crisil, 52% of Rs 23 lakh crore of outstanding loans across 35 sectors are from the moderately resilient category. How these companies fare remains interesting to watch. They belong to the sectors such as Automobiles, Manufacturing, Road Construction and Power Generation among others.

As they say, Revenue is vanity, profit is sanity and cash is reality. Companies that can survive the present phase may thrive when business environment improves.

Time for investors and creditors to come to terms with reality—not everything that shines is gold. Good businesses are often dull and boring.

Editor’s note:

Investing in the risk-off environment isn’t easy. Our research team recently conducted a 360 degree analysis of business models of India’s top 500 companies along with the quantum and predictability of their cash flows to spot the best investment opportunities. Our recently published report, Healthy Cash Flow stocks to BUY in COVID-19 correction, discusses 10 investment ideas for the risk-off environment.

You may also like to read: Back to square one: Roti, Kapda aur Makan

 

Disclaimer:

We, Ventura Securities Ltd, (SEBI Registration Number INH000001634) its Analysts & Associates with regard to blog article hereby solemnly declare & disclose that:

We do not have any financial interest of any nature in the company. We do not individually or collectively hold 1% or more of the securities of the company. We do not have any other material conflict of interest in the company. We do not act as a market maker in securities of the company. We do not have any directorships or other material relationships with the company. We do not have any personal interests in the securities of the company. We do not have any past significant relationships with the company such as Investment Banking or other advisory assignments or intermediary relationships. We are not responsible for the risk associated with the investment/disinvestment decision made on the basis of this blog article.

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