How to value upcoming internet IPOs; ICICI Securities shares framework to filter quality internet cos

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August 04, 2021 11:13 AM

With the success of Zomato’s IPO, a volley of internet companies are now looking to make their way towards stock markets.

Internet IPO, Paytm IPOPaytm is expected to enter the primary market this fiscal year and many others such as Nykaa have begun treading on the same path. (Image: REUTERS)

With the success of Zomato’s IPO, a volley of internet companies are now looking to make their way towards stock markets. This has forced several questions into the minds of stock market investors. Which model; which vertical; Which company are currently some of the billion-dollar questions in investor’s minds. Amid this rush of internet companies, domestic brokerage and research firm ICICI Securities has shared their 5 point framework to help investors filter through the barrage of internet IPOs. Paytm is expected to enter the primary market this fiscal year and many others such as Nykaa have also begun treading on the same path. 

Analysts at ICICI Securities find that metrics such as GMV, near-term losses/valuations are now commanding undue attention of the street, while more fundamental drivers of long-term scalability, sustainability and profitability are often overlooked. The brokerage firm tries to address these concerns by diving deep into the frequency of app usage, TAM per player, data monetisability, back-end operational muscle, and unit economics.

App usage frequency: Analysts says that a high frequency of usage results in strong customer engagement and scalability. “Frequency of usage across categories is a wide spectrum — from food-tech, payments, ride-hailing, and e-commerce at one extreme to auto, real estate classifieds, matrimony, etc. on the other,” they said. Users prefer to keep only a limited set of apps that are more frequently used on their phones, owing to device memory issues. This in turn has implications on customer engagement, behavioural data, brand loyalty, size of the network created, and hence scalability, the brokerage firm added.

Total available market (TAM): “Learning from mature internet businesses suggests that industry should eventually consolidate into monopolies or duopolies for the players to be able to make profits/cash flows sustainably,” the report said. Lower TAM signals an industry with scalability challenges or intense competition while high TAM per player segments have smoother risk-reward pay-offs for investors.

Data monetisability: Data is well and truly the new oil now and with internet companies having plenty of data of users, the ability to refine and monetise it plays a key role. “The ability to monetise varies — with search, social networks, payments, etc. on one extreme to ride-hailing, on the other. At times, even the operational (e.g. traffic density in ride-hailing) and regulatory hurdles may limit the monetisability,” ICICI Securities said. Investors should thus identify models with a high degree of data monetisation moat. 

Back-end operational muscle: Holding on to customers is helped by the operational model, resulting in greater retention and sustainability. “once the customer is on the platform, it is the back-end operational muscle of a company that drives customer satisfaction, retention and eventually the sustainability of the business model,” the report said. ICICI Securities highlighted that companies such as Tiny Owl and Doormint had to wind up due to operational weakness.

Unit economics: This forms a key part and is critical to assess long-term viability and profitability of the company. Most good internet businesses are not profitable at this juncture just as Zomato. This is due to spends on marketing, advertising and promotions, discounts, cash backs, among other factors that are targeted at driving customer adoption and branding. “Notably, these front-ended investments should create strong moats and drive back-ended benefits in the form of brand recall and network effect. Investors should scout for businesses with promising unit economics/contribution margins before these marketing overheads,” analysts said.

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