When stocks of technology companies in the new era went public, there was a paradigm shift. Everyone thought this was the future, these are new companies that will change the way we do business and how the profits will be and how this business will only grow. But now we’re seeing a complete reversal. Difficult questions being asked about fit, money burn, and mitigation?
Now I’ve learned that every time I hear about a new investment model or use new metrics or new terminology to explain how a business is valued, it doesn’t end well. I think there are different models for investing in technology and the most relevant at the moment is the Gartner model that talks about drivers of innovation. Then the peak of inflated expectations occurs and I think what we saw was closer to the peak of inflation expectations. Then there is what they call the trough of disappointment, which is what we see now in the market, which is usually followed by the slope of enlightenment.
The technological drive for innovation is clear. One reaches a certain critical mass in the technologies that actually facilitate a better value-added product or service. People get carried away a lot in what they can do. For example, look at cryptocurrencies and the entire region. There are a lot of use cases that are very valuable but reverted to values in fantasy areas.
Just to give an analogy, money is very important for playing Monopoly. Lots of tokens are very valuable for playing different types of games on the net and on digital media, but does that mean Monopoly money is really worth the money? Too often, we lose sight of reality. Not to mention that the whole architecture in the hack in terms of technology that the entire blockchain infrastructure represents is fundamental.
We will get more and more use cases as with Web 3.0 the subscribed reviews are completely out of control. This is where we experience a basin of disappointment. Then we’ll get the slope of enlightenment which means that some of these use cases are already emerging and then many of the use cases start to expand and we’ll see a slow recovery in those companies that will deliver these use cases.
We will eventually reach what is called a productivity plateau, when it is widely adopted, everyone will have it and then efficiency increases and so on. The additional innovation that usually takes place in every industry does not add marginal benefit to the customer and thus we do not stop any economic payment for it. So one gets investment returns if one invests initially. Then there’s that kind of climax where one has to come out and now we’re feeling a trough of disappointment. But let’s accept one thing. Technology has fundamentally changed the way we live and will continue to do so but we are going through an area of correction that is absolutely necessary in this life cycle.
If you parallel the TMT boom and bust, the number of companies that survived when the cycle reversed was less than 5%. Will we go through this change? Will it be survival of the fittest and only giant corporations will survive?
definitely. Let me tell you who are in trouble and will remain in trouble and who will not. There are some common patterns and mistakes that people have made in being over-excited and exuberant with technology in the recent past.
The first is the companies that created the augmented products, namely
But the investor, consumer or customer can’t pay for it and they have supported it for far too many customers. There are only 10 million consumers in India making more than six transactions on the network in a single year, but there are many companies building use cases of 50, 100, 200 million customers.
I’m 100% sure we’ll get there, but if you build on infrastructure a lot up front and then burn cash a lot up front or acquire clients that will bleed you for many years, the net present value of that for the investor will be pretty poor. We see one of those kinds of things.
The other thing is that companies that do more of the same and do what other traditional companies do but gain customers and show very high growth due to discounting in many ways and that’s across sectors.
There is a lot of this in the fintech space, so the benefit to the customer or consumer doesn’t improve but with the discount, they gain customers. We’ve seen this in gold loan companies and various types of new age fintech. They do not recover these costs from customers and burn a large gap but they are growing fast. That’s just one example, I mean, there’s a lot of this stuff going around.
The third point is that the inflation point to go from negative cash flow to positive cash flow is too far away. When the cost of capital is zero, this works well because your 20-year cash flow now equals your cash flow now and people would be willing to take those bets but with the rise of the long-bond in the US I would say the benchmark for the null rate worldwide risk above 3%.
Suddenly one has to recalculate that, and the issue is when the cost of capital starts to rise after 40 years of chronic decline, is that you do the opposite and start in the opposite direction. The problem now is that no one knows where it will end up in terms of cost of capital. Cash flows that are too far suddenly don’t look attractive anymore and again there is the revaluation.
Finally, there is also what I call absolute implementation shortcomings in these companies. It would also hurt. But if you look at global markets, I think the fifth point I’m going to mention is where regulators step in and put a cap on corporate economics. We’ve seen that in a big way in China with Alibaba, Tencent, Didi and others getting hurt as a result.
In India, payment companies have been disrupted by NCPI and UPI. We also see the government taking initiatives to create what they call an ONDC structure for retail access.
One has to look at government actions and government intent closely in the field of technology. But if one looks at big companies like Alphabet, use technology assessment metrics like M-Score. Just take the enterprise value of the company and calculate the five-year cumulative R&D expenditure which gives an M grade. It’s very cheap, Alphabet is really cheap today.
In terms of how you view companies and separate men from boys, as I mentioned, a lot of these metrics may give you false indicators as well. What is the right way for these companies to become valuable at some point?
This is what I say. Some of these really powerful companies are very attractive buys. A company like Alibaba for example, has 800 million customers and 10 million sellers. There are only 2.5 million companies registered in India. Alibaba has 10 million sellers and does not charge transaction fees. They only charge people to display their merchandise or to display their merchandise earlier. How do you rock a project like this other than potential regulatory pressure?
I think it’s basically a very powerful franchise. Likewise, with Google, it is very difficult to get rid of it and Alphabet, which is a publicly traded company. There are a lot of these very powerful companies with great cash flows and they are as low as 30%-50%. So how do you rock Amazon? Look at the kind of franchise they’ve built, and if Amazon raises their prices across the board by 2%, I don’t think they’re going to lose any business because the bottom line, the operating leverage is massive. There are these types of highly rated businesses that give investors opportunities to buy and then there are the types that I identified earlier.
Does the constant selling we’re seeing in a lot of US tech companies compare to the dot-com crash in the early 2000s?
Do we need to apply that very basic methodology in determining how to access the cash flows? I can understand the two-sided exchanges, saying that they are going to burn money because we need to build the population on both sides and that will result in an ecosystem where traditional cost curves don’t apply. We have a permanently low transactional marginal cost.
I can understand the money burn use case saying that this is a fixed unit cost; Once I get past this, my contribution becomes positive and I start making money. But there are a lot of those other types of situations that a lot of Indian tech companies are guilty of, where they get hurt and will continue to hurt until they fix things on the operating side. I don’t see the capital markets treating them very nicely.