Enigmatic Unicorns

We (my business associates) spent some time in Management Consulting before we were badly hit by COVID-19. During COVID lockdown too we never stopped ourselves from exploring both existing and emerging business models.

Management Consulting is a very difficult proposition for the Indian market. In our short journey, we met a few promising and smart entrepreneurs with steady revenue but inefficient operations. We coined a term called “BAU on Auto-Pilot mode”. By that, we explained that the business top heads need to relieve themselves from the monotony of daily operations and make some quality time for future growth.

However, Indian entrepreneurs are very controlling and our proposed model seemed to have taken out that control from the clutches of the existing management vesting into a more efficient and manageable management group. Irrespective of the operational distress they draw synergy spending time in fire fighting all the time. We burned our fingers not once but at least half a dozen times, before we finally put our business idea in the cold storage until we find the right takers.

We had a unique business proposition that integrates the daily operations and deliverables with project management tools that helps the business manage operations efficiently and deliver products and services at a lower cost.

Till date, more than 80 Indian start-ups have achieved the Unicorn status which means their valuation is over a billion USD (more than Rs.7,500 Cr.). The usual process of a valuation occurs when a start-up goes public (launching an IPO) or sells stakes to an investor. The current dispensation at centre is promoting the entrepreneurial eco-system and boosting start-ups like never before. The Make In India brand is visible again and we stopped looking down upon those products but with a sense of Pride. The brand new young entrepreneurs not only take the coming up technologies to a new level but also are very environmentally concerned.

Be that Neem Wood Toys, Bamboo Toothbrush, or an AI-based Live Stock Management System, all of them demonstrate both commercial and environmental appeal. The Toothbrush Industry itself is Rs.5000 Crores per year which produces million metric tons of plastic wastes further deteriorating environmental conditions.  The world Toy market is pegged at Rs.7 Lakh Cr., while the Indian market size is valued at Rs.5000 Cr. which is not even 1% of the world market. Now in India too Indian manufacturers were only catering to 25% of the market, the rest was dominated by China. So these start-ups will also generate employment and contribute significantly to India’s mission of a 5T USD economy.

Let me come back to the subject that is confronting me for the last couple of days is the intriguing business models of these start-ups. Though I am yet to absorb Wal-Mart’s acquisition of loss-making Flip-kart, however, I convinced myself that a small price that the former paid to access the Indian market with a tested business model. With approximately $40 billion valuation Flip-Kart tops the Indian Unicorn chart however its loss stands at Rs.2445 Cr. and Rs.2881 Cr. respectively for the wholesale and E-Commerce business.

But few recent events associated with the most successful international start-up Facebook which resulted in the loss of $251 billion in valuation forced me to dive deep into the subject. Just 4 weeks ago my associate was very upbeat while he called me up to tell me that his nephew got selected with FB UK with a handsome package. While discussing the FB business model I shared my concerns around the FB business model and sustainability against the growing awareness of users and their concerns for privacy.

In July 2019, Federal Trade Commission (FTC) imposed a $5 billion (roughly Rs.37,500 cr.) penalty on Facebook for violating new consumers’ privacy. More recently a federal judge approved a $650 million (roughly Rs.4,875 cr.) settlement of a privacy lawsuit against Facebook for allegedly using photo face-tagging and other biometric data without the permission of its users.

In the last quarter, at least half a million FB users left the platform and this continuous trend raise serious concern around the sustainability of the internet service business. Two decades ago Yahoo was valued at $125 billion now on the verge of a $5 billion company with near extinction in various services sectors such as Search Engine, Email, Messenger services.

Yahoo was reigning over the market until the arrival of a more focused IT Service Company Google which instantly took over the Search Engine business and eventually E-mail business. Facebook and WhatsApp snatched away customers for the Messager service. History repeats itself, In May 2021, Apple launched its App Tracking Transparency feature that allows users to opt-out of being tracked across apps and websites for advertising purposes. FB now blames this IoS feature for the mass exodus of FB users. It’s now up to Mark Zuckerberg to exhibit his leadership skill and drive FB out of this situation of potential annihilation. We all remember how Apple/Mac shined from nowhere and positioned them as the world’s most valued company though they registered their presence long back.

I had the opportunity to view a few of the start-up pitches on Shark Tank India on YouTube. I did some further study of the panel of sharks (Already leading successful start-ups), their product, business model, net worth, revenue, profitability, and valuation. I made it a point to watch all the episodes and learn from each of them wherever possible buy their products. During that time I constantly asked one question to myself, if I am an investor why would I invest in a particular venture (what would be my biggest driver). I think the conventional school of thinking will suggest profitability. Absolutely right, I invest a certain amount I take certain return (profit). Here comes another aspect of investors’ concern that is the security of investment. Security of investment can be ensured only with the sustainability of the business in the longer term. Any premium over the risk-free return (i.e. Interest on Bank FDs.) always comes with proportionate risk. The bigger the return higher the risk.

Very surprisingly these start-ups or Unicorns don’t trumpet their profit figures they rather focus on brand building and valuation. Every investor including the promoters earns from a higher valuation the profit is literally peanuts for them. This is not new at least for those who trade in share, for them the dividend earning of the share is the second priority, and an increase in value of a share is first.

One of my associates shared her experience in one of their recent collaborations with a beverage outlet; the client very smartly set aside all their suggestions on the operational efficiency and profitability and sold a minority stake to a Non-Resident partner with a valuation 10 times what my associate estimated. By this, the client not only recovered all his investment but also continued to hold the majority stake in the business. Since the set-up was built on one of the associate’s Bangalore properties and they had a fair understanding of the client's investment in the venture, hence the valuation proposed to the said partner stunned all involved. Now the sale proceeds of the stake covered the entire investment and the excess money used as working capital. In case the entrepreneur earns a cash profit that’s profit goes directly to his pocket no bank interest, no mortgage, so liability-free business. 

This is a successful business model: inflate the valuation, create a buzz around the brand, and exit through IPO launching or selling stakes to another investor. If we scrutinize all the start-ups most of them are either booking losses or have huge carried forward losses. As a result of which 50% of Nov 2021 IPOs fall below their issue prices amid a market crash. Paytm launched its IPO @Rs.2150 now traded in BSE @938 so the retail shareholders are ultimate losers. The initial investor won’t divest until they get a buyer at the projected valuation even if this means sustaining losses. But not every start-up is as fortunate as Flip-Kart or Paytm, there are cases of start-ups losing out Unicorn status and start-ups completely shutting down like PepperTap. 

When the valuation is purely based on the hyped buzz around a particular business idea or the perception of a brand, completely brushing aside the balance sheet, then that leads to a situation when a trivial market condition or a piece of mere negative news wipes out millions of dollars in the valuation.  

If you review the companies ranked by market cap, you will be surprised to find how much worthier companies are listed at the bottom, however, they perform very steadily throughout.