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Weekly Insights #5- Tech Start-ups Recent Focus on Profitability & The Investment Setup

In theory, what happens to a company’s stock price is a reflection of what is happening is the company’s business. And this is true for the most part.


But increasingly investors & markets are influencing the actual direction of the businesses & companies.


A classic situation wherein markets have a disproportionate impact on the actual company is in cases of an overleveraged company & promoter. In such cases, market’s expectation of default can create a situation that leads to the default itself.


The recent short squeeze of Game Stop is a good example of how market can influence the business. The massive short squeeze that led the company’s stock price soaring allowed Game Stop to raise nearly ~$1.6 billion by selling new shares. It used a part of that cash to payback its debt and is using the remaining cash to turnaround & transform the business. Both would not have been possible if the Short Squeeze would have not led the stock price soaring.


Back in 2019, we also saw how Endurance cancelled its diversification plan of tyres manufacturing due to market & investors reaction to its announcement. We saw something similar in IRCTC in 2021, when the decision to share convenience fee was reversed seeing the fall in the stock price.


We believe the recent focus on profitability by newly listed tech start-ups to a large extent is also a result of market’s influence.


In recent quarters, all these companies have started talking about profits, the path to profitability and even provided some guidance on when they would reach there. But this was not the case 1-1.5 years back at the time of their IPO.


A qualitative timeline of how the focus & commentary has changed since IPO for these companies-


  • IPO- Hardly any talk about profitability and all raised serious cash.

  • Initial quarters as a public listed company- Commentary was still largely around growth & long-term potential. Some comments around needing to be more prudent as a public company.

  • Subsequent quarters- Some initial commentary on breakeven and road to profitability.

  • Recent quarters- Lot of talk about profitability and timeline of when it would be achieved.


And this entire shift in commentary over last 1-1.5 years has coincided with increasing fall in stock prices & markets resent towards these loss making companies. Stock prices have corrected 60-70% from their highs here.


Now the companies might argue that it was always the plan to reach profitability in near term and it is not influenced by the market or stock price fall; something that CEO of Policy Bazaar did in his recent interview- (see from 5:15 mins)


But the very fact that he made this comment makes me think that markets have indeed influenced their decision making; atleast in a subtle/indirect way.


And the biggest evidence of this lies in the cash that these companies have. All of them raised serious cash at the time of IPO and are now sitting on this large cash without any specific plan on how they will use this cash; some have even started paying it back to their shareholders.


So, the question arises; if they were already focused on profitability and had plans to achieve breakeven or profitability in near term, then why raised such large cash in the first place right?


But all things said, this focus on profitability is actually a great thing (irrespective of whether it was influenced by markets or not) and provides for an investment case in atleast some of them.


In one of our recent Weekly Insights- Neglect & Disruption is a Great Hunting Ground, we talked about the Neglect & Disruption setups; and we believe that a similar setup is at play for these companies as well.


All these companies got listed at a time when liquidity was abundant & market was extremely bullish; basically they were trading at super normal valuations. But over last 1-1.5 years, the stock prices have corrected by 60-70% led by change in market environment; and this fall was further intensified by heavy selling from pre-IPO shareholders once their 1-year lock-in expired.


The recent up move that we are seeing in these stocks looks like a sort of mean reversion to a more normalized levels as the heavy selling pressure has abated and to reflect companies new focus & visibility on breakeven/profitability.


Post this mean reversion, the companies that will achieve breakeven & display their ability to deliver sustained profitability are the ones that will see a long-term trend emerge.


The possible investment setups here could be to-


1. Play the mean reversion- more of a short-term trade; played preferably through a basket approach.


2. Focus on the long-term trend- would require some effort to figure out which company will be able to do that, as well as patience to buy at a later stage (mostly at higher levels) but with more clarity & certainty.


Or if someone is already confident on a company’s ability to create that long term earnings trend and ready to accept some level of uncertainty & risk; they can look to capture both- mean reversion + long term trend.


Lastly, I would like to leave you with this interview of Mr. Sanjeev Bhikchandani wherein he made a very good argument on how current times are different than 2000s. (see from 14:15min)


That’s it for this week, new insight coming up next week. So stayed tuned!



 

Disclosure

Surge Capital is a trade/brand name used by Ankush Agrawal (Individual SEBI Registered Research Analyst INH000008941) to provide equity research services in the Indian Equity Markets.


“Registration granted by SEBI, and certification from NISM in no way guarantee performance of the Research Analyst or provide any assurance of returns to investors”


“Investments in securities market are subject to market risks. Read all the related documents carefully before investing.”


“The securities quoted are for illustration only and are not recommendatory”



Stock specific investment disclosure:

Endurance Technologies- No Investment. Not Traded in last 30 days. Not an active recommendation in Research Service.

IRCTC- No Investment. Not Traded in last 30 days. Not an active recommendation in Research Service.

Policy Bazaar- No Investment. Not Traded in last 30 days. Not an active recommendation in Research Service.


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