Wake up, SEBI

Circa November 2021

Nykaa issue price: Rs 1,125.

Paytm issue price: Rs 2,150

It was natural against the background of successful listings that in early 2022, the founders of an edtech start-up were in the US meeting investors to explore the possibility of a
US stock listing.

This company, valued then at $22 billion, the world’s most-valued edtech company, buoyed by the biggest fund raise in the start-up ecosystem of $800 million, eight acquisitions, and the surging demand for online learning thanks to Covid, was prompted to make yet another acquisition -- a tutorial company for slightly under $1 billion -- ostensibly foreseeing well before the others a move toward offline learning post-Covid.

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Using valuation to buy companies that are in a much lower multiple and putting it all together to make an ‘Action Defining Logic’ entity with a monster value was a strategy that was working and logical for the edtech company in that heady world of acquisition-led and fund-infusion-based valuation fantasy, before taking the company public and placing the monkey of that overvalued monster squarely on the shoulders of believing, FOMO retail investors.

The demand for online learning dipped, predictably, as the world crawled back to normalcy post-Covid. But, by that time -- a year later -- Nykaa’s stock price had fallen to Rs 150, an 87 per cent erosion in value in 12 months; and Paytm had fallen to Rs 800, a similar 75 per cent erosion in value in 12 months. Retail investors were losing confidence in these new-age, very visible businesses. The sentiment was not right to go public.

So, against this backdrop, and the start of a prolonged funding winter and rising interest rates, the edtech company seems to have used, with the help of investment banks (IB) and private equity (PE) firms, etc., a page from the PE playbook to list the sub-parts that were acquired by the parent company -- specifically one, the offline tutorial business, a year into its acquisition -- to raise capital.

It is important to note that the offline tutorial company had filed a red herring prospectus (RHP) for a stock market debut in 2018. The plans were shelved and, instead, a PE investor came on as an investor in 2019 for a 37.5 per cent stake at an enterprise value of $500 million. In 2021, this was bought at a 100 per cent growth in valuation by the edtech company. It was widely reported that the new owners, ie., the edtech company, were to re-file a RHP with SEBI for an IPO to raise $1 billion at an enterprise value of $4 billion. So, to the naked eye, the edtech company enabled the creation of 4x value in just one year and 8x value in two years by using the PE dealmaking playbook, with nothing to back this exponential growth in value, just to raise capital!

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All things considered, the re-thinking on this IPO plan and its shelving was a godsend for the retail investor. Over the past year, the parent company has imploded, with mass layoffs, investors and independent directors resigning, write-downs in valuation by 75 per cent, the jettisoning of the auditor, and unaudited losses of Rs 4,500 crore for FY21, the last year for which it has made data available.

The parent company, still in its heyday a year ago, was reflecting future value at 32-times revenue (the median value of edtech companies in 2022, according to Finerva, was 3.7x revenue) and was around that time thinking of offloading it on to the public.

The offline entity was to be listed at 10-times revenue, according to reports at the time.

Contrast this to a year after, when an investor, Prosus, the Netherlands-listed internet assets arm of Naspers of South Africa, valued its investment in the edtech company at a discount of 73 per cent (at $5 billion) when the company started to implode.

My questions to Madhabi Puri Buch, the Chairperson of SEBI, are these:

1. Where is the potential for wealth creation for the retail investor if valuations are 10-times the industry median? Would SEBI have allowed the listing of the parent at $22 billion or the offline subsidiary at $4 billion if the can of worms hadn’t opened up on its own? Would we have had a repeat of Nykaa, Zomato and Paytm, the issue prices
of which have left the retail investor high and dry?

2. Why is SEBI not looking at how these companies and their investors, who have an impending listing, raise and bring down values so opaquely?

What all this basically means is this: The usual suspects -- IB, PE, some founders, etc. -- were at it again, gaming the system. How can the value of such an entity grow every other year despite debilitating losses to match the value of, say, a Titan Company, which has a turnover of Rs 35,000 crore and a profit-before-tax (PBT) of Rs 5,000 crore with 45 years of history? And then, an investor overnight drives down the value 75 per cent by simply ‘writing it off’?

The edtech company and its investors need cash now, so that it can continue to ride the carousel and not get thrown off the roundabout until the next infusion and valuation. Value needs to be protected as stakes are high and everyone needs to get their money back. If new investors come in, they too will seek a profitable exit at some point. The SEBI must keep a watch on how these goals are achieved in order to protect the retail investor. The SEBI chief should know that if an IPO is the stated objective of an entity, then the route of value creation is as important as the RHP. It should watch for oblique forms of insider trading -- where the IPO is gamed to suit existing investors at a pre-decided value and retail investors are left holding the can.

(The writer is a former Managing Director of a Tata Company and now runs a successful Corporate Finance practice)