Foreign capital is fantastic but domestic capital will make a big change when India goes from say 2-3% of the market cap for tech to say 25-30% of the market cap, says Gopal Srinivasan, Founder, Chairman & MD, TVS Capital Funds.
Do you think growth companies — be it internet or logistics or IT — have hit a peak now?
When I was young, I loved photography and used to carry a tripod with me. I think I need to buy one again because what I see here is a tripod. The enormous amount of liquidity is one leg, growth is another leg and inflation and yields going up and down creating concern about real interest rates and real yields on equity is the third leg. My camera is a bit unstable right now. I really do not know what we should look at and therefore the whole approach right now is that obviously valuations have gone completely crazy! I just saw that the market cap is more than the GDP after a long time. Our approach in this particular time and especially in the area of tech stocks is to encourage people to be very patient.
When you are going after a valuation base, which is driven by growth strategy for investment, typically in a SaaS company of any kind, one has to be very patient. If you were planning for five years, plan seven now; if you were planning for seven, plan eight is what I would say given where things are going. Whether interest rates go up a bit or they come down or stay in some zone, the current valuation trends in the VC industry show people paying 30 to 40 times for a SaaS company in terms of revenue multiples. So one has to be more patient as far as tech is concerned. Things are not going to go as fast. There will be a flattening if I were to take a bet.
We have seen a mad rush in the secondary and the primary market and anything which has got to do with tech, AI or even sum of parts has got rerated. What would you advise those who are convinced that this decade belongs to all the tech players?
Let us look at first in terms of unlisted space in tech. There is a huge glut of money flowing from mainly hedge funds. The standard approach is people in a very short timeframe are allocating to multiple companies in the tech growth area. For example, a $100 million cheque with a $500-800 million valuation is offered at a very high speed. The underlying cause is this is a hedge fund operating. This is my personal assessment. They are basically not underwriting the same yield as a classical venture capital fund. They are underwriting basically an allocation of 20-30-40 such investments and maybe their net returns to their clients would not be necessarily that of an Indian VC fund, which is north of 20% at the fund level.
I suspect these are at a much lower level, even in dollar terms. As a result, there is this overvaluation and we have to make sure that private equity or venture capital allocators do not over allocate in this vintage. Allocate to the best assets you can buy, does not matter if you over pay but allocate judiciously is the policy I would recommend. I can only speak as a VCP, I cannot speak from a public market perspective. We must allocate judiciously during this time and not over allocate because what you are seeing as competition is not a classical VC fund, these are hedge funds. Look at the first two-three months. I think fundamentally the total investment in VCP in this timeframe will be approximately about $5 billion which is not much different from last year’s.
There is a lot of money flowing but the growth for startup allocation is dramatically changed which indicates this phenomena. At the same time, in India the total listed market for tech has not yet opened. The total share of tech as per ET is 2.5-3% of the market cap — leaving aside ITES — as against 22-23% in China and more so in America. We should look to the future and look at the regulatory changes that are coming around us.
For example, last week at the Sebi meeting, a bunch of rules related to liberalisation of listing rules under the innovator growth platform were taken up. The Alternative Investment Fund (AIF) rules have been relaxed so that venture capital funds can invest in fintech. The startup nomenclature rules have been changed also so that the angels and start-ups of the AIF are now aligned with that of the government. PPF, private provident funds, which have been permitted to invest in venture capital funds. That is a huge change. Imagine a private provident fund can invest in venture capital funds. The government has now opened a dedicated PE vertical. I look at all these regulatory changes and I think about a year or two ahead in terms of availability of capital. This capital is something we should prepare for in addition to the short term burst of tech valuation. I see a lot of changes in the environment in terms of regulation and that is a very good sign for the next two-three years in terms of availability of domestic capital especially for tech. This will define the market very differently from this current rush of foreign funds.
This year a lot of internet companies are going public. Yesterday, it was Nazara. It could be Nykaa, Zomato, PolicyBazaar soon. How do you think the public market positioning for some of these start-ups would change because the way you value companies in the private domain versus public domain?
This is the big coming of age year of start-ups. One is fundamentally starting with the acquisition of say 1mg or NetMeds or BigBasket by large groups like Tata and
. That is the first important step you saw where the large corporate world is beginning to embrace start-ups.
The second is the listing of the same companies that you mentioned. All put together, it is a very small part of the Indian market-cap. Maybe 2.28% will become 3.54%. There is a 10x growth ahead, it is going to be a great time for the next seven, eight years in India. The reason I bought up the IGP listing is because so many of the SAS companies have been domiciled overseas. Recently there was SPAC acquisition news of various kinds. These start-ups are domiciled in the US. That may also reduce and people may prefer the liquidity that is going to be available in India driving start-up listing even in the IGP level or in the main board like Zomato and PolicyBazaar. This is the beginning of a very long wonderful ride. It is very transformative. The public market managers — be it the PMSs or mutual funds — in five years’ time will look completely different from what it is today.
For the sake of argument, what are the challenges you foresee?
Let me just look at the tech space in general. I have a strong bias and I am going to put that on the table. Fundamentally, I believe it is the availability of domestic capital which will define the kind of investments that are made. Investments by large global funds, especially hedge funds are sometimes good; it is always good to get capital. It can never be bad but it can be distortive in terms of valuation because they are seeing a preference set and a strategy across the world. Indian capital or domestic capital is very fundamental because it is much more discriminative in terms of what is the kind of business it creates, all the value it has to create is within the country.
So I keep going back like a stuck record to the one idea that today domestic capital formation in India remains static at 24-25% even though savings sometimes go up to back to 31-32% that it used to be. The moves the government is making are very positive. They are going to release more and more capital to Indian managers, VC managers and PE managers, especially VC managers with all the changes that I listed above. This will create a very strong bias on performance by the start-ups being as important as basically rush to being valued as unicorns. Will all of them make it? You know very well all of them would not, there will be challenges, there will be crashes. But we are actually peripheral to a larger investment strategy of a global fund and as we become mainstream with more and more Indian funds emerging in the VC space, the next five years will create a selection bias to select start-ups which will actually perform more in terms of real metrics because with this interest rate going up and inflation coming which is globally visible, you are going to find start-ups which have to also generate cash because the cash is going to be far more important in the next two, three years.
Any asset today that is capturing inflation will be only possible if it is generating cash and that is why people are going into consumer discretionary and financial services stocks because they are also preparing for inflation to come. So I will go back to a simple idea; domestic capital. Domestic capital means more domestic funds, more domestic funds means better choices being made. When I use the word better to define businesses, I mean they will actually generate value whether they are start-ups or whether it is growth. I am very clear about the idea that foreign capital is fantastic but domestic capital will make a big change when India goes from say 2-3% of the market cap for tech to say 25-30% of the market cap. It is possible in seven, eight years, may 10 at the outermost.
A few years down the line when you say tech, do you see it purely as an online model that is really taking over?
There are two types of investments most of us are looking at; one is basically tech enabled businesses which are all going to be omni channels. We will see very few pure online businesses outside things like payment and payment infrastructure. So you are really going to see online, offline businesses like all ecommerce is today. The offline component is growing dramatically — whether it is Amazon or Reliance or any other player like Tatas buying BigBasket.
The conversation on online, offline has become an Omni channel conversation. But the real opportunity which I am seeing in India is basically technology providers and people who are providing technology which can be used by other technology providers. That is where the big growth is. The poster child of that would be Postman. They have got a billion dollar valuation practically with no revenue about six, nine months ago. Currently, Chargebee is being written about in the 100 unicorns list in Chennai which is basically a provider of subscription management services.
There was funding of a company called YAP last week which provides interconnectivity between various NBFCs, banks and payment gateways. The technology provider is the next big breakthrough and that is where we are spending a lot of time. These are people who are providers of technology and not traditionally the consumer internet which has an online-offline conversation.
I am more interested today in the tech providers for business or the tech for tech providers as we call them at TVS Capital; people like Chargebee. A lot of these companies are coming up and those are going to be the real big game changers of the next wave after edtech and consumer internet and payment which was the first big wave.
Now I think the next big wave is going to be around technology providers and Postman was a fantastic beginning. Keep your eye out for technology providers — be it Freshworks which is a great company but unfortunately listed in America because it is a child of that time or if Zoho decides to list. Then there is Chargebee in Chennai. Look out for more of those.
Has the pandemic given birth to new kind of businesses enablers — the back end? Is there a differentiation between what worked pre pandemic and what is working now?
Other than mass digitisation acceleration, the Covid impact has been phenomenal government reforms programmes. We see a lot more SaaS businesses delivering like you saw in the retail space and because there are more SaaS businesses, there will be more technology providers for those SaaS businesses.
There are tech enablers like YAP and Chargebee. There are also others like SETU, Decentro. All of these are basically providing technology for the SaaS companies to run their businesses. I look at pure technology providers providing software solutions as a service with the subscription model.
The other businesses can be seen in agriculture where a lot of lending businesses are using technology. We see similar things in terms of supply chains which is going through a major change in India. Supply chains for MSME financing are using technology but I am not sure it has been accelerated due to Covid or any such movement. It is fundamentally a trend that is becoming faster and faster.
There is a lot of technology in lending but I would not call them technology businesses. They are simple tech enabled businesses. Covid has accelerated processes which would have taken 4-5 years more,.
The key thing really is to look for more and more technology providers. Dream 11 was a dream, Nazara is another fantastic dream. Look for postman, look for Chargebee, look for Zoho, look for Freshworks, look for Capillary’s. That is where I would spend a lot of time. These are all businesses, which in some sense, have taken a leaf out of IT enabled services. They are developing products in India for the world.
The Chargebee founder has relocated to the Netherlands. Mad Street Den in Chennai is one of the only AI enablement platforms that is used by people all the way from Tata Digital to various brands abroad, which people turn to when they want to enable AI on their ecommerce platforms. I do not want to use a word like deep tech but these are technology providers for technology businesses and for people who want to use technology. That is the next five year wave of India.
It is a great point but what is happening to some of the stock prices of let us Shopify, or how Salesforce stock price has corrected in this market drop. Some would argue that from a market standpoint, this is a well discovered theme. If interest rates go higher, you may not actually give them valuations.
True I was sitting making a segway to the next three to five years. What you say is 100% true. You really need to look at businesses that are going to capture whatever inflation or interest rates increases that take place but since we are talking about technology, I just thought this whole emergence of companies that are pure technology companies is an area to keep an eye out.
If those companies list, then you are going to see listings like Snowflake. That I think is a big next five year game changer in this space. I am not into the next one year because we are investing for 5 to 10 years.
So in my summary look for technology providers. Domestic capital will create a new breed of funds and the regulatory environment has never been as positive as in the last 14 years that I have been in business in private equity. Look at the Prime Minister starting a seed fund to help incubators fund their incubatees and forming a council to advise them which consists of people from the industry. I just think that is a big story for domestic capital.
If somebody was to ask you, how can I get rich, give me a tip, how would you respond?
In the same old way. Build a great business. If you are an investor, find a great business and stay with them patiently. This is exactly what private equity does and that is what I think every retail investor should try and do. Surfing comes with a risk of accidents.
Do you think that India can actually climb the tech curve and get to a point where we see actual AI like what we see coming out of China or even super sophisticated encryption coming out of Israel?
India will look more like an extension of America. Israel is a very unique country. They have done some fantastic things, ALso unlike China which is a world economy, India will look more like an extension of America. It will look like basically the kind of companies that are coming out of America that is why I give the example of Snowflake. It is a very simple example all of us understand. It is really changing the way data is used and interchanged across data providers across the world.
While I hate to use words like silicon valley and so on to describe Bangalore, I think it captures the idea that India will look like America. It is very influenced by how America develops, it is very influenced by Indians who spent time in America, it is very influenced by Indians who live in America. Please remember what happened in 2000. How skill arbitrage and wage arbitrage developed and led to the ITes Industry. Just apply the same thing to developing tech providers and technology providers for business that is going to come up during 2020-2030. That is where our fund tries to invest 20-30% of our money.
