Is the time ripe for consolidation among new-age technology companies?

Tightening liquidity conditions and a shift in focus from growth to cash-flow is likely to drive consolidation among the new-age information technology (IT) companies going ahead, believe analysts. With tightening liquidity, start-ups, they said, have been shifting focus from growth at any cost to cash conservation as survival becomes key.

“Excess liquidity created a bubble, with many businesses lacking a path to profitability. Current conditions will bring-in the much-needed rationality, a positive for larger players, including traditional firms. Tough macro also present merger and acquisition (M&A) opportunities driving consolidation,” wrote Vivek Maheshwari of Jefferies in a recent coauthored note with Jithin John and Kunal Shah.

A rise in cost of capital has already weighed on the related stocks all across the globe over the past few months. After outperforming value until December 2021, the S&P growth index has underperformed for the past six months led by a rise in cost of capital (bond yields), the Jefferies note said. The NASDAQ is down around 30 per cent from peak, with Facebook, Apple, NVIDIA Corp., Google and Microsoft Corp, popularly known as the FANGMAN stocks, down 20-70 per cent led by drop in valuations.

Back home, the stocks of recently listed new-age companies – Zomato, PayTM, Nazara Technologies, Indiamart, Policybazaar etc. – have also suffered in this global rout and slipped 37 - 59 per cent thus far in the first half of calendar year 2022 (H1-CY22), ACE Equity data reveals. In comparison, the S&P BSE Sensex has lost around 9 per cent, while the mid-and small-cap indexes have slipped around 12 and 15 per cent, respectively during this period.

 

A rise in interest rates, according to Jyotivardhan Jaipuria, founder & managing director at Valentis Advisors, though will hurt India Inc. as a whole, but the section he would worry about most are the new-age companies. “Companies are making cash losses and were relying on private equity funds to fund these losses. A risk-off environment could hurt many of these start-up companies and they will be forced to cut costs drastically to survive in a tougher equity environment,” he said.

Tough liquidity conditions have already pushed companies to focus on profitability, according to Jefferies. Zomato management, for example, is clear on what the shareholders expect and will work hard to deliver on growth and profitability. 

“Nykaa has strong profitability DNA and sees no need to acquire lowest rung customers. Makemytrip intends to accelerate the profitability while keeping an eye on recovery to pre-Covid level. Start-ups are also facing the heat and taking hard decisions although illiquidity of private market insulates them from the rout seen in the profitless tech names,” the Jefferies note said.

A K Prabhakar, head of research at IDBI Capital also expects some consolidation in the industry going ahead as the cost of capital rises and the funding dries up. A lot of companies, he said, will have to change their business models in order to stay afloat.

“Bigger players like Jio Mart, Amazon etc. will do better as they have deep pockets. Over time, businesses will have to recalibrate their strategy and follow an asset-light model. The focus should be on breaking even. The current business model cannot work in a rising interest rate regime where credit is becoming difficult. Financiers, too, have rolled back their commitments. All this, I feel, will lead to an industry-wide consolidation in the new-age tech companies,” he said.