Niveshak September-October 2020

Issue II - Volume XIV

EDITOR'S NOTE Qui n’avance pas recule

Dear Niveshaks, We are delighted to present to you the September-October 2020 edition of Niveshak. With COVID raging all over the world with a second wave, multiple vaccines have reached the final trials. On the domestic front, COVID infection rate has considerably slowed down, but it is too early to say we are at the end of the tunnel. Global markets waited with bated breath towards directional bias on the back of US elections and further lockdowns across Europe.

Due to solid earnings growth and recovery across sectors and companies in Q2, global markets have been upbeat and Indian markets have also been in-tune with the global sentiment. Consequently, there’s optimism in the air leading to an increased appetite for quality IPOs.

TEAM NIVESHAK Harichandana Aritro Datta Hulash Goyal Arushi Mathran Ishan Pandey Hardik Goyal Megha Rekhani Manish Kumar Mehak Nihar Mehta Shivangi Pratyush Kumar Siddhant Saha Rakesh M K Tushar Gera Sandhaan Goyal Vignaesh S Vasundhara Misra

NIVESHAK | SEP-OCT'20

EDITOR'S NOTE

This is our cover story giving a bird’s- On the Shoulders of Giants is a eye view of what’s leading to the mad section for Nobel-winning economics and finance theories. This edition rush to IPOs and what lies ahead. covers improvements and inventions In the FinView section, we bring you in auction theory by Robert Wilson the views of VC expert Apoorva and Paul Milgrom.

Sharma on the state of VC and venture debt funds in India, the ‘Something Ventured, Something impact and importance of venture Started’ of this edition covers the debt for a country like India with funding received by different startup many startups. In the magazine's ventures and the reason as to why a classroom section, we leave you with particular company is valued at, and some food-for-thought on the what is the investors’ thinking while efficiency of stock markets and a looking at the potential future value variable such as information affecting of the company. this efficiency. With the new Niveshak team coming to the fore, there’s As a parting note, we wish all of you a always room for fresh ideas. very happy Diwali and hope Samvat Consequently, these ideas have 2077 brings in more prosperity and transformed into new sections such as relief to the badly battered world. We “Know your Sector,” “On the hope you enjoy the magazine and Shoulders of Giants,” “Something derive something valuable out of it.

Ventured, Something Started,” and finally, finance and economics trivia Stay Invested, TEAM NIVESHAK section “Quiz.”

Know your Sector of this edition talks about the FMCG sector, the dynamics, overall benchmarks, and performance metrics for evaluating the industry and touches upon fundamental “must-know” things of the industry.

All images, design and artwork are copyright of IIM Shillong Finance Club © Finance Club Indian Institute of Management, Shillong Disclaimer: The views presented are the opinion/work of the individual author and the Finance Club of IIM Shillong bears no responsibility whatsoever.

NIVESHAK | SEP-OCT'20

6

THE MONTH THAT WAS

THE MONTH THAT WAS 1. RBI buys ₹10,000 cr. of state bonds through OMO for the first time For the first time, the Reserve Bank of India purchased ₹10,000 crores worth of state bonds through open market operations. RBI has offered to buy ₹1,505 crores for 7.78% Maharashtra state development loan (SDL) 2029 and ₹1,199 crores for 7.17% Karnataka SDL 2029. This measure aims to improve the activity in the secondary markets.

2. Farm Bills The government has introduced three farm bills, namely The Farmers’ Produce Trade & Commerce (Promotion & Facilitation) Bill, 2020, The Farmers (Empowerment & Protection) Agreement on Price Assurance & Farm Services Bill, 2020 & the Essential Commodities (Amendment) Bill, 2020. These bills would change the way agricultural produce is sold & marketed across the country and would allow the farmers to sell their produce outside APMC mandis without paying state taxes.

3. Government announces a stimulus package worth ₹73,000 cr.

The central government announced a stimulus package worth ₹73,000 crores which is expected to give some boost to the demand in the economy during the festive season. The government has decided to offer a special advance of ₹10,000 to the central government employees. In addition to it, it has announced an LTC cash voucher scheme which can be used to buy products carrying GST of 12 % or more.

4. Vedanta's De-listing Failure

Vedanta Resources failed to complete the delisting process of the Indian arm Vedanta Ltd., from the stock market.

The reason stands to be the failure to gather 134 crore shares (90% of shares of the company) needed to complete the delisting. The company could manage to secure only 125 crore shares.

It may now make an open offer to increase its stake to 75%.

NIVESHAK | SEP-OCT'20

5. Nobel for auction theory Paul R. Milgrom and Robert B. Wilson won the Nobel prize in Economics (Sveriges Riksbank Prize in Economic Sciences) for ‘improvements to auction theory and inventions of new auction formats’. The Nobel Committee said that the auction formats proposed by the winners have been extensively used to sell radio frequencies, fishing quotas and airport landing slots.

6. TCS becomes the 2nd Indian company to cross ₹9 trillion in market capitalization After Reliance Industries Ltd., TCS has become the second Indian company to cross ₹9 trillion market capitalization. The TCS stock reached a record high of ₹ 2504.20 on the Bombay Stock Exchange giving it a market capitalization of ₹9.36 trillion.

7. Parliament approves ₹2.36 trillion COVID-related expenditure The Finance Minister has sought the approval of the parliament for incurring an amount of ₹2.36 trillion in FY21 to meet the increased expenses due to coronavirus. This additional spending would mostly be directed towards the government programs under the Garib Kalyan Yojana scheme and Atmanirbhar package.

7

THE MONTH THAT WAS

8. Monetary Policy Committee maintains the status quo The monetary policy committee has decided to keep the repo rate (4%) and the reverse repo rate (3.5%) unchanged, given the high inflation rate. Also, the committee expects the economy to contract by 9.5% in the current financial year.

9. Ant Group’s IPO - the biggest of all times Ant Group announced that it would raise $34.5 billion in its dual initial public offering. According to Ant group, the stock issuance would be split equally across Shanghai and Hong Kong. This IPO is considered to be the largest till now. The IPO of Saudi Aramco, worth $29 billion now stands to be the second largest in the world.

10. Bitcoin reaches a new peak After PayPal Holdings announced that it would allow customers to use cryptocurrencies, Bitcoin, the largest cryptocurrency, increased by 8.5% and surged to almost $13,000 for the first time since July 2019. The current price of Bitcoin stands to be $17,783.33.

NIVESHAK | SEP-OCT'20

8

NIF PERFORMANCE EVALUATION

NIVESHAK INVESTMENT FUND PERFORMACE EVALUATION

Return Measures Total Investment Value: ₹10,00,000 Current Portfolio Value: ₹18,01,975 Change in Portfolio Value: 1.22% Change in Sensex: 2.55%

Risk Measures Standard deviation NIF: 34.95 Standard deviation Sensex: 25.83 Sharpe Ratio: 2.71 (Sensex: 3.46) Cash Remaining: 1,46,352

Comments on Equity Market & NIF Performance Due to solid earnings growth and recovery across sectors and companies in Q2, global markets have been upbeat and Indian markets have also been in-tune with the global sentiment. Consequently, there’s optimism in the air leading to an increased appetite for quality IPOs. After initially facing minor fall in till mid-September the market turned bullish and Nifty 50 index almost touched 12,000 levels. The market is expected to remain bullish in the coming days given the geopolitical scenarios.

NIF showed a decent return with change in portfolio value at a decent rate of 1.22%. The net portfolio value has reached a level of ₹18,01,975.

NIVESHAK | SEP-OCT'20

9

NIF PERFORMANCE EVALUATION

Individual Stock Weight and Monthly Performance

Top Gainers for Sept-Oct 68.88% Blue Dart 18.18% ADF Foods 14.63% Dr Reddy’s

Top Losers for Sept-Oct -32.76% Indiabulls Housing -18.53% PVR -13.53% ITC

NIVESHAK | SEP-OCT'20

COVER STORY

10

THE MAD RUSH FOR IPOS WHAT LIES AHEAD? The IPO market seems to be in red-hot form in 2020 compared to last year.

Despite COVID-19 and the prolonged economic slowdown, IPOs worth around â‚š29,500 crores have hit the market this year compared to around â‚š13,000 crores in 2019. IPO frenzy is coming back big time after a dull period of a few years. As many as 80 organizations have approached SEBI this year to get necessary regulatory approvals for going public. IPOs have made a lot of money for investors. The listing gains have been tremendous in most cases except for the SBI Cards dampener on the back of COVID national lockdown. This year, every company that went public has been oversubscribed in almost every category of investors, and retail investors especially, have shown an increased appetite in the IPOs. The following graph shows the historical trend of the amount raised and the number of successful IPOs in India since 2007.

Why the interest?

IPOs of various sectors of the economy have gone public, from payment systems to defence companies to pharmaceuticals, and many are in the process of hitting the market soon. With a sharp turnaround in secondary markets, IPO markets have also rebounded quickly since March lows. Market awash with liquidity, falling interest rates, lack of alternative options has created this mad rush for IPOs. Most of the IPOs made strong debuts helping shortterm investors make significant gains.

NIVESHAK | SEP-OCT'20

11

The first half of 2020 has been impressive, but the second half is expected to be even more rewarding for investors and companies.

Some of the companies listed this year are unique, for which there are no listed peers. SBI Cards, for example, is a payment solutions provider. It is the second-largest credit card provider in the country with a card base of over 10 million and an extensive portfolio of premium, classic, travel, shopping, exclusive and corporate cards to cater to both individual and corporate needs. Happiest Minds, being an IT company, derives its revenues (almost 97%) predominantly from digital services, whereas benchmark IT companies like Infosys, TCS draw anywhere between 35-45% of the revenue from digital services. CAMS, a famous technology-driven financial infrastructure provider, is hugely dependent on AMCs for revenues and controls around 65% market share with no listed peers. Mindspace Business Parks REIT is the second only REIT to go public after Embassy REIT that

COVER STORY

went public in 2019. But why are companies looking to go public in the midst of one of the most prolonged recessions the Indian economy is going through?

Some analysts attribute this to benchmark indices witnessing a strong run in recent months on the back of COVID vaccine hopes and the economy's gradual reopening. Besides, things have been pretty slow since March, giving rise to pent up demand.

Listed companies raising capital through alternate mechanisms for tiding over the uncertain times are giving confidence. Additionally, the people's interest in the IPO's has also increased, as can be seen from them being oversubscribed. This is primarily the case because the grey-market premium is high and the hopes that the issue will result in listing gains due to recovery.

However, word of caution that investing in IPO does not necessarily always result in profits in the short run, irrespective of valuations. It has also been proved recently in the UTI AMC IPO case. A few factors contributing to the surge in the IPO issues are excess liquidity due to cuts in the interest rates and printing of currency by the US Fed, contributing to the revival of the Indian markets from their lows of March.

NIVESHAK | SEP-OCT'20

COVER STORY

12

Reforms by SEBI Besides, the Securities and Exchange Board of India (SEBI) rolled out a few measures to ease the whole process to promote capital raises. These provided many temporary relaxations and oneoff measures, including extending the validity of observations on companies' draft order documents, reducing the minimum subscription amount in rights issues by companies, and increasing permissible size variations from 20% to 50%. SEBI is soon expected to develop a consultation paper on equity dilution requirement from 10% to 5% for IPOs with more than ₹10,000 crores as post-issue capital. To illustrate this, assuming LIC's m-cap to be ₹10 lakh crores. Under current regulations, LIC would have to come out with an IPO of ₹1 lakh crores to ensure 10% dilution. But with SEBI's new regulations, if implemented, the IPO size can be between ₹50,000 to ₹51,000 cr for 5% dilution. This 10% rule is a constraining factor, and if proposed changes are implemented, it might help large Indian companies to go for Indian listing rather than foreign listing.

SEBI is also proposing to increase the timeline for maintaining minimum public shareholding from 3 years to 5 years for IPOs with more than ₹10,000 crores post-issue capital.

New guidelines will be finalized soon for overseas listing of Indian companies.

Once these guidelines are enacted into law, it would give more options for behemoths like LIC and many other Indian companies to directly list on individual foreign stock exchanges.

Global Scenario Globally, the last September quarter bucked the trend of a traditionally slow IPO period as the markets were flooded with liquidity, leading to the most active third quarter over the previous two decades by proceeds and the second-highest Q3 by deal amount.

An EY report as of October 18 on IPOs says that globally IPO activity has accelerated, resulting in a 14% increase in the total number of IPOs to 872. A PwC report shows a stellar 43% rise in proceeds to $194.8 billion, with Q3 2020 alone contributing $116.7 billion. India was ranked ninth globally in terms of the number of IPOs in Q3 2020.

Despite heightened volatility and uncertainty in global markets, IPOs continue to fare favourably compared to 2019.

Below is the graph that shows the historical trend of the amount raised

by IPOs since 2011, and after a stagnation period of few years, investor appetite seems to be coming back slowly.

The pie-chart shows the country-wise contribution of the number of IPOs in Q3 2020.

NIVESHAK | SEP-OCT'20

COVER STORY

13

What's next?

The other side of the story is Jack Ma's Ant Financial. It was anticipated to be the biggest ever IPO in the history of the world. The previous biggest was Aramco listing in Saudi exchanges raising $29 billion in 2019.

Ant Financial was looking to raise anywhere between $34-36 billion, but the whole process ended up a disaster amid the Chinese regulators denying permission for listing, citing "financial risk prevention."

Ongoing concerns regarding the evolution of COVID in the US and the impact of further lockdown in Europe remain the fundamental headwinds going ahead.

Many exciting companies are waiting to hit the markets. Kalyan Jewellers plans to raise around â‚š1750 crores.

Burger King and Barbeque Nation Hospitality have plans to mop-up a considerable amount of money. New age renewable solutions company ReNew Power Ventures is planning for a UK listing. Warburg Pincus-backed CleanMax Solar and Morgan Stanleyowned Continuum Wind Energy have started the groundwork for IPOs. State-owned RailTel Corporation has filed papers with the market regulator SEBI. Bajaj Energy, one of the largest private-sector thermal generation companies, is expected to hit the market any time in December. HDB financial services, NSE, NCDEX, IRFC, are also in the early stages of the process of getting required regulatory approvals.

IPO's to look forward to at a glance:

NIVESHAK | SEP-OCT'20

COVER STORY

14

But to top all this, the blockbuster IPO of Life Insurance Corporation (LIC) of India is expected to hit in Q4 of FY21 on the back of government struggling to mop-up revenues to bridge the deficit through disinvestment. The size of IPO is estimated to be anywhere between â‚š90,000 to â‚š1 lakh crores for a 9-10% stake sale, making it the largest ever Indian company by market capitalization. But the problem with LIC is its valuation. LIC has all kinds of assets making its valuation difficult.

But there's also the question of investor appetite & absorption of such scale by the Indian market. With management quality and the ability to take the company ahead, LIC is as good as it gets. Timing could be an issue for LIC, with the government under tremendous pressure to raise money.

It has never been the case when the stock market falls by 40%, and brokerages show rapid customer acquisition. In comparison with 2008, the acquisition rate had dropped significantly and had almost remained stagnant till the 2009 elections. This time, industry data shows massive retail participation in markets even during the lows of March this year.

Brokerages saw nearly a 70% rise in account opening, and 80% of these new accounts were by first-time millennial investors.

Even SIP data regarding mutual fund inflows indicate millennials sticking to SIPs in a falling market. Because of discount brokerages, availability of information, and technology easing the process of investing, young investors have more avenues for learning. Most market savvy millennials follow veteran investors and value their opinions. Young investors flocking into the market makes the scene even more interesting for IPOs. The second half of FY21 is expected to be a big draw for companies and investors. But will Samvat 2077 be a blockbuster year for IPOs is a question only time can answer. IPOs might continue to garner investors in the primary market after recent successful subscriptions.

Companies with the highest governance standards, differentiated business models, and financial positioning might find it easier to list going ahead.

50 40 30 20 10 0

NIVESHAK | SEP-OCT'20

15

ARTICLE OF THE MONTH

MODIGLIANI & MILLER PROPOSITIONS: THE IRREVERENCE IT TAKES TO MAKE FINANCIAL DECISIONS IRRELEVANT

By Akshay Pai, SCMHRD

It was in 1958 that professors Franco Modigliani of MIT and Merton Miller of University of Chicago published their paradigm shifting paper in the June issue of the American Economic Review. Innocently titled “The Cost of Capital, Corporate Finance, and the Theory of Investment” the paper went about knocking down prevalent financial wisdom for decades after publication.

Like an explosive revelation, the theory singed decades of conventionally accepted practices with its ‘irrelevance propositions’. In the succinct 30-page article detailing their work, the two professors elaborated transformational new ways of reforming the conventional corporate finance approach that earned them a well-deserved Nobel prize in Economics. Though the Nobel Prize is never disputed, the theory has had its fair share of critics, with most of the criticism being centered around lack of practical applications of the theory, which requires far too many assumptions to be grounded in appreciable reality.

This arcane (for most management graduates) theory, which is a mystery shrouded in an enigma wrapped in a puzzle for finance novices can be brought down from its lofty perch in economics to the practicalities of Dalal Street and everyday life by concentrating on what the theory is, why it matters and how knowing about it can impact you.

What is the M&M Theory?

The revolutionary theory peddles the astounding supposition that under the right assumptions: financing decisions are irrelevant, cash management is unimportant, capital structuring is unheeded by the market, dividend policy immaterial, financial risk management is peripheral at best, shareholding patterns don’t hold any importance and last but not the least, diversification is not a business necessity.

The theory achieves this impact through two enigmatic propositions which are deceptively simple at first glance.

NIVESHAK | SEP-OCT'20

16

Proposition 1 Under the right assumptions, the firm’s total market value is independent of its capital structure; that is to say, the market value is independent of the percentage of debt or equity in its capital structure. The proposition stresses that the value of the firm is determined only by the left half of the balance sheet (composition of assets) rather than the right half of the balance sheet (composition of equity and debt).

Proposition 2 Under the right assumptions, the firm’s cost of equity increases in proportion to its debt-equity ratio. Greater the presence of debt in the capital structure, greater would be the expected rate of return expected and demanded by the equity holders.

What real world applications does the theory have?

The reason why these propositions were so revolutionary is that they went against the core tenets of Wall-Street in the 1960s, which was maximizing returns. Firms used (and still use) leverage to maximize shareholder returns by adjusting debt levels,

ARTICLE OF THE MONTH

providing financial and operating flexibility.

M&M propositions proposed that in an idealised world (the real world for economists!) leveraging debt will not work miracles, the ideal capital structure would be one which best bolsters the operational parameters of the enterprise, and not the one which would supposedly provide best return to investors.

The theory proposes total market value for levered and un-levered companies remain the same given a level of risk and operations and firmly puts the onus of value creation on the company’s operations and not on its finances.

The theory is controversial because like most economic theories, it is based on a multitude of assumptions, most of which involve conditions difficult to create or maintain in actual financial markets.

The assumptions involved in the theory are – information is symmetric, markets are frictionless and efficient, investors are rational, cashflows remain unimpacted by financial policies (no bankruptcy), there is no taxation (corrected in a later version of the theory).

NIVESHAK | SEP-OCT'20

17

These assumptions led to a generation of scholars investigating the theory, some tried to improve it by bringing it down from the ivory tower and lofty ideals of economics to the metricdriven world of Wall Street.

Critics have chosen the following three avenues of attack to negate the theory’s importance – the tax shield effect, the agency & bankruptcy cost debates, and the fact that information by its very nature is asymmetrical. Modigliani and Miller accepted the tax shield deficiency in their original work and modified the theory to account for corporate taxation.

The other two critical points while not directly addressed in the theory, only exist as sore issues because the financial markets don’t function the way they are supposed to function, the blame for market and regulation inefficiencies can hardly be passed on to Modigliani and Miller.

Why do MBA grads and future CXOs need to know about M&M theory?

Modigliani and Miller’s theory brings the balance sheet from out of the

ARTICLE OF THE MONTH

boardroom and onto the production floor, by positing the company’s value creation to be a function of its operations rather than its financial structuring.

In professor Modigliani’s own words, the best thing the theory did was teach future generations of CXOs that the prevalent concept of management existing to maximize profit or shareholder returns could be wrong, instead they could aim to maximize the market value of the firm by running it better, which is after all what the market likes.

M&M Theory has had a second coming with the rise of ESG considerations in funding and financing that has taken place in the last decade. The assumptions involved in the two propositions lead critics to question the base practicality of the theory, however the theory that proves pretty much everything else irrelevant, holds its relevance even after half a century of scrutiny and skepticism.

The starry-eyed MBA students of today (like the author) will be joining the workforce in the post-Covid era, with markets all over the world facing the

NIVESHAK | SEP-OCT'20

18

ARTICLE OF THE MONTH

most desolate and darkest of all depressions in history. This will inevitably lead to a tightening of purses and credit may well be made available on the basis of salt of the earth numbers like operational returns and asset valuations rather than glossy figures on the right half of the balance sheet and easy to manipulate financial metrics.

The M&M theory also offers another parallel to Andrew Sheng’s famous quote regarding financial engineering and real engineering in the cult classic ‘The Inside Job’ – “Why should a financial engineer be paid 4 to 100 times as much as a real engineer, the real engineer builds bridges while the financial engineer builds dreams… and when those dreams turn out to be a nightmares, other people will pay for it.”

The M&M Theory helps put to bed the age-old question - 'Is it Financial Management that creates value to the firm, or is it the Engineering line and staff that create value, which is then maximized by the Management’s decisions?'

Akshay Pai MBA – Infrastructure Development and Management, 2019-2021 Symbiosis Centre for Management and Human Resources Development (SCMHRD)

NIVESHAK | SEP-OCT'20

19

FINVIEW

FINVIEW MS. APOORVA SHARMA Apoorva Sharma, CFA Principal, Stride Ventures Alumna, IIM Shillong

Venture India Debt Fund I sector-agnostic, or are there only specific sectors you look at?

Here’s some context about venture Q1. Can you brief us a bit debt funds.

Venture debt has two about Stride Ventures' maiden fund - Stride Venture India elements: Debt Fund I? 1. A coupon-bearing term loan, which is the debt component that Stride Ventures is a category II AIF gives the debt IRR. venture debt fund under SEBI. We 2. A small portion of warrants are received its license in July 2019 and associated with every transaction, started deployment of funds in and all these warrants are November last year. It has deployed premium-free equity options in the funds across 11 companies, including company. There’s an exercise SUGAR Cosmetics, HomeLane, Miko, period associated with it and you etc. The fund is being operated at the can exercise it during that period partner level by ex-bankers who have and book the capital gains. That more than 65 years of experience in the gives the warrant IRR. banking domain across multiple domestic and foreign banks.

The targeted return for venture debt is Q2. Can you give us some between 18-20% IRR on a gross basis, context about venture debt in net of fees, but pre-tax. It is pretty India? And is the Stride sector-agnostic. Venture debt is highly underpenetrated in India as compared

NIVESHAK | SEP-OCT'20

20

FINVIEW

to the US. To give you a sense of the quantum, debt would roughly be about 15% of venture capital in the US. In India, venture debt is around 1.5% to 2% of venture capital. In general, while venture debt is pretty sector agnostic, it usually comes to a company that has raised a certain amount of equity. At Stride Ventures specifically, at present, we’re looking at agri-tech, logistics, direct-to-consumer, & ed-tech.

So, this asset class has evolved and become much more matured over thelast five to six years, but it’s still in its early stages when you compare it to the developed markets.

Q3. On the point of under penetration of debt in India, do you see the perception changing in the near future?

There have been a lot of challenges.

While India does have early stage funds, India needs more domestic growth-stage funds that can support the company at later stages when it requires a high amount of capital.

A lot of the unicorns like OYO, Paytm, Byju's, Ola have attracted significant capital from Chinese investors specifically. The reason that these unicorns have gotten to the stage they are in is that they have been able to attract foreign capital. Domestic capital probably would not have been able to support them this far. So, it is important that foreign capital flow into the Indian economy.

Post April, the Indian government stalled automatic-route FDI and placed certain restrictions on raising capital from neighbouring countries. This has been a major setback for many startups and created a lot of uncertainty in terms of survival or valuation of these companies. I’m aware of many startups

Venture debt has evolved over the last 5-6 years. Founders & the venture capital community have become more accepting to this asset class. There has been some capital flowing to it and that’s the reason why there are 4 venture debt funds in India and hope more will come soon. There’s substantive amount of interest from Limited Partners (LPs) that this asset class has been able to gain. Earlier, “how will negative-EBITDA companies service debt” and hence “what is the value proposition for taking debt” were some things people didn’t get, there was a lot of education required and it had its own gestation period. But now, more and more founders understand the use-case for venture debt and how they can preserve dilution by having a good mix of debt.

Q4. Will India be able to bring foreign venture capital postCovid? What is the role of foreign venture capital in India?

NIVESHAK | SEP-OCT'20

21

that had received term sheets and were ready to sign but these were later pulled at the last moment due to the uncertainty relating to FDI. There have been major down-rounds, future sustenance of the company has gotten impacted.

For some startups with significant Chinese shareholding, the investors are not able to support their existing companies let alone investing in a fresh, newer set of companies.

So, we hope for some relaxation there soon because India does need foreign venture capital.

Q5: In the current economic climate, which sectors do you find particularly interesting and which ones do you not find interesting when looking at the start-up space? Why? With respect to the pandemic, the economy has broadly opened, and restrictions have eased. Things will change, some sectors where there has been a bubble will soon come to a halt.

During the pandemic, one of the first sectors that benefitted was ed-tech.

Many ed-tech companies raised a substantial amount of capital from the venture capital and venture debt during this period. These start-ups were doing very well, they saw a substantial reduction in customer

FINVIEW

acquisition costs (CAC) because they were taking market share away fromthe offline players and people were keen to adapt to it.

Health-tech also saw a big boom. In India, people still consider healthcare to be a personalized space. They are not very comfortable with virtual consultations or even buying medicines online. The pandemic has given a massive push towards the adoption of technology and making these things more acceptable. Similarly, content and gaming saw a boom.

The screen-time for a lot of people increased during the lockdown with work-from-home. There was a boost for content and gaming companies.

Also, collaboration tools, any company that has a SaaS-based collaborative tool that helps in remote working, learning management systems, collaboration saw an uptick. Direct-to-consumer brands benefited. Earlier they used to say that the distribution channel that a consumer brand creates is its moat (how many general trade stores, modern trade stores, tier-2 and tier-3 cities presence), but during the pandemic these direct-to-consumer brands got a boost because they took market share away from offline players.

E-commerce obviously saw a boom; Amazon, Flipkart, Swiggy Genie, BigBasket benefitted a lot.

NIVESHAK | SEP-OCT'20

FINVIEW

22

In the startup space, the hardest hit sectors were automotive and sharedmobility companies like Bounce, Vogo. There were not too many people on the road and therefore utilization of capacity already installed was lower.

This underutilization of capacity was a big problem. Similarly, co-living and co-working spaces suffered. Startups where there was a lot of capacity installed (and therefore fixed costs) and the utilization suddenly contracted suffered. I don’t think this will last in the long-term though. In my personal opinion, ed-tech has grown exponentially, but with vaccines around the corner and people moving out, it can see some correction in valuations.

basis, the company should not be burning money at a unit level. The reason that these startups have negative EBITDAs is because they haven't reached the scale to cover corporate overheads and selling and administrative expenses. However, there can be a stage 3-4 years down the line when the company can become profitable because inherently the fundamentals look strong.

Second is companies potential.

scalability. VC's like with hyper-growth

Thirdly, how big is the Target Addressable Market (TAM). If you are in a very small market with a lot of competition, it probably does not make Q6. While investing in a start- sense. If you’re in a blue ocean with up, what are the key factors very few competitors, or even if you’re that you take into in small market with few competitors, the TAM is huge and the company can consideration? do a lot with it.

From a financial perspective, there are some very different things that you Further, there are softer aspects like look at because all the financial ratios the founder, their vision and their that we learned about like the Debt background which attracts venture Service Coverage Ratio (DSCR), the capital. Above all, it’s about how well Interest Coverage Ratio (ICR) won’t the founder tells their story. From a be applicable since a majority of these debt-lender perspective, it also matters companies have negative-EBITDA. who are the other venture capitalists You look at there is unit economics; backing the company. This is because see how much the company is making debt cannot replace equity, it is an on a per-order or per-transaction ancillary source of capital. Debt in

NIVESHAK | SEP-OCT'20

23

FINVIEW

Indian startups typically won’t be more than 15% of the total equity raised till date. The reason is that these companies are cash flow negative and they are not generating cash to return the principal in the short-term.

Q7. Given that the venture capital space is known to be difficult to break into, what is your advice for students of IIM Shillong who want to pursue a career in this domain?

My only advice would be that apart from whatever we learn, it is essential to keep following startups, try and form your opinion around the business model and analyse why some startups do well and some fail. There are a lot of resources available on the internet; there are some subscriptions that a finance enthusiast can subscribe to like The Ken, AJVC. In general, be aware of the startup community and frame your opinion on their business model and their founders.

Apoorva Sharma is an investment professional with combined experience of about five years in the fields of Wholesale Lending and Investment Banking. She has completed her CFA Charter, worked for reputed firms like Deloitte, HSBC, Xander Finance Private Limited and is currently working at Stride Ventures.

NIVESHAK | SEP-OCT'20

24

FINGYAN

RCEP AND WHY INDIA IS NOT A PART OF IT

By Siddharth Mishra & Rishabh Sharma, NIBM Pune

Regional Comprehensive Economic Partnership (RCEP) is the economic agreement being negotiated since 2012 between ASEAN and Free Trade Agreement (FTA) member partners.

And finally, after eight years, the world's largest trade pact in terms of GDP was signed on 15th November 2020 at a regional summit in Hanoi.

RCEP includes 10 Association of Southeast Asian Nations (ASEAN) members - (Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand, Vietnam) and the five countries with which the bloc has free trade agreements (FTAs) – (Australia, China, Korea, Japan, and New Zealand). Earlier, India was the 6th FTA member, but India decided to opt-out of the pact last year.

These countries account for 2.1 billion people, approximately 30% of the world’s population, contribute over 25% of world exports, and makeup around 30% of the global Gross Domestic Product.

The signing of the deal is a blow to the rival Asia Pacific group, i.e., Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), which the USA had exited in 2017 under Donald Trump. The USA is absent from both RCEP and TPP, leaving the world's largest economy out of the two trade groups that span the fastest growing region globally.

Aim of RCEP The pact's objective is to create an integrated market so that it would be easier for the products and services of every member country to be available across the entire region. It also aims at promoting investment in developing countries and includes other provisions on intellectual property, telecommunications, financial services, e-commerce, and professional services.

The new rules of origin, which officially define where a product comes from, will qualify countries for tariff reduction among RCEP members. The

NIVESHAK | SEP-OCT'20

25

bloc also promises to eliminate some tariffs on industrial and agriculture products and set out rules for data transmission.

Why this deal is a blow for USA The trade war between China and the USA in 2019 led to export fall from China to the USA by 8.5%, whereas it rose by 2.1% with the rest of the world.

Faced with a production surplus, China was forced to lower its tariffs in May last year. Since the USA is not showing engagement in Asia, RCEP may cement China’s position more firmly as an economic partner with South East Asia, Japan, and Korea, putting itself in a better place to shape the region's trade rules. Also, this deal would help Beijing cut its dependence on overseas markets and technology.

This new group includes many US allies, and this is a windfall primarily resulting from Trump’s retreat from TPP. A Comparison with TPP It appears that RCEP is not likely to usher in comprehensive economic integration in East Asia. TPP, on the other hand, were it not to be abandoned by Trump, would have been the most extensive FTA in terms of market opening. There were questions about TPP promoting

FINGYAN

a "free trade" or a highly discriminatory "managed trade." Three sticking points where the agreements differ are in elimination, labor, and environmental standards. Compared to RCEP, which includes Canada, Mexico, and Chile, it aims to eliminate tariffs, labor restrictions, and environmental standards and attempts to place restrictions on state-owned enterprises.

That’s because the smaller and less economically developed ASEAN states in RCEP are financially unable or unwilling to commit to TPP level standards.

Why India opted out of the deal Last year India decided to withdraw from this deal as our PM Shri Narendra Modi believed that this deal in its present form does not reflect the fundamental spirit and guiding principles of RCEP. He also mentioned that neither the Gandhi Talisman nor his conscience permits him to join RCEP. Following were the primary reasons that prevented India from joining RCEP: 1) China's cheaper products would flood the Indian market. India was looking for an auto-trigger mechanism that would allow it to increase tariffs on products when imports cross a specific cap.

NIVESHAK | SEP-OCT'20

26

2) RCEP participants like China are known to use non-tariff barriers in the past to prevent India from growing its exports to the country. About this, India has already expressed apprehensions on lowering and eliminating tariffs on several products from countries.

3) The criteria used to determine the product's national source were not appropriately addressed. Current clauses and provisions do not prevent countries from back-channeling or routing through other countries' products on which India maintained high tariffs. It is anticipated that this allows countries like China to pump in more products in India.

4) Protection of the domestic industryIndia had sought to safeguard domestic industries' interests through measures like seeking a 2004 base year for tariff reductions instead of 2013 India has raised import duties on several products from 2014-2019, and using a base year before 2014 would mean a drastic drop in import duties on these products.

5) India has an over $50 billion trade deficit with China, and this was also an important reason for India not joining in. India’s bilateral trade as increased post-FTA with South Korea, ASEAN countries, and Japan, but imports to India have risen faster than India's exports. According to a paper published by NITI Aayog, India has a

FINGYAN

bilateral trade deficit with all of the member countries of RCEP. Will the decision hurt India?

Experts say that the decision will affect the bilateral trade relations of India with the RCEP members. This is primarily because the members might be inclined to concentrate on bolstering economic ties within the bloc. There are also concerns regarding this decision impacting the AustraliaIndia-Japan military and commercial network in the Indo-Pacific.

Several RPCs expressed their strong inclination to re-engage with India, and RCEP Ministers even adopted a Declaration on India’s participation in the agreement leaving the door open to India to join RCEP Agreement as an original partner and signatory at a later stage. Further, India has been given the ‘observer’ status and invited to participate in RCEP meetings and economic cooperation activities undertaken by RCEP members. RCEP members have also agreed to restart negotiations, discussions with India once India submits a formal request citing its intention to accede to the agreement. Japan will play a significant role in RCEP to keep the doors open for India. India's alternative option is to renew its existing bilateral Free Trade Agreements with its RCEP members.

NIVESHAK | SEP-OCT'20

27

CLASSROOM

CLASSROOM: EFFICIENT MARKET HYPOTHESIS Are the stock markets efficient?

One of the famous questions in finance, there has been heated debate on this issue. Let’s break this down.

First of all, what does “efficient” mean?

The stock market is ‘efficient’ if it reflects all the information about all stocks in the prices of those stocks.

Secondly, which “information” are we talking about here? There are different types of information here, which leads to three forms of the efficient market hypothesis (EMH): - Weak EMH: This posits that stock prices reflect all information in the history of stock prices and returns. That is, all information about past performance is already incorporated in the price of the stock.

- Semi-strong EMH: This variation says that stock prices reflect all publicly available information. The semi-strong EMH is what most people mean when they say “markets are efficient”. This form of the EMH does not mean that prices won’t change; in light of new

publicly available information, the stock price will adjust quickly to incorporate new information.

- Strong EMH: Stock prices reflect all relevant information, including inside information about a stock.

While here is much debate about whether markets are efficient or not, there have been some interesting findings related to the EMH. One of these is the Post-Earnings Announcement Drift (PEAD). In the case of an earnings surprise, where actual earnings deviate significantly from expected earnings, while the EMH would lead us to believe that the stock price would quickly adjust in the direction of the earnings surprise, researchers found that the prices kept adjusting, for several weeks or even months.

So, are markets efficient? If so, to what degree? Something to think about, till the next edition of Niveshak!

NIVESHAK | SEP-OCT'20

28

KNOW YOUR SECTOR

KNOW YOUR SECTOR: FMCG Fast-moving consumer goods are the fourth largest sector in the Indian Economy. Although this is one of the fastest-growing sectors globally, however, in India, the case is quite the opposite.

The per capita consumption is one of the lowest in the world when it comes to the FMCG sector. Nevertheless, this gives the industry a long way to grow. Broadly the FMCG sector can be divided into three parts: Household and personal care Healthcare Food and Beverages

The FMCG sector is characterized by high barriers to entry and a highly fragmented and competitive environment. With more and more MNCs entering the market, competitive pressure has pushed the players to invest heavily in advertising and aggressive marketing strategies to gain market share.

HUL, Nestle, Godrej are a few of the top FMCG companies in India.

They are highly valued by investors because of consistent sales, profit and most importantly volume growth in the past decade leading to increased investor value.

NIVESHAK | SEP-OCT'20

29

KEY RATIOS - Out of Stock Rate (number of items out of stock at the time customer places an order, Industry average - 8%) Managing your inventory is one of the most crucial tasks in order to attain supply chain efficiency. The thorough analysis behind the causes of Out of Stock situations allows one to identify the key touchpoints where actions need to be taken.

- Delivered On-Time & In-Full (the portion of shipments reach their destination on schedule and quantity ordered, good performance 90%) Broadly on-time refers to the date requested by the retailer (or as promised by the manufacturer) and in-full Is quantity, measured at the time of delivery. It helps not only in reaching an agreement between the supplier in terms of performance expectations but also reduces supply chain complexity.

- Cash-to-Cash Cycle Time (time between payment is made to the suppliers and payment is received from the customers) It refers to the number of days cash is tied up in working capital.

Understanding the cash to cash cycle allows the business to predict payments, track products' movement, and keep track of cash flows. It is measured by the following formula: DOI (days of inventory) + DOP (days of payables) – DOR (days of receivables).

KNOW YOUR SECTOR

- On Shelf Availability (percentage of time a product is visibly accessible on the shelf for sale) It helps analyze the capacity of a business to meet customer demands and is usually measured either by physical identification and audit or by inventory data analysis.

- Carrying cost of inventory (cost of storing unsold goods) It is referred to as the total amount spent on holding inventory in a given time. It includes the owning cost, storing cost, and the cost associated with keeping items in stock. The cost is expressed as a percentage of the total inventory in the given time.

Businesses can use this metric to gauge how much can be earned based on current inventory levels. In the FMCG business, inventory costs account for a large portion of current assets on the balance sheet.

NIVESHAK | SEP-OCT'20

30

ON THE SHOULDERS OF GIANTS

ON THE SHOULDERS OF GIANTS Allocating scarce resources is the bedrock of economics. In the present era, auctions have played a pivotal role in this regard. Auctions are everywhere and affect our lives, be it e-bay, the sale of google ads or the telecom spectrum, or the case of cricket players at IPL. Yet this centuries-old phenomenon has become so complicated that this year’s Sveriges Riksbank Prize in Economic Sciences, also known as the Nobel Prize in Economics, in Memory of Alfred Nobel was awarded to Robert B Wilson and Paul R Milgrom “for improvements to auction theory and inventions of new auction formats.”

Auction - "It is an event where different parties bid to purchase a good, a service, or a right."

The Laureates’ Contribution:· • Wilson showed that rational bidders tend to place bids below their own best estimate of the ‘common value’ for fear of paying too much (Common value is the value of an item that is deemed to be the same for everyone).

This tendency is popularly known as the winner’s curse, wherein the bidding amount exceeds the true worth of an item due to the overestimated evaluation of an asset.

• Milgrom complemented it with theories on ‘private values’, i.e., when the perceived value of something differs from bidder to bidder.

• Thus, an auction format will give the seller higher expected revenue when bidders learn more about each other’s estimated values during the bidding process.

NIVESHAK | SEP-OCT'20

If information about the item is highly uncertain, say in the case of oil fields where the quantum of oil is unknown, it would make buyers cautious and reduce the seller’s profit.

Hence, there is an incentive for sellers to gather and share expert information with bidders within different auction formats.

New Auction Format: Simultaneous Multiple-Round Auctions Often, auctions of interdependent items would create uncertainty in the minds of the buyer. For example, the rights to frequency bands were auctioned region by region.

As a result, the national telecom companies couldn’t be sure of acquiring the same frequency everywhere. To deal with such a situation, they devised the simultaneous multiple-round auction in the early 1990s wherein they advised the United States Federal Communications Commission (FCC), a new way to allocate licenses to the broadcast spectrum used for wireless communications.

31

ON THE SHOULDERS OF GIANTS

Under this method, all the items are sold simultaneously (say frequency bands of different regions), and bidders can bid on any number of items. Since auction takes place in multiple rounds, it not only mitigates the risk of “winner’s curse” but also gives the bidders a chance to re-evaluate their strategies with any new insights they would have observed from the other bidders’ in the previous round. India, United Kingdom, Canada etc., have successfully adopted this model.

A major highlight was that they brought their work to the real world and transformed the government policies toward auctions worldwide.

NIVESHAK | SEP-OCT'20

32

SOMETHING VENTURED, SOMETHING STARTED

SOMETHING VENTURED SOMETHING STARTED Fresh-To-Home, the well- known meat e-commerce company, has raised $121 million in its Series Cfunding round, backed by investors like the Investment Corporation of Dubai (ICD), Ascent Capital, and the US-based institution – DFC. In the Series B funding round, the company has raised $20 million lead by Iron Pillar as the lead investor.

The company has now raised a total of $152 million in 7 funding rounds.

David Wehner, the chief financial officer of Facebook, had also participated in the latest round, valuing the direct-to-consumer fresh food firm at a post-money valuation of $380-$400 million.

The main competitors of Fresh-To-Home are other major meat e-commerce platforms like Licious and Big Basket, as well as smaller players TenderCuts and ZappFresh. Fresh-To-Home also faces stiff competition from local players that use Swiggy and Dunzo for their supply chain.

Licious has currently raised $94 million with annual revenue of around $15 million.

Zappfresh is a relatively smaller player with total money raised around $3.3 million and annual revenue of $4.8 million. With monthlyorders growing from 420,000 last year to 1,500,000 this year (257% growth), the company turning profitable at the EBITDA level, and nearing annual recurring revenues of $80 million, this round will add firepower to the late-growth stage startup.

Annual Recurring Revenue (ARR) is a significant growth and momentum metric in subscription-based startups and venture capital. The company aims to cross the $200 million ARR mark by next year (150% growth).

Shan Kadavil, CEO Fresh-to-Home, believes that the market is untapped and has much more potential since 99% of India's fish and meat market is dependent on wet markets. In India, the fish and meat market is around $94 billion, The company has just entered the market, and with capital raise and support, the company can expand its operations rapidly in India.

NIVESHAK | SEP-OCT'20

33

QUIZ

QUIZ 1) According to India's International Investment Position data as at end of March 2020, released by RBI, FDI in the country has raised by how much?

A. $13 billion B. $15 billion C. $19 billion D. $11 billion 2) Hyundai Motor India Limited partnered with which bank to offer industry's 1st online auto retail financing on its end-to-end online automotive retail platform, 'Click to Buy' to the customers?

A. HDFC Bank B. Axis Bank C. DCB Bank D. Federal Bank 3) The cabinet committee on Investments has been set up to address which of the following:

A. To submit a report on the hurdles creating bottlenecks in the economy B. To boost big ticket investments and untangle red-tapism C. To fast track disinvestment in PSUs D. To attract foreign investment into India 4) Which company became the first to hit the $800 billion market valuation?

A. Apple B. Tesla C. IBM D. Blackberry 5) Which company has signed a non exclusive term sheet to acquire FreeCharge?

A. mCheck B. Obopay C. Paytm D. PayMate

NIVESHAK | SEP-OCT'20

34

6) Which was India’s second largest IPO by issue size till date?

A. Coal India B. Reliance Power C. GIC Re D. SBI Cards 7) Coffee Day Enterprises recently announced to sell its majority stake in Way2Wealth Securities to ___________ A. Shriram Credit Company B. ICICI Securities C. Zerodha D. Cholamandalam Investments 8) The infamous paper napkin story of U-shaped tax revenue vs tax rate policy leading to US President Ronald Reagan reducing tax rates was written by ________ A. Arthur Laffer B. Milton Friedman C. Walter Adams D. Jack Hirshleifer 9) Milton Friedman said _________ is a form of taxation that can be imposed without any legislation whatsoever.

A. Additional surcharge, cess and duties B. Inflation C. Income tax D. Utility tax

QUIZ

10) Sarwan and Sunita Poddar are an NRI couple who own 7.2% of a public, unlisted company. They received their share of the company after they gifted one of the founders an island. They are the second-largest shareholders in this company. Identify this well known, privately held company.

A. Baidyanath B. Sri Sri Tattva C. Patanjali Ayurved Limited D. Biotique 11) Which is the 1st Indian pharma company to make a strategic move to shift its manufacturing of some essential drugs from India to the US on Trump’s executive order directing US federal agencies to “Buy American”?

A. Jubiliant Life Sciences B. Cipla C. Lupin D. Sun Pharma 12) It is the 1st bank in the country to invest in note sorting technology and has deployed industrial robots to automate the process of handling the high volume of currency notes at its vaults. Which is this bank?

A. SBI B. HDFC Bank C. ICICI Bank D. AXIS Bank

NIVESHAK | SEP-OCT'20

35

QUIZ

13) Recently, Indiabulls Housing Finance Limited’s shares were excluded from NIFTY 50 index. Which company replaced it in the index?

16) The cost of which source of capital requires adjustments for taxes in the calculation of a firm’s weighted average cost of capital?

A. HDFC Life B. Shree Cement C. Nestle India D. SBI Life

A. Common stock B. Preferred Stock C. Bonds D. All of the above

14) Consider the following statements about MCLR:

17) Recently, BSE partnered with which bank, to empower Small and Medium Enterprises?

a. RBI has replaced Base Rate with MCLR b. MCLR is more sensitive to price changes in comparison to Base Rate Which of the statements are correct?

A. a only B. b only C. both a & b D. Neither a nor b 15) In an acquisition, the interests of minority shareholders are best protected through the use of __________ A. Sell-out rights B. Clawback provisions C. Covenants with indentures D. Executive remuneration

A. AXIS Bank B. Yes Bank C. Kotak Mahindra Bank D. ICICI Bank

Answers 1) C 2) A 3) B 4) A 5) C 6) B 7) A 8) A

9) B 10) C 11) C 12) C 13) C 14) B 15) A 16) C 17)B