New Age Tech Stock Correction – a Possible Investment Opportunity?

The past year has been a roller coaster for new-age internet-based companies to list with much fanfare — from garnering massive interest in IPOs (initial public offerings) until their stock price plummeted from its peak. The main factors that could explain this fall are the global technology crisis, sky-high valuations, the Indian market unaccustomed to such fast-growing “loss” businesses, as well as technical and company-specific issues.

We focus on three main aspects. First, is the movement of stocks in the new internet age a bubble? Second, we try to understand the mindset of new-age entrepreneurs. Third, we look at ways to identify winning stocks.

Is this the new age tech stock bubble: The level of fear that new-age companies are witnessing seems overwhelming. However, the platform/networking age also allows successful companies to reap incredible rewards much faster than in the previous era. Despite the global sell-off in tech stocks, five of the top 10 most valuable companies globally are tech companies. Even in India, while some of these companies may fail, it is likely that some will emerge with great success.

Asymmetric investment opportunities appear in the midst of panic with very few participants. As such, for long-term investors, panic over new-age stocks could present an opportunity. The Book of Peter Thiel Not to One emphasizing that “The opposite does not mean that dumb people disagree with you; that means smart people don’t agree with you.” Most smart investors agree that investing in proven ideas is better than investing in unproven ideas. However, business model innovation involves trying something new and is therefore unproven.This paradox is often true for all investment opportunities at inflection points.

Understanding the New Age Entrepreneurial Mindset: When a startup matures to the point of having a killer product, a large market, and a strong distribution channel, it can become a ‘scaling’ company. Usually, the fastest and direct path from startup to scale is the hypergrowth created by ‘Blitzscaling’, this is a term popularized by Reid Hoffman in his book replication. When a market is ready to take, the risk is usually not underperformance – the real risk is playing too safe. Now, Blitzscaling involves doing things that don’t make sense under traditional business thinking, such as prioritizing speed over efficiency despite an uncertain environment.

Amazon has been criticized for consuming capital without providing a steady profit. But the global e-retailer’s ‘underperformance’ has helped it dominate online retail, e-books and cloud computing. The power of ‘Blitzscaling’ lies in the ‘first scaler advantage’. Once scaling takes a high place in its ecosystem, both talent and capital flow in. This explains why venture capitalists want entrepreneurs to pursue exponential growth, even if doing so is more costly and increases the likelihood of failure. The bigger risk is moving too slowly and allowing competitors to gain market leadership.

How to determine possible winners: Growth alone does not create value, unless combined with an innovative business model. For example, a company can achieve high levels of customer satisfaction and revenue growth if it sells a $bill 100 for $10. But none of the scale of this model will create any sustainable value. Reid Hoffman offers a set of tools, principles, and frameworks for evaluating innovative business models and winners.

How to know if a business model can deliver exponential growth: The first is the ability to predict the entire addressable market and how it will develop. Next, the new age company must evaluate whether they can leverage existing networks to create a viral distribution model—where users bring in more users. The third factor is the ability to generate large gross margins. Finally, the company must be able to create a network advantage.

Then there are a few patterns to look for. Models based on electronic bits are more scalable than atoms of matter, as with digital goods. Then a platform of scale and network effects is a great combination to have. Third, free services are powerful, Google and Facebook are great examples. Fourth, the market has produced many global winners, which become stronger when combined with a double-sided network effect. Five, the subscription model has a significant distributive advantage. Finally, feed-based businesses, like twitter or Instagram can have a significant advantage.

We believe that long-term investors can leverage these tools, principles, and models to identify potential future winners.

Siddharth Bothra is a fund manager at Motilal Oswal AMC.

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