Startups with billion-dollar valuations are staring at uncertainty and lower valuations. Who’s down and who’s up? Most unicorns have sufficient capital to see out even a prolonged crisis. Also, over the long term, the crisis is expected to speed up digitization

MUMBAI : As the new coronavirus started spreading quickly in India last month, the founders of a fast-growing unicorn scrambled to introduce measures to protect their staff from transmission. The company, however, kept the lights on at its Bengaluru offices, in the belief that its operations would continue, with a few disruptions, no matter what happened, one of the founders said on condition of anonymity.

But as cases kept rising and panic spread, more and more employees took to working from home. Then, India enforced a nationwide lockdown starting from 25 March. Out of habit, the entrepreneur drove to his office in Bengaluru on the first day of the lockdown. Standing outside, he just couldn’t believe that the office, and the street outside, were deserted.

“How do you plan for something like this? This can set us back by years,” he said.

Used to skyrocketing growth, internet companies have been stunned by the near complete collapse of their businesses during the lockdown, now in its sixth week.

The crisis presents a particularly vexatious problem for many of India’s 20-odd unicorns, or startups with billion-dollar valuations. While India’s unicorns have together raised more than $21 billion in capital, according to Tracxn, they still do not generate profits. Most of these firms—including Oravel Stays Pvt. Ltd (Oyo), Paytm (One97 Communications Ltd), Ola, Swiggy and Zomato Media Pvt Ltd—were anyway facing a reckoning as tech investors across the world demanded that companies show profitability rather than kicking the can down the road after the failed public offering of WeWork last year.

But the covid-19 crisis has both accelerated that reckoning and transformed it by another order of magnitude. According to estimates by RedSeer Management Consulting, India’s internet economy is set to decline by as much as 90% this month compared with April 2019. The fall is driven by travel bookings, online retail and food delivery. In calendar 2019, the overall internet market stood at $70 billion, according to RedSeer.

Worse, even after the lockdown ends on 3 May, it’s unclear when business will resume. Fact is, the coronavirus has a higher propensity to spread in metros and other cities that account for nearly all of internet commerce.

Funding slowdown

Apart from vanishing revenues, the covid-19 outbreak has made it tougher for unicorns to raise capital. New restrictions on Chinese investors, who had become the most prolific startup investors in India over the past three years, have made it tougher to attract fresh capital. In addition, SoftBank, the default source of capital for unicorns, is struggling to cope with its own problems. The Japanese firm is unlikely to take large new bets and has become choosy about backing existing portfolio companies.

Already, the proposed funding rounds at transportation app Ola and gaming app Dream11 are being delayed because of the crisis, people familiar with the matter said. Ola has seen a plunge in its core cabs business while revenues at Dream11, which gets a large part of its business from cricket-related gaming, have dropped over the past month because of the postponement of the Indian Premier League and other cricket tournaments.

Dream11 declined to comment. Ola didn’t respond to an email seeking comment.

“New investors are saying: let’s talk later,” an early-stage venture capitalist said. “A lot of rounds are on hold because of the uncertainty around covid-19. No one wants to risk putting capital until some clarity emerges about how bad this is going to be in India and how long it’ll last.”

Even before covid-19 hit India, new investors were unwilling to match the valuation expectations of companies, including Ola, Swiggy and Zomato. The three companies had been trying to raise $400-$500 million from the second half of last year, but Swiggy and Zomato had to settle for far lower cheques, while Ola is still scrambling to secure fresh capital. Swiggy and Zomato both raised $150-160 million over the past three months, mostly from existing investors. Swiggy’s valuation was flat in the funding round at $3.6 billion, while Zomato’s edged up only slightly to $3.25 billion.

That these flat funding rounds at two prized unicorns occurred right at the start of the covid-19 crisis are an indicator of worse times ahead.

For much of the past decade, valuations of loss-making unicorns in India and other countries have been far richer than those of listed tech companies because of an excess of private capital. That gap will finally start to close over the next two years. “It’s been a good run for private company valuations, especially unicorns in India, but private market valuations have far exceeded their public market (peers) for a number of reasons, some valid, some hype,” said Jatin Bery, managing partner, JB Capital, a Delhi-based investment bank. Now, tech investors will be more measured and unicorns will need to “grow into their valuations more than ever,” he added.

To be sure, the companies mentioned above as well as most other unicorns have sufficient capital to see out even a prolonged crisis. Still, they will need to hit the market at some point over the next year to replenish their reserves. When they do, their valuations will fall, steeply in some cases.

“Looking at the trends in public markets and Chinese private tech market developments, one can assume valuation corrections are likely to happen over the next 12-18 months, and some could even lose their unicorn status,” said Karan Sharma, executive director and co-head, digital and technology, Avendus Capital, a Mumbai-based investment bank.

“The pace at which companies have been added to the unicorn club will slow down, although I still expect 5-10 unicorn additions in the next 12-18 months … On the whole, there could be a 1-2 year reset for internet startups overall in terms of valuations and exit timelines,” he added.

Pivot or perish

Faced with a near-complete collapse in business, unicorns have adopted some common tactics. Swiggy, Zomato and Udaan have cut jobs while Oyo has put thousands of employees on temporary leave. Most companies have slashed their marketing budgets and are looking to reduce other expenses. Companies are also working with others in their respective sectors to lobby the government for relief packages. Though the covid-19 crisis is unfolding by the week, early evidence provides some clues about its likely impact on unicorns.

Oyo and Ola:

Travel and hospitality will be hit hardest and a recovery in these sectors will take time. This means that Oyo and Ola will have to cope with weak demand and falling cash reserves for many quarters to come. Oyo, in particular, is in dire straits, and the prolonged decline in business makes its $10-billion valuation look untenable, as Mint wrote on 15 April.

Swiggy and Zomato:

They, too, are likely to face a decline in sales for 3-6 months as people cut back on ordering food for fear of transmission and take to cooking at home. The two food delivery companies are trying to expand their grocery businesses but their efforts, even if successful, can only make up a very small part of the shortfall in revenues. According to RedSeer estimates, because of a combination of sluggish demand and labour shortages, the food delivery sector could decline by 40% this year.

Lenskart and Firstcry:

These specialty e-commerce firms, both of which are backed by SoftBank, have also been hit by the lockdown and are likely to suffer from the overall slowdown in e-commerce this year.

Paytm, PhonePe and others:

Digital payments have seen a relatively smaller drop in gross merchandise value than sectors like food delivery and e-commerce. More people are using Paytm, PhonePe and other services to make electricity and other bill payments, which has helped these firms make up for some of the shortfall arising from sectors like travel and movie bookings.

The beneficiaries

Three notable beneficiaries have emerged so far: BigBasket, Byju’s and Policybazaar Insurance Brokers Pvt. Ltd.

BigBasket and Grofers:

Grocery delivery firms have seen a huge spike in order volumes since India started shutting down in the fourth week of March. But because of the sudden and disorderly imposition of the lockdown, actual revenues at BigBasket and its smaller rival Grofers India Pvt. Ltd were hit by a shortage of delivery staff and forced closure of warehouses. Still, over the next year, the online grocery market is expected to expand considerably.

Grofers chief executive Albinder Dhindsa said that after the lockdown was announced, demand immediately surged by five times. But because of the restrictions around the lockdown, Grofers couldn’t meet the demand initially and its revenues declined. Now, however, capacity utilization has inched up to 90%, and despite a prolonged labour shortage, Grofers is serving 200,000 daily orders, double its pre-lockdown levels, Dhindsa said.

Byju’s:

Its chief operating officer Mrinal Mohit said that the company has registered a 200% increase in the number of students using the app over the past few weeks. Last month, more than 6 million new students used the app after Byju’s said on 11 March that it would offer all its learning programmes free of cost on its app till the end of April and launched live classes. “This shows that with schools continuing to be shut and all other learning sources being unavailable, digital adoption has increased significantly during this time,” Mohit said.

Policybazaar:

A company spokesperson said that the company has seen an increase in demand at its core insurance business as large numbers of people are buying health and life insurance products. However, Policybazaar’s lending business has been hit because of the broader economic crisis, the spokesperson said.

Smaller funding rounds

Four trends are clear, regardless of how long covid-19 crisis lasts.

One, most unicorns are facing a fall in revenues this year. Hopes of recovery after the peak of the outbreak passes could be dampened by a possibly devastating economic slowdown.

Two, the already poor margins of unicorns will worsen further as fixed costs pile up in lockdown-hit months and they are forced to spend more on discounts after business resumes.

“There will be a lot of pent-up consumer demand and we’re expecting a sharp increase in sales in sectors like e-commerce, food delivery in the second half of the year, particularly in the Diwali festive season,” said Mrigank Gutgutia, associate director at RedSeer. “But growth in most sectors will still drop for the year overall, and some sectors will decline. Companies will also need to take a one-time hit to unit economics.”

Three, both the size of funding rounds and valuations will fall at unicorns, depending on how badly their businesses are hurt and how desperate they are for cash.

“The era of mega funding rounds of $700 million-$1 billion is over, at least for the next two years,” a managing director at a large venture fund said. “It already started with Swiggy and Zomato and it’ll get worse from here. It’ll be tough for companies to justify asking for more than $150-200 million in capital. Getting that amount itself will be a struggle.”

Four, the fall in valuations will erode the holdings of entrepreneurs. In the previous funding winters of 2016-17 and 2012-13, too, founders’ equity had dipped as they were forced to scoop up capital at unattractive prices. Because building an internet business here requires far more capital compared with the US and China, entrepreneurs at most Indian unicorns already hold single-digit stakes that are bound to slip further.

Over the long-term, however, the crisis is expected to speed up digitization in many sectors. Some analysts expressed optimism that this will lead to faster expansion for many startups.

“The internet space on the whole will benefit immensely over the long-term,” Avendus’ Sharma said. “This crisis is promoting behaviour change in consumers toward digital, and sectors like e-commerce, logistics, e-health, education and digital content are getting a big push,” he added.