In 2018, a record number of Chinese companies listed on US exchanges. Investors the world over watched with intent as China’s economic transformation entered a new era. Chinese executives gleefully rang the opening bell at NYSE or NASDAQ on a seemingly constant basis. This was yet another example of China’s burgeoning economic prowess being exalted onto a global stage, further reinforcing the country’s profile as a prominent business incubator, and showcasing the success of state-run capitalism that many analysts previously scrutinized as rigid and lethargic.
IPO followed IPO, with 31 companies debuting on US exchanges in 2018 alone. However, quantity did not beget quality. 2018 was an exceptionally difficult year for Chinese ADRs listed in the US. In fact, in 2018, out of the 129 public Chinese companies listed in the US, 112 saw a decline in their stock price. Half of these 112 companies saw their share price decline by over 40% during the year. This begs the question, if the capital market environment seemed unfavorable towards Chinese companies, why would a record number of them rush to IPO? Given the trade tensions between the US and China, with some more radical pundits in the United States calling for restricting Chinese companies’ access to US capital markets, perhaps the timing wasn’t right.
Instead, investors were likely more keenly aware of these companies’ unit economics, questioning whether a sustainable path to profitability existed. One of the obvious major characteristics of China’s economy is its enormous scale. This can be seen as an advantage, allowing companies to accumulate massive user bases and leverage scalable technologies to dominate an industry as we have seen with behemoths like Tencent and Alibaba, and emerging titans like Meituan-Dianping and Didi Chuxing. However, the massive scale of China’s economy means that many businesses are incredibly capital intensive, with many user acquisition models burning mountains of cash in a brutally competitive environment. This thirst for operating capital often drives Chinese companies to list sooner than maybe they should.
Following Uber’s lackluster IPO due to questions about the sustainability and potential profitability of its business, Chinese ride-hailing leader Didi is likely hesitant to open themselves up to the bearish market that has intensified the focus on profitability. Just look at WeWork’s quite public debacle as they attempted an IPO with unclear profitability projections.
Consider Luckin Coffee, China’s on-demand rival to Starbucks. Luckin’s business model burns cash due to the thin margin on their coffee, combined with aggressive subsidies to aggregate market share. The company’s share price now sits at $19.09, just below its IPO price of $20.38. Meituan-Dianping spent $4 billion in the past seven years in a vicious war against Alibaba’s Ele.me for dominance in the O2O services market. Ziroom, a Chinese home-rental platform raised $622 million in January 2018 to continue its business model of taking out long-term leases of existing homes from individual landlords. Online education giant VIPKID has relied heavily on consistent fundraising to cover their high-cost customer acquisition strategy.
The rapid pace at which Chinese internet companies raise capital has jokingly been coined the “2VC model” where companies are forced to continue raising money to fund their operations rather than building a sustainable revenue model. Rather than developing a sustainable and profitable business based off 2C or 2B models, companies were fixated on selling their businesses to venture capitalists. A premature IPO can be seen as the most extreme symptom of this 2VC model.
Xiaomi founder and Chinese technology icon Lei Jun once famously said, “If they know how to ride the winds of capital, even pigs can fly.”
Michael Norris, a consultant at AgencyChina focusing on China’s tech sector explained the rise of the 2VC Model, “Chinese digital and technology firms rode three dividends – an explosion of new internet users, increases in time of mobile devices and an abundance of capital.” In 2018, nearly one third of global venture capital investment flowed into Chinese tech startups, up from just 4% in 2013 according to consulting firm Bain.
India is one of the most promising markets for internet companies in the decades to come, with many conditions and characteristics that are extremely similar to China in the early to mid-2000s, including a massive population, a high degree of price sensitivity and a hyper-competitive market. Additionally, rapid increases in mobile internet penetration, coupled with rising consumption power from India’s growing middle class have created a sizable consumer class for internet companies to target. The flag bearer for India’s digital revolution is the e-commerce company Flipkart. Often lazily described as the “Amazon of India”, Flipkart is actually competing with Amazon India in its domestic market.
Flipkart was founded in 2011 by two ex-Amazon employees, who sought to create a digital e-commerce company in their native India. Initially, the company sold books, perhaps paying homage to the roots of Amazon, and eventually transformed into a comprehensive marketplace selling a wide variety of goods. Flipkart has expanded to cover over 160 million users in India, and plans to corner even more of the market by rolling out a Hindi language version to capture even more Indian users.
Kalyan Krishnamurthy, CEO of Flipkart Group, spoke on this effort to localize for the Hindi speaking population, “As a home-grown company, Flipkart has the advantage of understanding the Indian market and all its nuances in a much better way. We are committed to developing solutions that will help the adoption of e-commerce by the next 200 million consumers who come online. We have deployed around 80-90% of our resources towards solving for Bharat with our Hindi interface being one of the biggest catalysts in this transition. As language is a convenience and not a barrier, we believe this native language capability will play a significant role in further adoption of e-commerce in the country.”
However, despite the massive user growth potential for an Indian internet giant like Flipkart, they are still not eyeing an IPO in the near future. The reasons are multifold. Karthik Reddy, co-founder and managing partner at Blume Ventures, is skeptical of Indian companies’ attractiveness to the global investor community, saying, “Almost no Indian company, unicorn or otherwise, is in a position to make its financials public, let alone chart a clear path to profitability.” Here Reddy underscores the emphasis on profitability that many investors look for in these internet companies from emerging markets.
Flipkart was acquired by US retail giant Walmart in 2018 for $16 billion. It represented a major commitment from Walmart, dampening its bottom line by considerably boosting the company’s expenditure. In fact, Walmart was met with skepticism from the investor community as their share price dropped 4% following the announcement of the Flipkart acquisition. Another reason Flipkart has not mirrored Chinese companies’ eagerness to go public has to do with their private investors. Prior to the Walmart acquisition Flipkart was backed by $2.5 billion from Mahayoshi Son’s SoftBank Vision Fund among others. Such influential private investors have deep pockets and long-term investment horizons, often imploring companies to focus on discovering the elusive path to profitability rather before risking exposure to the dogged investor community.
For Indian firms, they can look to China as an economic and developmental harbinger, foretelling the dangers of quickly raising funds and rushing into public capital markets without the foundational business fundamentals to create a profitable long-term strategy. Flipkart seems to be heeding the warning, and will not seek an IPO in 2020, with rumors circulating that an IPO in 2022 would be the earliest considered. In the meantime, Flipkart can continue to leverage its impressive economies of scale to reach a level of sustainability within their business model to allow the unicorn to flourish in the long-term as a public company.