Thread by @MultipieSocial

Decent correction in recent Tech listings in India.

We visited Motilal Oswal’s Wealth Creation Study in Digital Era - and sharing ket learnings & success traits, learnings from global models and possible winners in India.
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Let’s start with how wealth is going to be created in the coming years.

The report claims that value is migrating from atoms (businesses dealing in physical matter) to bits (businesses that are digital in nature) across the globe.

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How are companies classified as atoms and bits?

- Atoms - smallest element of physical matter (eg. cos in cement, autos, pharma, steel, etc sectors)
- Bits - smallest unit of information that can be stored in digital form (eg. Google, Yahoo, eBay, Oyo, Airbnb, Zomato, etc)

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Value is migrating from the physical to the digital.

Let’s understand the evolution of US companies. It is evident that companies like Apple, Facebook and Netflix (the “bits”) have handsomely outperformed companies like Walmart, Coca Cola and General Electric (the “atoms”).

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Consider the tables below - 7 out of the top 10 companies (as per MCap) are bits. The current profit of Apple is multiple times higher than the top 10 company’s profit in the year 1995.

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Key takeaway: The outperformance of bits is not only seen in the market cap (stock markets) but also on the fundamental metric of profit. It is evident that value (defined as profit + market cap) is silently migrating from atoms to bits.

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Now, what is the situation in India? We all know that India is on the cusp of digitization. And following are the supporting factors:

1. Digital revolution; penetration of telecom and internet is high
(wireless subscriber base at 1.2 bn; 0.75 bn users access internet)
cont.

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2. Growing start-ups in edtech, foodtech, fintech sectors; PE/VC firms are backing such ideas (unicorn count at 70)
3. SEBI relaxing norms; permitting listing of loss making cos (Zomato, Nykaa and Paytm were listed this year and already have a MCap of more than INR 1 TN).

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As per the report, there are six key success factors that set the stage for hyper growth in bits cos. -

1. Higher TAM - larger the market, better the growth prospect
2. Product-market fit - the product should satisfy the market needs
3. Wide and strong distribution

cont.

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4. Network effects - leveraging existing network to bolster growth
5. Favourable unit economics; to ensure long term value
6. Operation scalability - having adequate human and infrastructural capabilities

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Compared Zomato, Nykaa & Angel on these:

Zomato: Leader in food delivery (40 cr annual)
- TAM to grow 3-4x over next decade
- Strong distribution; ~148k restaurants & ~300k delivery partners
- Unit economics: Turned profitable at Rs 19 from negative contribution of Rs. -33

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Nykaa: Beauty flywheel
- Industry at Rs 1.1 tn (growing 8% p.a)
- Wide range of products on its platforms (from mass brands to premium global brands)
- Cover 86% of pin codes pan India; 18 warehouses 70+ physical stores in 38 cities.
- Moat due to trust & authentic products

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Angel One (previously Angel Broking) - seamless, online share trading platform.

- Only 5% of the Indian population has demat accounts, thereby depicting higher growth opportunities. Other revenue streams eg. asset management (underpenetrated in India)
cont.

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- Has the largest Authorized persons network of 15,000+
- Its flat fee model have made it profitable with EBITDA margin of 44%
- It does not require any physical infrastructure to scale its customer base, as it works on a complete tech model

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But there are some financial problems with “Bits” companies:

1. No distinction between capex and opex, as human capital is expensed to the P&L as employee cost. Such expenses do not get any place in the B/S. This is why they have high accounting losses in the initial years

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2. Another important observation is that the value of bits companies’ intangible assets appreciate with higher use, whereas the value of physical assets of Atoms depreciate with use

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Valuing “bits” companies:

- Due to the high amount of losses in the initial years, conventional fundamental and valuation metrics - RoE, RoCE, Profit growth, P/E, etc - cannot be applied.

- However, as cash flow is a great leveler, DCF valuation can still work (although for some start-ups, initial cash burn is very high, thus their cash flows would stay negative for some time; increasing the risk of inaccurate valuation).

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- When the company is making losses, the common metric that is used is Price-to-Sales, calculated as Market Cap/Sales. This metric has its own problem as it does not take into account the growth rates.

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Risks with “Bits” companies:

1. Survival Bias (tendency to ignore the cos. that failed; eg. - Lycos, Orkut, etc)
2. Hype Factor (over-subscription in case of IPOs)
3. Criticality of contribution (unit economics should be positive)

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How to play “Atoms” to “Bits”?

The focus should be on digital business designs and their enablers. To focus on Digital Business Designs, the following matrix can be considered:

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Second way is betting on digital enablers (i.e. IT service providers) run be great managements. Such companies will be adding value in all four quadrants of the aforementioned framework, thereby being the biggest beneficiary of “Atoms” to “Bits”.

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Bottom line - value migration from “Atoms” to “Bits” is inevitable. India is at the cusp of harnessing digital potential. Buy into sure winners in digital, successful digital transformers and classical Indian IT companies.

Join the Multipie platform at multipie.co/get-app to explore a simple visual dashboard for these companies, meet peer investors in 'Bits' companies or frown at the valuation of these company with other 'Atom' investors :)