When Aswath Damodaran, Professor of Finance at the Stern School of Business at New York University and the 'dean of valuation', decides to value Indian startups heading for the bourses, you take notice. 

 

Last week, he valued Paytm's* impending IPO. 

 

If it gets the regulator's nod to go ahead with the listing, Paytm is likely to be among the biggest IPOs in India. The company aims to raise Rs 16,600 crore (US$2.13 billion) and news reports say it is expecting to list at a valuation of anywhere from US$20-30 billion. Damodaran valued it at the lower end of these estimates at US$20 billion. 

 

In comparison, he had valued Zomato at about US$5 billion compared to the US$8 billion it was expecting to list at. It's another matter that the Zomato stock zoomed after listing and is now valued at over ~US$14 billion. In his analyses, Damodaran actually attributes lesser risk of failure to Paytm than he did for Zomato. The probability of failure for Paytm, he says, is 5% as opposed to the 10% he had pegged for Zomato. 

 

Now, both are loss-making companies. Both operate in intensively competitive markets. But, as the professor notes, Zomato's ability to make revenue from each order at about 20-25% of the order value is much more than Paytm's take rate (revenue) of 1% on the transactions it processes. So why does Damodaran peg a higher valuation for Paytm than for Zomato?

 

Reading his notes, it seems to be a function of the market the two companies operate in. He says: The Indian food delivery market is small, relative to markets elsewhere in the world, and especially compared to China, the only other market of equivalent size in terms of population. 

 

But when it comes to Paytm, he says: The value story for Paytm starts with a large and growing digital payment market in India, one that has surged over the last four years, and is expected to increase five-fold over the next five years, as the smartphone penetration rate rises for India and more merchants accept mobile payments.

 

Large market size notwithstanding, Paytm's future hinges on the management's capability to see it through. Damodaran notes that too. In fact, he says this is the kind of stock you need to be actively watching to make an investment decision. 

 

But there seems to be a disconnect between how Damodaran sees Paytm, and how Paytm sees itself. 

 

Damodaran believes that Paytm's core value comes from being an intermediary. The company, though, wants to become more than an intermediary—it wants to make its own financial products. We wrote about what that endeavour looks like here, and which parts of Paytm's IPO don't add up here. 

*Paytm founder Vijay Shekar Sharma is an investor in The Ken

Now, IPO valuations aren’t simple at all. But it turns out that traditional investment products aren’t very simple either, as Anand will now tell you. 

 

On Friday, the Reserve Bank of India (RBI) left the repo rate unchanged once again, instead of hiking it as some were pushing for. This was expected, given the central bank’s ongoing focus on keeping economic growth going rather than on keeping inflation in check.

 

The upshot: Borrowers will continue to benefit from low interest rates. 

 

On the other hand, savers will continue to scrounge for fixed-income investments that give decent, inflation-beating returns. Most bank fixed deposits don’t make the cut now, but many small savings schemes do, as we had written last Monday. There’s another option that could tick this box—corporate fixed deposits, some of which offer good rates. Except that what you see here may not be what you get. 

 

Corporate deposits and bonds come with higher risks; there’s no absolute guarantee you’ll get your money back. Even with the best credit rating (AAA), they are not as safe as government-guaranteed options. Now, that’s okay because the higher the risk, the higher the return. Or at least, that’s how it’s meant to be. 

 

The problem is that companies often exaggerate the yields these deposits offer. This entices depositors on a hunt for higher returns, especially in the kind of low-interest environment we are in now. Put plainly, this is mis-selling. 

 

Consider this. On its cumulative deposits, Muthoot Capital Services offers 6.75% for a three-year tenure, and the interest is compounded annually. But the company says that the annualised yield on this deposit is 7.22%. How’s that even possible? Finance 101 says that in a cumulative deposit with annual compounding of interest, the yield and the interest rate should be the same—6.75% in this case.

Source: Muthoot Capital Services

 

Here’s what’s happening. The company is calculating yield based on the formula for simple interest; i.e., taking the total interest earned at the end of the three-year tenure and dividing it by the principal (amount invested) and three (the number of years). What it should really be using is the compound interest formula.

 

That’s because in a cumulative instrument, the interest you earn is reinvested and also earns interest in the subsequent periods until maturity. The compound interest formula takes into account the return on the principal and also the accumulated interest, while the simple interest formula doesn't.

 

Muthoot Capital Services is hardly alone. Many other companies that accept deposits from the public advertise exaggerated yields. Mahindra Finance, PNB Housing Finance, and ICICI Home Finance, for instance, offer 6.3%, 6.6%, and 5.75% respectively on their three-year cumulative deposits. The effective/tentative/indicative yield they advertise is 6.71%, 7.05%, and 6.09%.

 

Enamoured by big numbers, investors could end up making wrong choices. Many companies seem to be taking advantage of the lack of a standard definition of yield. It’s high time regulators such as the RBI and Sebi laid down and enforced the rules. Until then, brush up your basics on Simple Interest and Compound Interest, and put them to good use. Or use the ‘Rate’ function in Microsoft Excel to find out the correct yield. Calculate before you take the bait.

This is true for this other lending-meets-personal finance product too, as Arundhati writes.

 

Every time a VC sneezes, a unicorn is created. But peer-to-peer lending (P2P lending) is one space where there are no unicorns prancing. I reckon the reason for this is the trust deficit in the product. If it was just about discovery, a VC-backed company would have solved that with the universal startup hack—cashbacks.

 

In 2017, the RBI created a special class of non-banking lenders called P2P NBFCs. Their role was to act as a platform to bring together lenders and borrowers, and match demand for loans with people looking to lend. The interest that lenders earn here can be upwards of 20%.

 

At times like this, when yields in other savings instruments are low, such returns become very attractive. But they come with a very high default risk. P2P platforms like LenDenClub claim they have a default rate of about 5%, but our reporting from 2018 shows that this can run as high as 20%, or even 50%. So far, since these platforms have largely been online, it’s mostly investors looking for alternative investment options that have flocked to them. 

 

But that's about to change. 

 

LenDen has found a hack to scale trust. It has partnered with Vakrangee, which offers various financial inclusion services across 11,500 kendras (centres), 70% of which are in tier-5 and tier-6 towns. Now, LenDen hopes to tap into this network.

 

This is what it said in its press release:

 

Customers can avail instant personal loans at any of the nearest Kendra across 19,000 pin codes in the country for a wide variety of services such as online shopping, purchase of agri products or healthcare services. Borrowers can thus avail hassle-free digital loans instantly, even if he is situated in a remote part of the country. Additionally investors can also avail the platform as an investment avenue to pool in their savings to earn an attractive source of income ranging anywhere between 10-12% which is far superior to other traditional investments such as bonds or equities.

 

Vakrangee works with many public sector banks and, call them what you may, they still remain institutions that people trust. With centres licensed to sell insurance, operate ATMs, issue direct benefit transfers, and do Aadhaar enrolment, Vakrangee is also likely to have earned the trust of the neighbourhood.

Source: Vakrangee

And all that companies like LenDen would have to do is incentivise Vakrangee’s salespersons to push these risky "investments” alongside risk-free products like bank deposits. For Vakrangee, which has had its share of corporate governance issues in 2018 and hasn’t really recovered stock price-wise, this is a chance to enlist more small-time investors and increase its relevance.

 

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Take care.

 

Regards,
Arundhati Ramanathan and Anand Kalyanaraman