A strong brand, a reliable distribution network and the ability to generate cash flows are among the key parameters investors focus on when valuing a consumer-centric company, said panellists at News Corp VCCircle Consumer Investment Summit.
The panel, which was themed 'Consumer and retail transaction valuation – What justifies it?', was moderated by Nandini Chopra, managing director, Alvarez & Marsal. The panel saw participation from Sid Talwar of Lightbox, Sahil Dalal of Advent International, Sandeep Reddy of Peepul Capital and Ritesh Chandra of Avendus Capital.
Panellists opined that high valuation does not necessarily reflect high value. Therefore, companies and investors need to be prudent about cash and burn rate, which can negatively affect valuations and value.
"We take necessary steps of not getting caught in a valuation trap. It is necessary to keep future exit possibilities in mind when investing, not just in consumer-centric firms, but across sectors," said Talwar. Determining valuation is a theoretical process, and investors should not solely focus on the topline, but also look at the broader economics in which a company operates in, he said.
"Many times, entrepreneurs use valuation as the scorecard and it is a flawed philosophy," Talwar said.
As India aspires to grow at 7.5% with a growing population, rising affluence and changing consumer demographics and behaviour, India's expenditure is set to touch $4 trillion by 2025. Given the growth, consumer and affiliated sectors have also seen a busy deal activity, with as many as 123 deals worth over $900 million struck from the start of 2016.
Dalal said valuations in the consumer space have been expensive, now and even 10 years ago, and therefore cash flows, strength of the brand, and distribution network are the key to determining valuation.
"We look for parameters where we would make a good company into a great one. Our job is to get through the clutter. Also, the public market is an area of competition. So if we don't invest, a company or an investor has the option of going to public market and getting a high valuation," Dalal said.
Chandra said valuations in the consumer space will remain healthy going forward. The high valuations are justified keeping in mind forward earnings, besides the scarcity of quality companies for investments.
"Valuations have been rich and consistent because people are willing to pay a premium for good quality companies. We have seen a significant shift from unbranded to branded products. This is creating an opportunity for newer investments at a time when the internet is playing a huge role," Chandra said.
Consumer companies and frothy IPO markets
Panellists also discussed the scope and valuations offered by the initial public offering (IPO) route and how it has been a major means for private equity and venture capital firms for achieving part or full exits. Public markets have been more forgiving and offer easier liquidity, besides better valuation as stock markets have seen a boom in recent times, they said.
Indian firms benefitted from the boom in stock markets, with the benchmark Sensex rising 28% and with that primary market activity moving in tandem. About three dozen firms went public in 2017 cumulatively raising Rs 67,000 crore, a record sum. More so, the majority of the IPOs in the past four years have seen private equity investors make part or full exits on their investments.
"Public markets have been frothy for the last six to 12 months, and a road that appeals to all promoters. While an IPO may be the best option for a promoter in reaping high valuations, they need to be aware if an IPO is the best solution for the company and the business. Companies need to be more mature before going public which is the easiest thing to do in India," Chandra said.
"Fundamentally, greed and valuation drive public markets approach. We counsel promoters that valuations are cyclical and frothy. Also, IPO is just a liquidity event and many companies need to scale up before going public," Dalal said, adding that Indian firms are tapping IPO markets three-five years ahead of time.