September 30, 2022

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Why Are Technology Stocks Declining?

The shares of loss-making technology companies continued falling as the hunt for yield slows down,...

The shares of loss-making technology companies continued falling as the hunt for yield slows down, and investors move into less risky assets. Both public and private market valuations have been soaring over the last few years, especially for technology companies and crypto. However, with expectations of the Fed’s tightening monetary policy faster than expected, investors have begun reducing exposure to risky assets.

Companies such as Netflix, Peloton, and others saw the shares fall almost 20 per cent during trading hours. The 20 per cent fall in Netflix, shaved off $45 billion worth of investor value.

India has seen the shares of Zomato, Nykaa, Paytm, and PolicyBazaar have slipped below their listing prices as well. FreshWorks, the most popular Indian software-as-a-service company, has fallen by 50 per cent.

Why are Technology Stocks Declining?

One way of explaining the decline in these stocks could be that investors had invested in these markets on the basis of growth, that is, future revenue. As rates rise, discounting cash flows that lie in the future results in a lower present value.

In addition, sometimes the growth could be overestimated, like in the case of Netflix, where the management has guided for substantially lower growth in the future.

Peloton Interactive saw its stock collapse as the company decided to stop production of its sports equipment. It has decided to revamp the organisation with a focus on restructuring costs – a task for which it has hired McKinsey. The decision was rooted in a decline in demand for Peloton’s products. While the consensus did estimate a decline in demand for Peloton’s product as the pandemic ended, the severity of the decline has been surprising.

Another way of looking at the decline could be a move towards safer assets as investors move away from risky assets as the risk does not justify the return anymore. An index compiled by Goldman Sachs that tracks unprofitable technology companies has moved around 10 per cent this year, while investors continue to move into “old-economy stocks”- banking, insurance, and industrials.

In India, tech IPOs which gave handsome returns to their investors on listing, have been on a downtrend over the last few months. After its tepid IPO, Paytm has seen the largest decline, almost 38 per cent from its listing value. The decline could have an adverse impact on the IPOs of other technology companies such as OYO and others that have filed their initial IPO papers.

Blank-Cheque Companies are Cancelling IPOs

The US has already seen blank-cheque companies cancelling their IPOs. The special purpose acquisition vehicles (Spacs), raise money from public shareholders and then acquire companies, majorly from the technology and healthcare space. The popularity of Spacs was evident from the fact that these offerings raised as much money as traditional IPOs in 2020.

However, as the market sentiment for such companies begins waning, Spacs have decided to withdraw from the proposed IPOs. Altogether, in the past 20 days, around seven Spacs have written the the US’ Securities and Exchange Commission about their plans to cancel their IPOs. These companies were cumulatively raising $2.5 billion.

The decision to withdraw can be attributed to lower investment interest, poor past performance, regulatory scrutiny and scandals. An increasing number of shareholders have been asking for their money back as well, a trend that does not bode well for Spac founders.

Private Market Valuations could Correct

Private market valuations are expected to cool down as well, as the public markets set lower valuation parameters. Rajan Misra, the Chief Executive Officer of Softbank Vision Fund, said that private markets were overvalued and that if the public markets were to remain at the current valuations, private market valuations would correct.

“If the public markets stay where they are, then the private markets, which are overvalued, have to rebalance. And we’re seeing that already,” Misra said.

Shailendra Singh, Sequioa’s India and South Asia Managing Director supported Misra’s view on Twitter. In a tweet, Singh said that a “much-needed” valuation correction would be healthy for the start-up environment. India saw the highest numbers of unicorns being created in 2021, with 40 companies across sectors reaching the $1 billion valuation.

Altogether, Indian start-ups raised a record $36 billion from investors in 2021 at high revenue multiples, as investors expect rapid growth. With two of the most influential players in start-up funding in India signalling that private markets are overheated, it is likely that deal-making could slowdown and start-ups could reach reasonable valuations.

It is possible that valuations technology stocks could go through a time correction or a price correction, till fundamentals catch up.

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