Tuesday, September 14, 2021

The ESG Movement: The "Goodness" Gravy Train Rolls On!

Last year, I wrote a post on ESG and explained why I was skeptical about the claims made by advocates about the benefits it would bring to companies, investors and society. In the year since, I have heard from many on the topic, and while there are some who agreed with me on the internal inconsistencies in its arguments, there were quite a few who disagreed with me. In keeping with my belief that you learn more by engaging with those who disagree with you, than those who do, I have tried my best to see things through the eyes of ESG true believers, and I must confess that the more I look at ESG, the more convinced I become that "there is no there there". More than ever, I believe that ESG is not just a mistake that will cost companies and investors money, while making the world worse off, but that it create more harm than good for society.

ESG: Value and Pricing Implications

Rather than repeat in detail the points I made in last year's post, I will summarize my key conclusions, with addendums and modifications, based upon the feedback (positive and negative) that I have received. 

1. Goodness is difficult to measure, and the task will not get easier!

The starting point for the ESG argument is the premise that we can come up with measures of goodness that can then be targeted by corporate managers and used by investors. To meet this demand, services have popped up around the world, claiming to measure ESG with scores and ratings. As I noted in my last post, there seems to be little consensus across services on how to measure goodness, and the low correlation across service measures of ESG has been well chronicled. The counter from the ESG services and ESG advocates is that these differences reflect growing pains, and just as bond ratings agencies found convergence on measuring default risk, services will also find commonalities. I think that view misses a key difference between default risk and goodness, insofar as default is an observable event and services were able to learn from corporate defaults and fine tune their ratings. Goodness is in the eyes of the beholder, and what you perceive to be a grevious corporate sin may not even register on my list, as a problem. To illustrate how investors can differ on core values, consider the chart below, where investors were asked to assess which issues should rank highest, when considering corporate goodness:

Based on this survey, younger investors want the focus to be on global warming and plastics, whereas older investors seem to focus on data fraud and gun control. If you expand these factors to include other social and religious issues, I would wager that the differences will only widen. As ESG scores and ratings get more traction, researchers are also looking at the factors that allow companies to get high scores and good rankings, and improve them over time. Studies of ESG scores find that they were influenced by company size and location, with larger companies getting higher ESG scores/rankings than smaller companies, and developed market companies getting higher scores and rankings than emerging market companies:

LaBella, Sullivan, Russel and Novikov (2019)

It is entirely possible that big companies are better corporate citizens than smaller ones, but it is also just as plausible that big companies have the resources to play the ESG scoring game, and that more disclosure is a tactic used by these companies that want to bury skeletons in their current or past lives, rather than expose them. In fact, a JP Morgan study of ESG Ratings and disclosures also points to a larger danger from enhanced ESG disclosure requirements, which is that the ESG ratings seems to increase across companies, as disclosure increase. 

Chen et al, JP Morgan

While I am sure that there will be some in the ESG community who will view this as vindication that disclosure is inducing better corporate behavior, the cynic in me sees companies learning to play the ESG game, at least as designed by services, and using the disclosure process to check boxes and up their scores. To me, the parallels to the corporate governance movement from two decades ago are uncanny, where services rushed to estimate corporate governance scores for companies, accountants and rule writers added hundreds of pages of disclosure on corporate governance, and promises were made of a "golden age" for shareholder power. The fact that the corporate governance movement enriched services, consultants and bankers, and left shareholders more powerless than they were before the movement started, holding shares in companies with dual class shares or worse, should act as a warning for ESG disclosure/measurement advocates, but I have a feeling that it will not.

2. Being “good” will add to value some companies, hurt others, and leave the rest unaffected!

If the ESG sales pitch to companies, which is that if you are a "good" company, you will be worth more, is right, why do we need ESG? In fact, Milton Friedman, the bĂȘte noire of ESG advocates, would stand vindicated, and companies would do good, because it made them more profitable and valuable, and not because of lectures about morality and goodness. This may be cynical, on my party, but the very fact that ESG advocates keep insisting that being "good" increases value must be because they are themselves unsure why or whether this is true. The framework for tracing out the effect of ESG on value is a simple one, since ESG, if it affects value, has to affect one of four variables: revenue growth (by increasing or decreasing growth), operating profit margins, reinvestment efficiency (the payoff to investing in new capacity)  or risk (through the cost of funding/capital and failure risk). In last year's post, I noted that the empirical evidence that ESG has a positive payoff is weak, at best, and inconclusive, for the most part:
The strongest evidence that is supportive of ESG comes on the risk front, with evidence that it does not pay to be a "bad" company, with some  a higher cost of funding and greater risk of catastrophes, but much of that evidence comes from fossil fuel companies. The weakest evidence in ESG's favor is on profitability and cash flows, since almost every study that purports to find positive correlation between profitability and ESG scores trips up on the causality question, i.e., are "good" companies more profitable or are companies that are more profitable able to take the actions that make them look good? An objective look at the data would lead us to conclude that while one can make a reasonable case that companies should work at "not being bad", there is very little evidence that there is a payoff to  spending more money to be "good".

3. The ESG sales pitch to investors is internally inconsistent and fundamentally incoherent

If the argument that ESG translates into higher value is weak, the argument that incorporating ESG into your investing is going to increase your returns fails a very simple investment test. For any variable, no matter how intuitive and obvious its connection to value might be, to generate "excess" returns, you have to consider whether it has been priced in already. That is why investing in a well managed company or one that has high growth does not translate into excess returns, if the market already is pricing in the management and growth. Applying this principle to ESG investing, the question of whether ESG-based investing pays off or not depends on not only whether you think ESG increases or decreases firm value, but also on whether the market has already priced in the impact.

  • If the market has fully priced in the ESG effect on value, positive or negative, investing in 'good' companies or avoiding 'bad' companies will have no effect on excess returns. In fact, if being good makes companies less risky, investors in good companies will earn lower returns than investors in bad companies, before adjusting for risk, and equivalent returns after adjusting for risk.
  • If the market is over enthused with ESG and is overpricing how much being "good" will add to a company's profitability or reduce risk, investing in 'good' companies will generate lower risk-adjusted returns than investing in 'bad' companies.
  • If the market is underestimating the benefits of being good on growth, margins and risk, investing in 'good' companies will generate higher returns for investors, even after adjusting for risk.
In the latter two cases, the excess returns (negative in the "markets are over estimating" case and positive in the "markets are under estimating") will manifest only when the market corrects its mistakes.   Bringing in market pricing into the discussion is important for two reasons. 
  • The first is that it suggests that much of the research on the relationship between ESG and returns yields murky findings. Put simply, there is very little that we learn from these studies, whether they find positive or negative relationships between ESG and investor returns, since that relationship is compatible with a number of competing hypotheses about ESG, value and price. 
  • The second is that bringing in market pricing does shed some light on perhaps the only aspect of ESG investing that seems to deliver a payoff for investors, which is investing ahead or during market transitions. In my last post, I pointed to this study that find that activist investors who take stakes in "bad" companies and try to get them to change their ways generate significant excess returns from doing so. Another study contends that investing in companies that improve their ESG can generate excess returns of about 3% a year, but skepticism is in order because it is based upon a proprietary ESG improvement score (REIS), and was generated by an asset management firm that invests based upon that score. 
If you are interested in making market transitions on ESG work in your favor, you also have to be clear about the strengths you will need to get the payoffs, including skills in divining not only what social values are gaining and losing ground and which changes have staying power.

4. Outsourcing your conscience is a salve, not a solution!

    Even if being “good” does not increase value or make investors better off, could it still help, by making the world a better place? After all, what harm can there be in asking and putting pressure on companies to behave well, even if costs them? In the short term, the answer may be no, but in the long term, I believe that this will cost us all (as society). The ESG movement has given each of us an easy way out of having to make choices, by outsourcing these choices to corporate CEOs and investment fund managers, asking them to be “good” for us, while not charging us more for their products and services (as consumers) and delivering above-average returns (as investors). Implicit in the ESG push is the presumption that unless companies that are explicitly committed to ESG, they cannot contribute to society, but that is not true. Consider Bill Gates and Warren Buffett, two men who built extraordinarily valuable companies, with goodness a factor in decision making only if it was good for business. Both men have not only made giving pledges, promising to give away most of their wealth to their favorite causes in their lifetimes, and living up to that promise, but they have also made their shareholders wealthy, and many of them give money back to society. As I see it, the difference between this “old” model of business and the proposed “new ESG” version is in who does the giving to society, with corporate CEOs and management taking over that responsibility from shareholders. I am willing to listen to arguments for why this new model is better, but I am certainly not willing to concede, without challenge, that a corporate CEO knows my value system better than I do, as a shareholder, and is better positioned to make judgments on how much to give back to society, and to whom, than I am.

    For a perspective more informed and eloquent than mine, I would strongly recommend this piece by Tariq Fancy, whose stint at BlackRock, as chief investment officer for sustainable investing, put him at the heart of the ESG investing movement. He argues that trusting companies and investment fund managers to make the right judgments for society will fail, because their views (and actions) will be driven by profits, for companies, and investment returns, for fund managers. He also believes that governments and regulators have been derelict in writing rules and laws, allowing companies to step into the void. While I don’t share his faith that government actions are the solution, I share his view that entities whose prime reasons for existence are to generate profits for shareholders (companies) or returns for investors (investment funds) all ill suited to be custodians of public good.

Cui Bono? The ESG Gravy Train (or Circle)!

    If ESG is a flawed concept, perhaps fatally so, and if the flaws are visible for everyone to see, how do we explain the immense push in both corporate and investment settings? I think the answer always lies in asking the question "Cui Bono, or who benefits?". With ESG, the answer seems to be everyone, but those it is purported to help, i.e. corporate stakeholders, investors and society. The picture below captures the groups that have primarily benefited from the ESG boom, and how they feed off each other.

Given how much ESG disclosure advocates, measurement services, investment funds and consultants feed off each other, it is no wonder that they have an incentive to sell you on its unstoppable growth and inevitable success. Given that shareholders in companies and investors in funds are paying for this gravy, you may wonder why corporate CEOs not only go along with this charade, but also actively encourage it, and the answer lies in the power it gives them to bypass shareholders and to evade accountability. After all, these are the same CEOs who, in 2019, put forth the fanciful, but great sounding, argument that it is a company’s responsibility to maximize stakeholder wealth, rather than cater to shareholders, which I argued in a post then that being accountable to everyone effectively meant that CEOs were accountable to no one.  In some cases, flaunting goodness has become a way that founders and CEOs use to cover business model weaknesses and overreach. It is a point that I made in my posts on Theranos, at the time of its implosion in October 2015, and on WeWork, during its IPO debacle in 2019, noting that Elizabeth Holmes and Adam Neumann used their “noble purpose” credentials to cover up fraud and narcissism. 

I should add that, notwithstanding my negative views about ESG, I do not think that ESG consultants, fund managers and analysts are venal, but I do think that they, like everyone else, are driven by self interest. I also believe that many in the ESG ecosystem are driven by good motives, a desire to do good for society and make the world a better place, but that are being used by a few at the top of the ESG pyramid, whose commitment to the cause is skin deep. If you are someone working in the ESG space or a true believer, please do look to the highest profile spokespersons for your cause, mostly corporate CEOs and investment fund titans, and remember the adage about waking up with fleas, if you lie down with dogs.

A Roadmap for being and doing Good

    My skepticism about ESG notwithstanding, I understand its draw, especially on the young. As individuals, each of us has a moral code, sometimes coming from religion, sometimes from family and sometimes from culture, but whatever its source, our actions should be consistent with that code. Since those actions involve what we do at work, and in investing, it stands to reason that there are some investments you will and should not make, because it violates your sense of right and wrong, and other investments that you will make, because they advance your view of goodness. It is for this reason that I would suggest a more nuanced and personalized version of ESG, built around the following principles:

  1. Start with a personalized measure of goodness, and don’t overreach: The key with moral codes is that they are personal, and for goodness to be incorporated into your investment and business decisions, you have to bring in your value judgments, rather than leave it to ESG measurement services or to portfolio managers. I would also recommend that you focus on core values, rather than try to find a match on every one, not only because adding too restrictions will constrain you in your choices, perhaps to the point of paralysis, but also because you may find yourself accepting major compromises on your key values in order to meet secondary values. 
  2. As a business person, be clear on how being good will affect business models and value: If you own a business, you are absolutely within your rights to bring your personal views on morality into your business decisions, but if you do so, you should work through the effects on growth, margins and risk, and be at peace with the fact that staying true to your values may, and probably will, cost you money. If you are making decisions at a publicly traded company, as an employee, manager or even CEO, you are investing other people’s money and if you choose to make decisions based upon your personalized moral code, you cannot justify these decisions with hand waving and double talk. In fact, you have an obligation to be open about what your conscience will cost your shareholders, a twist on disclosure that ESG advocates will not like.
  3. As an investor, understand how much goodness has been priced in: If you are an investor, you don’t have to compromise on your values, as long as you start with the recognition that, at least in the long term, you will have to accept lower returns than you would have earned without that constraint. If you are tempted to have your cake and eat it too, and who isn’t, you may be able to do so by getting ahead of the market in detecting shifts in social mores and pushing for change in the companies you invest in, to change. 
  4. As a consumer and citizen, make choices that are consistent with your moral code: If you believe that owning a portfolio of “good” stocks or running a “good” business is all you have to do to fulfill your moral or societal obligations, you are wrong. Your consumption decisions (on which products and services you buy) and your citizenship decisions (on voting and community participation) have as big, if not greater, an effect. Put simply, if your key societal issue is climate change, your refusal to own fossil fuel stocks in your portfolio is of little consequence, if you still drive a gas guzzler, air condition your house to feel like an ice box all summer and take private corporate jets to Davos every year.
On a personal note, I have always found that the people that I've known who do good, spend very little time talking about being good or lecturing other people on goodness. I would extend that perspective to companies and investment funds as well, and I reserve my skepticism for those companies that spend hundreds of pages of their annual filings telling me how much "good" they do.

In conclusion
    The ESG movement’s biggest disservice is the message that it has given those who are torn between morality and money, that they can have it all. Telling companies that being good will always make them more valuable, investors that they can add morality constraints to their investments and earn higher returns at the same time, and young job seekers that they can be paid like bankers, while doing peace corps work, is delusional. In the long term, as the truth emerges, it will breed cynicism in everyone involved, and if you care about the social good, it will do more damage than good. The truth is that, most of the time, being good will cost you and/or inconvenience you (as businesses, investors or employees), and that you choose to be good, in spite of that concern. 

YouTube Video

Wednesday, September 1, 2021

China's Tech Crackdown: Its about Control, not Consumers or Competition!

For the last two decades, China has been the dominant story for both the global economy and capital markets, as the country's immense growth and infrastructure investments have sustained commodity prices, and altered the balance of world economic power. That growth has come (or should have come) with the recognition that in almost every venture in China, public or private, the Chinese government is not just a player, but often the key player determining the venture's success and failure. Afraid of being shut out of the biggest, growth market in the world, companies operating in China have accepted limits and constraints that they would fight in almost every other part of the world, including in their own domestic markets. That includes not just foreign companies, seeking to operate in China, but domestic companies, who, while benefiting from Beijing's backing, knew how quickly the iron fist could replace the velvet glove, in their dealings with the government. In the last year or so, Chinese tech companies, including shining stars like Alibaba, Tencent and Didi have also woken up to this recognition, and investors have had to readjust their expectations for these companies. In this post, I will begin by tracing out the rise of China to global economic power, and then focus on Chinese tech companies, with the intent of examining how government actions and inactions can affect value and pricing.

The Rise of China

While China's rise in the last two decades has been meteoric, it is worth remembering that China was a dominant part of the global economy centuries ago. The graph below draws on one of the most fascinating (and fun) datasets in the world, maintained at the University of Groningen which estimates (or at least tries to estimate) the GDP regionally going back to 1 AD.
Angus Maddison, University of Groningen
In 1500, China had the largest GDP of any country in the world, followed by India, not surprising since output and population were tied together strongly at the time, when human labor was the key driver of economic output. With the advent of the Industrial Age, both India and China fell off the pace, and by the start of the twentieth century were punching well below their (population) weight.

I am not an historian or political scientist, and will not probe the reasons, but China spent much of the twentieth century with a stalled economy, and in 1970, China's GDP accounted for 4.63% of global GDP, down from more than 30% in 1820. The turn around that occurred in China's economic growth occurred is one for the history books, and you can see the rise in the graph below, where I look at China's GDP, relative to the United States (which had the dominant share of global GDP) and to the rest of the world between 1960 and 2020:
World Bank Database

The United States, which used to account for close to half of global GDP in 1960 has seen its share drop go global GDP drop to 25%, while China's share has climbed close to 20% in 2020.  To get a sense of how dependent the world economy has become on China for its growth, take a look at the table below, where I report World GDP growth, by decade, with and without China:
World Bank
Put bluntly, without China, the world economy would have tread water for the last decade, since China accounted for close to two thirds of global GPD added on during the decade. As China's economy has grown, its financial markets have also found their footing, albeit at a slower pace. In the graph below, I plot the market capitalization of Chinese listed companies, in dollar terms, and as a percent of market capitalization of all global companies: 
World Bank Database

Chinese equities have risen from a negligible share of global market capitalization, in 2000, to more than 10% of global market capitalization, in 2020. It is beyond debate that China's economy and markets have had a renaissance, cementing the country’s place as a leading economic power. 

While many of the companies listed initially on the Chinese markets represented infrastructure and financial service companies, the last decade has seen the rise of the Chinese tech behemoth. That transition can be seen when you compare the fifteen largest Chinese companies, in market capitalization terms, at the end of  2010 to the fifteen largest Chinese companies, again in market capitalization terms, at the end of 2020. 
S&P Capital IQ
At the end of 2010, of the fifteen largest market cap companies in China, only two were tech companies (Tencent and Baidu), and they were towards the bottom of the rankings; banks and insurance companies dominated the list. By the end of 2020, six of the top fifteen were technology companies, and Tencent and Alibaba topped the rankings.

The Chinese Tech Decade

The rise of technology as an economic force and  market driver is not unique to China. After all, the FANGAM stocks (Facebook, Amazon, Netflix, Google, Apple and Microsoft) were the engine that drove market capitalization up in the US, for the last decade, with COVID super charging their rise in 2020. In this section, I will focus on the Chinese tech market, by looking at some its biggest success stores, and using them to gain an understanding of both the promise and peril in this business. 

Chinese Tech Plays - The Lead In

In this day and age, every business brands itself, at least in part, as a technology company, and it is always tricky to try to crystallize the diverse mix of technology into a tech sector. That said, there is an advantage to taking a deeper look at some of the biggest winners in the tech business, not only to understand why they succeeded, but also to get insights into whether they can sustain that success in the future. It is for that reason that I will focus on four Chinese tech companies (Tencent, Alibaba, JD.com and Didi) for the rest of this post, the first three because they make the top fifteen list of market cap companies in China, and Didi because of its high profile IPO, just a few weeks ago. 

I am not a fan of extensive corporate write ups, with long treatises about corporate history and developments, since they often operate more as distractions than as sources of information. Instead, I will try to compress what I know (which is not much) about the evolution and operations of each of the four companies. I will start with Tencent, in deference to its age (it is the oldest of the four) as well as its standing as the largest market cap company on the list. 

Tencent is the most versatile of the four companies, in terms of its business mix, and while it has been in existence for 20 years as a publicly traded company, its growth in the last decade has converted it from a minnow to a whale.  Moving to Alibaba, the second largest Chinese tech company in 2020, I drew on a blog post that I wrote ahead of its IPO in 2014, where I described it as “the Real China Story”, because so much of Chinese retail traffic travels through its platforms (Taobao and TMall), with the company collecting a slice of the transaction revenues, in return for its intermediation services.

While Alibaba is sometimes characterized as China's Amazon, it is closer to Google in its business model, collecting most of its revenues from customers using its platforms to buy goods and services. Staying in the online retail space, I look at JD.com, which operates more as a retailer, selling goods and services through its platforms.

Note that JD.com, while posting strong revenue growth rates for much of the last decade, has had trouble generating significant operating profits. That, in my view, is not accidental, since the company has been open about its focus on increasing market share, at the expense of profitability, following the Field of Dreams model (If we build it, they will come)... The final company in my list is Didi, a company that I had tracked in the process of valuing Uber and Lyft, and it followed them into public markets in 2021:

Didi's acquisition of Uber China has given it dominance over the Chinese ride sharing market, but it is difficult to see the payoff in the numbers. Revenues have stagnated between 2018 and 2020, and the easy excuse of COVID does not explain the stagnation, since growth was tepid even in 2019. The company has also shown an almost unparalleled capacity to lose money and burn through cash, even by ride sharing company standards.

Chinese Tech Plays - Valuation Stories

To value the Chinese tech companies, I have to construct valuation stories that fit them, and as you can see there are big differences across the four companies (Tencent, Alibaba, JD.com and Didi) not only in where they are in terms of growth potential, but also in terms of profitability and business models. That said. there are some commonalities across these companies that I will explore in this section.

Big Markets (Squared)
There are many aspects that make Chinese tech companies attractive to investors, but the one overriding attraction of these companies is their access to the Chinese market. As I noted in the first section, China was the engine that drove global growth over the last decade, and with that growth has come a surge in buying power for Chinese consumers. Companies that are positioned to take advantage of this growth, whether domestic or foreign, have been rewarded by investors with higher market capitalizations, even if the promise has not translated into profitability (yet).  With tech companies that are disrupting conventional businesses, there is an added allure of growth occurring at the expense of the status quo. Tencent in the gaming business, Alibaba and JD.com, with retailing, and Didi, with logistics, are all disruptors of the status quo, in the businesses that they operate in. You could argue that this combination of China and disruption creates growth stories on steroids, as investors load on dreams of one big market (from disruption) on top of another (China). 

As with any steroid-driven story, there are downsides. First, I have had multiple posts on the big market delusion, where I argue that investors often over estimate the likelihood and payoffs of success in big markets, because they fail to factor in new entrants, and changing technology fully. This argument applies to Chinese companies, generally, and to Chinese tech companies, specifically, as "the market is huge, the company's value has to be immense" argument often wins the day. Second, the size of the Chinese market, in conjunction with local dominance, has also meant that Chinese tech companies prioritize domestic market growth, simply because it is easier and often more profitable. Of the four companies that I am analyzing, Tencent is the only one where foreign market revenues are substantial enough to make a difference to its valuation. Alibaba has aspirations to grow in foreign markets but has little to show yet in terms of profits, and Didi and JD.com are almost entirely China-focused. Clearly, their global ambitions notwithstanding, Chinese tech companies have remained overwhelmingly Chinese. There are benefits to getting growth from domestic markets, but that dependence also makes these companies extraordinarily exposed to government regulations and restrictions in these markets.

Attuned to the Chinese Market
The argument that the big (and growing) Chinese tech market explains the success of the winners (like Alibaba, Tencent, JD.com and Didi) short changes these companies, by underplaying what each of them brought to the game that allowed them to succeed. Note that these companies were very much part of the pack, competing with foreign and  domestic players, just a decade or two ago, but have managed to separate themselves from their competitors, in the years since.  While there are many factors that may have contributed, one in particular stands out. Rather than copying what successful US tech companies were doing to gain market share and profitability, these companies tailored their business models and product offerings to the Chinese market, adapting to what Chinese consumers cared about and wanted. In my IPO post on Alibaba, I argued that the reason it was able to vanquish eBay and more established competitors was because it created what the Economist called the "world's greatest bazaar" and a payment mechanism that Chinese consumers felt comfortable using online. Tencent not only built a gaming platform specifically focused on Chinese consumers, but was well ahead of its US tech competitors in building the world's leading social media platform in WeChat. Didi was conceived as a cab-hailing company in 2012, but it too tailored its services to the local characteristics of the Chinese market, acquiring its main domestic rival in Kuadi Dache in 2015, and forcing Uber to capitulate and sell its Chinese segment in 2017.

Corporate Governance Nightmares
There is another feature that Chinese tech companies share, and it is not a favorable one. While Alibaba, Tencent, JD.com and Didi are undeniably Chinese companies (both in terms of operations and where they get their revenues), three of these companies (Alibaba, JD and Didi) made their public market debuts in New York, with NASDAQ listings. In fact, these three companies are also incorporated in the Cayman Islands, and Tencent began its corporate life as a Cayman Island listing. In fact, the structure (called a variable interest entity or VIE) used by these companies essentially means that shareholders are technically owners of shell companies rather than the Chinese enterprises that they they think they are buying. 
Why do Chinese tech companies favor this convoluted structure? The answer lies in Chinese laws and regulations that restrict the types of business that foreign investors are allowed to own shares in, and technology is one of those restricted businesses. Variable interest entities are a technicality that allows Chinese tech companies to get around the law, but they hold up only because the Chinese government has looked the other way, perhaps because the benefits to China (of tapping into foreign capital) exceed the costs. The legality of variable interest entities is still much debates, but if its gets litigated, stockholders in these companies may find themselves with limited standing. As an added complication, each of these companies has elaborate subsidiary structures, including wholly owned, majority owned and minority owned subsidiaries that are, at best, opaquely reported upon, and at worst, a blank slate.

Beijing: A Silent (or not-so-silent) Partner!

The discussion of variable interest entities (VIE) its a good lead in to the third component that Chinese tech companies share in common, which is that the Chinese government is a player in the game, no matter what business you enter into in China. Note, though, that the notion that governments are neutral arbiters who don't affect company value is utopian, since governments in every market affect almost every dimension of value, sometimes positively and sometimes negatively. In the figure below, I have used my value drivers framework, where I connect the value of a company to key drivers of value (revenue growth, operating margins, capital intensity and risk), to examine how government action (or inaction) can affect each driver.

There are a myriad of ways in which governments can add or detract from value, and the net effect will depend on the company and government in question. I have found this framework useful in dealing with a effect on value of everything from crony capitalism and political connections to regulation.

If this is true for all companies, why make this an issue with just Chinese tech companies? There are two reasons. 
  • First, the Chinese government can not only change the competitive balance and business more decisively than democratic counterparts, where making laws involves trade offs and bargains, but also make the changes more permanent, since a change in government is not in the cards. 
  • Second, in most countries, government rules and regulations have to run a gauntlet of legal challenges, before becoming law, since a judiciary can over ride, delay or even set aside government actions. This may reflect my ignorance, but I have never heard of a Chinese government law or regulation that had to be withdrawn or suspended, because a Chinese court ruled it illegal. 
Put simply, the Chinese government has more power to give and to take away from its companies than any other government of consequence in the world. Sensible investors have always understood this power, and tried to price them in, but for much of the last decade that has led them to bid up Chinese companies, on the assumption that Beijing would tilt the playing field in favor of domestic companies, at the expense of foreign competitors, and that the governments' push for more economic growth would make it more likely to be an ally, rather than an adversary, to companies. 

That calculation, though, does miss the other quality that the Chinese government has always valued, which is control, and the tussle between the two (growth and control), in  my view, explains much of the crackdown on Chinese tech. As Chinese tech companies have become larger and more valuable, they have also become repositories for data on their customers, and that data is what Beijing not only fears, but covets. While the government may frame its crackdown on big tech as designed to protect Chinese consumers’ privacy or to prevent market domination, the truth is that  this is mostly about the Chinese government increasing its control of data and markets. Just as a thought experiment, if the Chinese government had the information that Tencent and Alibaba have about their customers, do you believe that they would not keep it? Whatever the reasons for the Chinese government’s actions, it is undeniable that they have changed the calculus, at least for the moment, of how the Chinese government affects Chinese tech company valuations. As investors bring in the downside of the government effects on value, markets have reassessed the pricing of all four of the companies that I am valuing, dropping market capitalization by 17% for Tencent, 46% for Alibaba and 7% for JD.com in 2021, over the most recent year, and providing a frosty reception to Didi’s IPO, with the stock price dropping 42% from its offer price of $14 a share , just a few weeks ago. The question is not whether the mark down on price has a good reason (it does), but whether the market is over or under reacting to the new relationship between Chinese tech and the Chinese government.

Investing in China Tech

With that long lead in, I think that we are positioned to not only value Tencent, Alibaba, JD.com and Didi, but also to bring in the effect of activist government on their value drivers in the future. In the process, the question of whether these companies are cheap, given their recent mark downs, or expensive, will be answered. 

Valuing Chinese Tech Companies
As I noted in the last section, investors have priced Chinese tech companies for much of the last decade, on the presumption that the Chinese government would be a net plus for these companies, stifling competition from foreign companies and easing the pathway to growth to profitability. It is for that reason that investors have been shocked by the realization that what governments can give, they can take away. Rather than bury you in details of each company's valuation, I have summarized the key inputs and valuations of each company, under three scenarios, built around views of the government - the government as benefactor, the government as a net-negative (more likely to hurt the company than help it, reflecting my current view on the Chinese government's relationship with these companies) and the government as adversary - in the table below:
Tencent: Government as benefactornet negative and adversary
Alibaba: Government as benefactornet negative and adversary
JD.com: Government as  benefactornet negative and adversary
Didi: Government as  benefactornet negative and adversary
The effects of the Chinese government on the valuations of these technology companies can be seen in the range of values per share that you get for each company. In making my assessments of how government affects value, I believe that almost all of the effect will be in the cash flows for the companies, since most of the restrictions are on growth (constraints rising from anti-trust moves) or on margins (costs associated with meeting privacy needs). While there is talk of banning tech companies from listing on foreign markets, using shell structures, I don't believe it will be retroactive, and the companies on my list are big enough to transition. With Didi, I do believe that a strong push by the government to restrict how it does business will increase the chance that the company will not make it as a going concern, since its business model is still a work in process.

Based upon my assessments, the quick takeaway is that at current stock prices, all four of the companies are under valued, with what I believe are reasonable constraints brought in by government actions. Alibaba is the most undervalued (by 12.7%), followed by Tencent (by 8%), but Didi and JD.com are close to being fairly valued (undervalued by 3.65% and 2.07%). Digging deeper, there is substantial downside if the government becomes openly and actively adversarial, with Didi dropping to becoming almost worthless, if that happens. On the upside, if any of these companies finds a way into the government's good graces, the benefits that flow from it can increase the upside at each of these companies, but most at Didi. Didi is clearly more exposed to government actions than the other three, suggesting a broader principle at play, which is that young companies are more affected in terms of both upside and downside, by government actions and regulations, than older companies.

Investing in Chinese Tech Companies
Valuation is a pragmatic, rather than a theoretic, exercise, where the end game is not just understanding and estimating the value of a company, but acting on that valuation. If you are an investor, you should be willing to buy under valued companies and sell short on over valued companies, with the caveat that you need a market correction to make money, and that correction may take time. Since I find all four of the Chinese tech companies under valued, what would I do next? First, I would remove Didi and JD.com from the mix, largely because they are closer to fairly valued, than under valued. In fact, I would argue that looking at Didi's still unformed business model, and the huge consequences of government action or inaction, it is closer to being an option than a conventional going-concern valuation. Second, with Alibaba and Tencent, both of which are under valued in my base case (government as a net negative), I have three choices:
  • Buy both Alibaba and Tencent, and hope that the "government as adversary" scenario does not play out for either. 
  • Buy one of the two, based upon not just the valuation but also the rest of the company, including corporate governance and structure.
  • Buy neither, because you believe that the "government as adversary" scenario is more likely than the "government as benefactor".
I am not inclined to double down (buying both companies) on betting on how the Chinese government will behave in the future, and if I had to pick one, I would pick Tencent over Alibaba for three reasons. The first is that Tencent is a more rounded company in terms of being in business mix, and I think that the WeChat platform, like the Facebook platform, adds a premium to their valuation. The second is that I prefer buying Tencent on the Hong Kong stock exchange to buying Alibaba's Cayman Islands shell company on the New York Stock Exchange. The third is that while I admire Jack Ma as an entrepreneur, I am believe that personality-driven companies have an added layer of risk, since that personality can draw attention and fire. In fact, there are some who believe that the increased regulation of Chinese technology can be traced to Jack Ma's challenging Beijing in 2020. 

With my Tencent investment, I faced a secondary choice of investing directly in Tencent or indirectly buying shares in Naspers, a South African holding company. If you are puzzled about why Naspers enters the  equation, the company acquired 46.5% of Tencent in return for a $32 million VC investment in 2001, and as Tencent surged in market capitalization, Naspers has become a proxy for the stock, with 80% or more of its value coming from its Tencent holdings. The one difference is that the market is discounting the holding by 20-30%, in Naspers hands, reflecting concerns about taxes due and corporate governance at Naspers. That discount seems immune to almost every attempt by Naspers to make it disappear; for instance, Naspers spun off a Dutch entity, Prosus, and endowed it with a portion of the holding, in an attempt to eliminate the discount, but the discount persists in Prosus as well, albeit a little smaller. I decided that the potential upside of hoping that the discount narrows over time is exceeded by the downside of creating an extra layer between me and my Tencent investment. (For those of you who want to track my Tencent investment, and perhaps taunt me if (or when) I get wrong, I bought the ADR on August 31.)

In valuation, we seldom consider the explicit effects of government policy and regulations on company value. The rationale that is usually offered for this practice is either that the government's capacities to add and detract from value offset each other or that the current numbers for the company (growth, margin etc.) already incorporate the government effect. While ignoring governments may be defensible, when government policy is stable, it breaks down when governments deviate from the script, and behave differently that they have in the past. With Chinese tech companies, long used to the Chinese government being an ally in their search for growth and profits, the last year has been a rude awakening to a new reality of a more activist and punitive version. That said, I don't for a moment believe that the Chinese government cares about either consumers or competition, the stated reasons for the crackdown, and am convinced that this is more about the it exercising control over both companies and data. I also believe that the adjustment in market prices that we have seen in Chinese tech companies is reflecting the fear that investors have now that the government will act as a constraint rather than an accelerator on future growth and profitability. As markets recalibrate prices to reflect the new reality, there are opportunities for solid returns in this space, and I hope to one of the beneficiaries! 

YouTube Video

  1. Tencent: Government as benefactor, net negative and adversary
  2. Alibaba: Government as benefactornet negative and adversary
  3. JD.com: Government as  benefactornet negative and adversary
  4. Didi: Government as  benefactornet negative and adversary

Monday, August 2, 2021

A DIY (Do-It-Yourself) Valuation of Zomato

Just over a week ago, I valued Zomato ahead of its market debut, and as with almost every valuation that I do on this forum, I heard from many of you. Some of you felt that I was being far too generous in my assumptions about market share and profitability, for a company with no history of making money, and that I was over valuing the company. Many others argued that I was understating the growth in the Indian food market and the company's potential to enter new markets, and thus undervaluing the company, a point that the market made even more emphatically by pricing the stock at about three times my estimated value. A few of you posited that I was missing the point entirely, and that Zomato is a trader's game, and that there are plenty of reasons for traders to be optimistic about its future prospects.  In this post, rather than impose my story (and value) on you, I offer a template for telling your own story about Zomato, and arriving at your own estimate of value.

The Prelude

After I posted my valuation last week, I did find some of the portrayals of my post to be a little unsettling. Some started by describing me as some kind of valuation luminary, and then proceeding to describe what I did to arrive at value as the result of deeply insightful research. Let me dispel both delusions. First, there is nothing in valuation that merits the use of “expert” or “guru” as a descriptor, since it is for the most part, common sense, layered with a few valuation basics. Second, while valuation practitioners have created their own buzzwords to create an aura of mystery, and added complexities, often with no reason other than to intimidate outsiders, I believe that anyone should be able to value a company, as I hope to show later in this post.  There was also some who misread my post to imply that I disliked Zomato as a company, or that I was trying to talk others out of investing in the company. Neither assertion is true, and since they relate to what I view as fundamental truths about investing, let me elaborate:

  1. Good Company versus Good Investment: While it is true that, at least in my assessment, Zomato is over priced, making it a bad investment, it does not follow that it is a bad company. I have written about the contrast between good investments and good companies before, but the picture below captures the essence:

    In short, your assessment of whether a company is good, average or bad is based upon how you see their business model playing out in future earnings and cash flows, but your assessment of whether it is a good investment depends upon whether your expectations for the company are more positive or negative than the market expectations for that company. My story for Zomato is a very positive one, where the company not only maintains its market share of a growing Indian market, but preserves its profitability, in the face of competition. That is one reason that I emphasized that unlike some, who have concluded that its money-losing status and big ambitions make it a "bad" company, my conclusion is that it is a good company. That said, the market seems to be pricing in the expectation that it will be a great company, and in my view, that judgment is premature.
  2. Taking ownership of investment decisions: I value companies for an audience of one, and that audience member is forgiving and understanding, because I see him in the mirror every day. It has always been my belief that as investors, each of us needs to take ownership of our investment decisions, and that buying or selling a company because someone else is doing so, even if that person has legendary investment credentials, is a dereliction of investment due diligence. Thus, if you find Zomato to be cheap and buy it, I have no desire to talk you out of your decision, since it is your money that you are investing, and that decision should be based upon your assessment of the company's prospects, not mine.
If investing is all about market price and how it relates to your assessment of value, it follows that there will never be consensus, and that disagreement is not only part and parcel of the process, but a healthy component in good valuation.

Valuation Storytelling: The Feedback Loop

In my valuation of Zomato, I laid out the story that I was telling about the company and how it played out in valuation numbers. It is part of a broader theme that I have harped on for years, which is that a good valuation is a bridge between story and numbers, and in my book on how to build that bridge, I talked about a five-step process:

In my last post on Zomato, you saw much of this process play out, but I want to focus on the fifth step, i.e., keeping the feedback loop open, and what it requires:
  1. Talk to a diverse audience: We live in a world of specialization, in almost every aspect of life, and that trend comes with mixed blessings. On the plus side, we now have experts who have spent their entire lives delving into an extraordinarily narrow slice of a discipline, often at the expense of the rest of that discipline. On the minus side, this expertise creates tunnel vision, where these experts often lose the forest for the trees. To make things worse, we have created workplaces, where these specialists often interact only with each other, making their isolation almost complete. I am lucky that I am able to interact with people with very different backgrounds (bankers, VCs, founders, CFOs, regulators), from different geographies and with very different perspectives, through my teaching and writing, and my suggestion is that you hang out less with people who think just like you do (often because they have the same training and credentials) and more with people who do not.
  2. Transparency over opacity: You have all heard the old saying about economists (and market gurus) needing three hands, because they constantly seem to have two of them busy, with their "on the one hand, and the other" prevarications about the future, that leave listeners confused about what they are predicting. I start with my valuation classes with the motto that I would rather be transparently wrong than opaquely right. Consequently, when I value companies, I try to take a stand on value, and be open about process, data and mechanics, so that anyone can not only replicate what I did, but  also find their own points of disagreement, and reflect those changes in their own assessed values. I am also well aware of the risk that by putting out valuation details, I will be proven wrong in the future, but I like the accountability that comes with disclosure. In commenting on my Zomato valuation, some of you pointed to how wrong I have been in valuing Uber and Tesla in the past, and while that is fair game, I have made peace (really) with my mistakes.
  3. Listen to those who disagree with you: I try to listen to those who disagree with me on any forum, whether it be social media or snail mail, for a very selfish reason. On every company that I value, I know that there are people out there who know more than I do about some aspect of the company (its products, market or competition) that I am valuing, and I can learn from them. With Zomato, for instance, I have learned about online food delivery and restaurants in India in the two weeks since I posted my Zomato valuation. I have some understanding of why Zomato Pro has not caught on as quickly as the company thought it would, why some of you prefer Swiggy, and even what you like to order from restaurants. (Biryani seems to a much bigger draw, for Indian diners, than it was in the days that I was growing up in India.)
  4. Be willing to change: The three most freeing words in investing and valuation are “I was wrong”, and I would be lying if I said they comes easily to me. That said, I find it easier to say those words now that I have had practice, and while some view this as an admission of weakness, saying it releases you to tell a better, and sometimes different, story. Bill Gurley’s critique of my narrow definitions of total market in my first Uber valuation significantly changed not only my valuation of that company, but has played a role in how I estimate total market size and value sharing economy companies.
The feedback that I have received on Zomato has already had tangible effects on my valuation. For instance, some of you noted that the corporate tax rate in India is 25%, not 30%, and while the Indian tax code with its predilection to add in surcharges that seem to last forever, and exceptions, still leaves me confused, I will concede on this point (pushing up my value per share marginally from 41 INR/share to about 43 INR/share). I have had pushback on my story’s focus on Indian food delivery, with some pointing to the potential for Zomato to expand its market globally, and others to the expansion possibilities in Indian grocery deliveries and from cloud kitchens. While I believe that the networking advantage that works to Zomato’s benefits will stymie them if they try to expand to large foreign markets and that the grocery delivery market, at least for the moment, offers too small a slice of revenues to be a game changer for the company, those are legitimate points.

A DIY Valuation of Zomato

 If, as you read my Zomato valuation, you found yourself disagreeing with me, I would like to offer you a way of valuing the company, with your disagreements incorporated into the value. Put simply, I will take care of the background work and the valuation mechanics, if you can supply the story. So, if you are ready, let’s go!

1. Total Addressable Market & Scaling Growth

The first and biggest part of the Zomato story is the total market that it can go after, since it defines how big a story you can tell, and by extension, how big your value can be. In my valuation, I assumed that Zomato’s primary revenues would continue to come from customers ordering food from restaurants for pickup and delivery, and that notwithstanding its global ambitions, India will remain its main market. That assumption led to my base case estimate of about 2,000 billion rupees (just over $25 billion) for the total market. This was the assumption that got the most pushback, on two fronts, first that I was ignoring the possibility that Zomato’s global reach could expand that market and second that adding grocery deliveries could make the market bigger. Some also mentioned the potential for growth from cloud kitchens, i.e., restaurants (small and large) that offer food only for delivery. So, with no further ado, here are your choices:

DIY Valuation Spreadsheet

For pessimists about Indian growth and eating habits, I offer the possibility that the total market will grow to only 1,125 billion ($15 billion) in ten years. For optimists, allowing for more growth in the Indian market or adding global growth makes the market bigger, and adding grocery deliveries to the total market more than doubles the market. In addition, you can make a judgment on whether the growth will be front ended (more growth in the early years) or spread evenly over time:

DIY Valuation Spreadsheet

This choice will be tied to how quickly you think that the Indian economy and food delivery market will develop over time.

2. Market Share

Zomato is currently one of the two largest companies in the Indian food delivery market, with a market share that is just above the the 40%. In my valuation, I assume that the food delivery market, following a pattern that seems to be forming globally, will remain dominated by a couple of players, and leave the market share at 40%. Many of you suggested that the Indian market’s diversity, across regions and income classes, would result in a more splintered market, with lower market share, but a few argued that Zomato’s capital raise would allow it to dominate the market, earning an even higher market share:

DIY Valuation Spreadsheet

In making this judgment, keep in mind that the more expansively you define the total market, the more you may have to pull back on market share. Also, if you do choose a dominant market share (60% or higher), consider the potential for legal and regulatory pushback. 

3. Revenue Slice

The driver for the online food delivery business remains the slice of the total food order that accrues to them as base revenues, and this slice is what has to use to pay delivery personnel, cover operating costs and be used to acquire new customers. In my base case valuation, I assumed that Zomato would get to keep the 22% of gross order value in the future, a little higher than its COVID-affected FY 2021 numbers and a little lower than its FY 2020 numbers. As Zomato tries to maintain its leading market share of the Indian market, this number will be the one that will come under the most pressure, since an aggressive competitor (like Amazon Food) may be willing to settle for a lower percentage. Note that there is also the possibility that the Indian food delivery market will end up dominated by two or three companies, and that these companies could come to an implicit agreement to leave the GOV slice untouched. That would be unfair to restaurants, but will improve the bottom line for the online delivery companies:

DIY Valuation Spreadsheet

In making a choice on revenue slice, recognize that it will be affected by your choices on market size and market share. Thus, if your total market is much bigger, because you have added in grocery deliveries, you should also be using a lower revenue slice, since grocery stores, with their lower profit margins, are reluctant to let delivery companies keep more than 10% of the order. In the US, for instance, large grocers have pushed back against Instacart’s cut (about 9%) of gross order value, and have started their own delivery services.

4. Operating Margins & Pathway to Profitability

In my valuation of Zomato, I noted that one of the advantages of being an intermediary is that the gross and operating margins tend to be high, once growth subsides that the expenses (selling and advertising costs) associated with  delivering that growth scale down. In my base case, I assumed a pre-tax target operating margin of 35%, but that margin will depend on how the competitive landscape evolves. If you have only two or three players, with a live-and-let-live attitude, margins will be high for all of the competitors, but if they continue to try to aggressively claw back from market share, through advertising and discounting, they will decline for all of the players.

DIY Valuation Spreadsheet

In my Zomato valuation, I also assumed that the company would continue to lose money in the near term, but that operating margins would converge on the target value in year 7. This assumption implicitly stands in for your views on how smooth the pathway to profitability will be for Zomato, with rockier pathways leading to a longer time period before you reach the target margin:

DIY Valuation Spreadsheet

Here again, the assumptions about margins will depend on the businesses that you believe that Zomato can enter, using its platform capabilities. In the last week, I have heard arguments that Zomato can go beyond food delivery into running cloud kitchens, enter the health/fitness market and even be a lender to restaurants. While all of these are possible, these are businesses with very different profitability profiles, and are unlikely to earn operating margins even remotely close to the margins that can be earned in the online food delivery business.

5. Reinvestment

The key ingredient connecting value to growth is the reinvestment needed to sustain that growth. Put simply, a company that has to reinvest large amounts to deliver a specific growth rate will have lower cash flows and be worth less than an another company with the same growth rate, but lower reinvestment needs. The input that I used in the Zomato valuation to bring in reinvestment is the sales to  capital ratio, a metric measuring how much revenue is generated for each dollar of capital invested, with reinvestment defined broadly to include net capital expenditures (capital expenditures minus depreciation), working capital needs, technology investments in the platform and acquisitions, with a higher number reflecting more efficient reinvestment. In my story, I see a continuation of their historical pattern of reinvesting in acquisitions and technology, albeit with more efficient growth in the near term, as the company bounces back from the COVID effect; my sales to capital ratio for next year is 5.00, dropping to 3.00 in years 2-5, before settling into 2.50 in steady state. Here again, there is room for debate, since you could argue for less reinvestment in the future (than I am assuming), based upon past acquisitions paying off, or for more reinvestment, if the company tries to buy its way into new markets and businesses.

DIY Valuation Spreadsheet

Since the sales to capital ratio is not one that is widely reported, you may find yourself lacking perspective on what comprises a high, low or typical number.

6. Risk 

There are two risk parameters in intrinsic valuation, the cost of capital accounting for the risk or variability in expected cash flows and the failure probability incorporating the risk that your company will not make it as a going concern. In the Zomato valuation, I attached a 10% chance of failure, with the large cash balance (especially after the IPO) offsetting concerns from the company's money losing, cash burning status. For the cost of capital, I followed the traditional route of estimating the company's costs of equity (based upon its exposure to market risk) and after-tax cost of debt, to arrive at an initial cost of capital of 10.25%, which I lowered over time to 8.97%, with both numbers in Indian rupees. For those of you who may disagree with my estimates on these numbers, I will make the confession that in this valuation, this input is not on my top ten list of key inputs. To see why, consider this histogram of costs of capital (that I computed) for publicly traded Indian companies in July 2021:

My Data Update from 2021
Note that 80% of Indian companies have costs of capital between 8.01% and 13.16%, and that half have costs of capital between 9.50% and 12.06%. To estimate a cost of capital for Zomato, consider this simplistic (but effective) approach, based on these estimates:
DIY Valuation Spreadsheet
Thus, if you feel that I have underestimated Zomato's risk in my valuation, consider going with an initial cost of capital of 12.06% (the third quartile), whereas if you believe that I have overestimated the risk, go with 9.50% (the first quartile). Then, move on to the inputs that really matter, since, in my view, this is not one of them.

Possible, Plausible and Probable

A common pushback against story telling is that it allows investors, analysts and appraisers to let their imaginations run riot, creating fairy tale valuations. It is to counter that possibility that I argue that every valuation story has to go through a three part test:

As you navigate your way through the choices, you may be tempted as an optimist to go with the most positive (for Zomato's value) choices on each variable (biggest market, highest market share, highest margin, lowest cost of capital) or the most negative (smallest market, lowest market share, lowest margin, highest cost of capital). In fact, the former if often labeled a "best case" and the latter a "worst case" valuation, when in fact, neither passes the possible/plausible/probable test, since assuming that you will go after the biggest market will mean accepting lower margins and higher reinvestment. Thus, I could tell you that the best case value is ₹423 and that my worst case value is ₹0, but that would be both useless and misleading. That said, you can already see, no matter what your priors, that there is a whole range of stories for Zomato that pass the test, and that they can yield values per share that are very different:

No failure risk in juggernaut stories, 10% risk in others

The most upbeat story that passes the plausibility test, albeit barely, is the one where Zomato targets the food and grocery delivery markets, while maintaining its revenue slice at 25% and margins at 45% (duopoly levels) and a low risk profile, and even with that unlikely combination of assumptions, the value per share is ₹150, about 10% higher than its stock price of ₹140, on August 2nd. Most of the plausible stories fall between ₹30 and ₹60, with your views about growth in the Indian economy & delivery market, revenue slice, margins and risk determining where you fall in the spectrum. This table contains only a small subset of the stories that can be told about Zomato, and I would encourage you to try your hand at the DIY valuation. Once you are done, please go to this Google shared spreadsheet and stake out your value. In a world where we trust crowds to get things right on every aspect of our lives from what restaurant to eat at to what movies to watch, let's get a crowd valuation of Zomato going.

Playing the Zomato Game

I am sure that there are some of you are wondering whether any of this discussion matters, if the market pricing is based upon mood and momentum. After all, if enough buyers line up to buy Zomato shares, perhaps drawn to it by the success of others, there is no reason why the price cannot continue to rise, no matter what the value. I don't disagree with that sentiment, and it goes back to the contrast I draw not just between value and price, but between investing and trading. As an investor, I am having trouble finding a pathway to justify paying 140 INR per share, for Zomato, even with the most upbeat stories that I come up with, for the company. That may of course reflect a failure of imagination on my part, and you may be able to find a narrative for the company that allows you to invest in the company. As a trader, the question of whether you should buy Zomato comes down squarely to how good you are at playing the momentum game, knowing when to get on, and more importantly, when to get off. For you, the value of Zomato may be irrelevant, and you will need a different set of metrics (charts, price and volume indicators) to make your decisions. I wish I could help you on that front, but trading is not my game, and I have neither the tools nor the inclination to play it. I wish you the best!

YouTube Video


  1. A DIY Valuation of Zomato
  2. Google Shared Spreadsheet (Crowd Valuation)