Funding start-ups is the new normal

Total equity initial public offerings (IPO) in Pakistan in the last one year (Jul20-Jun21) stood at Rs20.1 billion ($126 million). And that only when the number of offerings were the highest in the last 14 years (highest since 2007: 12 listings), meaning, this has been an ‘exceptional year’ from IPOs’ standpoint. This equity amount raised through IPOs in this period is also the highest-ever amount raised in Pakistan.

On the other hand, total Startup funding, only in the first 6 months (Jan-Jun21), fetched Rs20.3 billion ($127million) – higher than the amount raised through IPOs in 12 months. This funding figure does not include the latest largest funding rounds of Airlift ($85 million) and Bazaar ($30 million) for comparison purposes, which, with a couple of more from the HealthTech and others, makes the total Startup funding go beyond $250 million.

Stretching funding period from 6 months (Jan-Jun21) to 12 months (Jul20-Jun21), similar period as that of the IPOs’, makes the total Startup funding cross Rs28.3 billion ($177 million, excluding Airlift’s and Bazaar’s). This is 40 percent higher than the total funding raised through IPOs from the Pakistan Stock Exchange (PSX), despite that this has been termed as an exception year for IPOs.

Interestingly, since 2015, total funding raised through IPOs in Pakistan stood at $480 million while total funding raised by Startups stood nearly $460 million – not too far off at that stretch too, given that the Startup space has started getting traction since last few years only.

Further, even the single largest private sector IPO in Pakistan raised Rs5.0 billion ($36 million), while the next one is expected to be not more than around the same level either. While on the other hand, the single largest funding round of Airlift just happened ($85 million) alone dwarfs all the Top-3 largest equity IPOs in the country put together, hinting at a sleeping giant that is warming up in Pakistan!

From valuation’s perspective, this single funding round puts a valuation tag of $275 million on this single company (Airlift), which is i) greater than 90 percent of the companies listed at the PSX in terms of valuation. For instance, the valuation of Airlift alone equals 21 percent of total technology sector market value (KSE-100 Tech Market Cap is around $1.33 billion). Moreover, this single startup, if listed, would have become 45th most-valued company on the PSX; in the benchmark KSE-100 index, out of more than 520 companies listed at the PSX.

Even valuation of individual companies who went for IPOs recently, the largest one was valued at $285 million on IPO day (Interloop – one of the largest hosiery manufacturers in the world), which was close to valuation of a Startup that has just reached Series-A funding (3rd round).

What does this all tell us?

It’s about conventional capital versus patient capital. It’s about ‘conventional’ company IPO versus new-idea economy and tech-enabled ecosystem with innovative business models emerging and disrupting the traditional businesses in both the ways: what they do and how they operate.

Startups are uplifting the new tech economy by solving some of the critical problems facing the society at large for ages, most in basic areas like how the business takes place (technology infrastructure and solutions), how one buys/shops (e-commerce), how one gets it (logistics tech), how one pays for it (fintechs), how one acquires quality health and education (health-techs and ed-techs), thereby enabling the economy with ease, efficiency and comfort at a competitive price while leveraging technology and the digital ecosystem. Majority of Startup funding (70 percent) in Pakistan is flowing into Ecommerce, Fintech, and Logistics/Transport, followed by HealthTech and few others, which shows investors' readiness for embracing the tech-enabled solutions addressing chronicle inefficiencies in the business and social entrepreneurial space.

This valuation-at-IPO being lower than the valuation-at-early/mid-stage in Pakistan is also a rare phenomenon. It’s mostly the opposite globally that an early-stage Startup is valued lower than a mature company being eventually valued at public markets. Because companies climb a gradual valuation ladder as they achieve a growth milestone on their way up and get their ultimate valuations from the public market at multifold than their earlier-stage valuations. In fact, companies at public markets mostly get higher premiums on valuations given their long journey accomplished with improved team maturity and risk profiles.

Take Zomato’s case as a relevant example from India here. Zomato (a tech-driven food-delivery Startup) has recently done its IPO raising $ 1.26 billion (35X oversubscribed at $12 billion valuation!), after completing a decade-over journey from receiving $1million as Seed Capital back in 2010 followed by Series-A $3.5 million in 2011, totaling $2.1 billion funding raised over 12-year journey (from both VC and PE), eventually unlocking value at public markets. India currently has total 44 Unicorns in Startup space, with 11 Unicorns made only in the past 8 months (Unicorn is a billion-dollar-valuation company), while the listed Unicorns in India are 335 – about 380 Unicorns in total, versus Pakistan having 11 Unicorns in total (only in conventional listed space).

Even Bangladesh has listed Unicorns where 4 are directly/indirectly related to technology, while there is none related to tech out of total 11 in Pakistan’s case (all oil, banks and basic commodities). Largest Unicorn listed at the Dhaka Stock Exchange is valued at $5.8bn (telecom) versus OGDC (oil explorer) in Pakistan having largest market value under $2.5bn.

There is another very important takeaway from two different markets and risk appetite of investors in the funding value chain. 1) Higher valuations being achieved at Startup levels than at later-stage companies raising funds from public/institutional investors, is due to the fact that conventional corporates are not being able to achieve valuations until they adopt new idea/tech-enabled knowledge and innovation economy. Conventional models have failed to attract investor attention (both local and foreign); hence getting lower valuation premiums. In fact, discount to their intrinsic valuations is rather deepening ever.

One clear evidence of such investor preference at home is that, PSX’s current/forward trading multiples are at a deeper discount to their historical averages than what have been in the last 8-10 years. 2) Second reason for such low multiples offered by the market yet not being availed by average investor is that, KSE-100 index is more conventional sector-heavy (oil & energy, banks, cement, fertilizer, autos, and few others make up 77 percent of the index), whereas its peer in the region are becoming increasingly technology-heavy, thereby improving overall market valuations and investor returns.

For instance, listed Technology sector at PSX only has 6.6 percent weight in the KSE-100 (even half in the PSX All Index) while the largest sector is commercial banks (over 21 percent weight), followed by oil (up/mid/downstream at 16 percent) and fertilizer with 12 percent. While next door India, technology sector alone holds 20 percent weight in the benchmark Sensex-30 Index, while 17.4 percent in the Nifty-50 Index. It’s over 20 percent in Dhaka Stock Exchange (DSE) in Bangladesh.

Even from foreign investors’ perspective, with MSCI Emerging Markets and Frontier Markets going technology-heavy. Pakistan MSCI Index has zero weightage in tech (only financial & materials), versus MSCI India having 18 percent weight in tech sector, while the MSCI Emerging Markets (which Pakistan is part of) and the MSCI World Index, have 21 percent and 23 percent weights in technology sectors, respectively. This is one of the key reasons why our weight in the MSCI EM Index is microscopic and hence we have not seen any substantial foreign flows through it into the market.

Given that the PSX has more share of oil and conventional financials than growth-driven tech, PSX continues to trade at significantly low multiples, not only versus its regional and global peers, but also at its own historical averages too.

Another evidence of investor preference is that, technology sector at the PSX (despite most being very conventional models instead of any AI/Deep Tech) are trading at its historic peaks. This tells a key aspect that the market multiple will only be unlocked if more and more companies operating from the tech/data/information economy are listed, and, more importantly, the existing listed companies expand and diversify their exposure towards new innovation economy enabled by technology as well as the new technology itself as a service. This will help unlock market multiples for companies in true sense and will attract all sorts of capital to/within the country to both Startup and public markets, which is an essential ingredient to taking risk and venturing into unconventional territories for sustained progress.

Not only listed but big businesses/groups, who are the custodians of corporate Pakistan, need to take risk and invest into new ideas, perspectives, technologies, and verticals so to break into exponential growth and progress thereby developing higher chances of creating massive wealth not only for their investors/stakeholders but to set the future of the country altogether on a new growth path.

The question remains: Why are we not tapping this huge potential through policy incentive despite that Pakistan is the most untapped/under-tapped economy in the world, particularly in Asia, despite one of the fastest growing digital landscape it offers alongside one of the youngest populations on the face of the earth? The policymakers have rather withdrawn recently the basic tax benefits to VC and PE capital providers. Even tax and other efficiency benefits for forming a holding corporate structure has been withdrawn. Listing benefits have been withdrawn too. Inconsistent policy decisions, such as these, only play counter-productive and convert strengths into weaknesses and opportunities into threats. Our mindsets need a major upgrade. Because, to create disruption in the economy and existing business models, our mindsets need to be disrupted first; towards fresh thinking, perspectives, ideas and big visions, a can-do attitude with a well-thought execution strategy to unleash our true economic potential that we have been long blessed with.

The writer is an investment banker