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Data gathered from the Deals Barometer, a free to read monthly overview of the most significant developments in dealmaking in the Asia region, served as a springboard for a lively discussion in DealStreetAsia’s most recent webinar.
Titled ‘Market sentiment update: What Q1 2022 can tell us about the second half of the year and beyond’, the panel included Conrad Tsang, founder and chairman, Strategic Year Holdings; Rishika Chandan, managing director, Venturi Partners; Dimitra Taslim, VP, GGV Capital; and Peter McMillan, MD and head of sales for APAC at Donnelley Financial Solutions (DFIN).
Here are some of the key takeaways from the session:
It will take until Q2 or Q3 results to form an accurate picture of 2022
Investors on the panel cautioned against reading too much into the good performance of India and Southeast Asia through Q1. It did not guarantee that 2022 would be a record breaking year for these regions like 2021. The investors anticipated India and Southeast Asia following the trajectory of China and scaling back on the irrational exuberance of the year gone by.
GGV’s Capital Dimitra said, “As markets mature in the US and China, investors are looking for more exciting, nascent markets. But due to regional differences within private markets, you may see a correction a lot quicker in China and the US, than in the southern hemisphere: India, Southeast Asia and LatAm.” His opinion was echoed by Venturi Partners’ Chandan who believed that the Q1 numbers had been distorted to an extent by a large amount of follow-on funding to well established companies on the one hand, and a spill over of deals that were actually signed in 2021 on the other. She said, “Last year, the number of deals doubled in India, as did the average deal size from $12 million to $25 million. But Q2 and Q3 this year will show us reality. There is a cautionary approach with investors and founders waiting for the impact of what is happening in the US and China to trickle down.”
Despite significant dry powder, the ‘flight to quality’ will spell tough times for startups that are not category leaders
Even if they had been immune to valuation corrections so far, founders across Southeast Asia and India would have to temper their expectations going forward. Chandan said, “Many founders raising capital will face a new reality. Investors — including us — are going to focus more on unit economics and robust business models, rather than growth at all costs.” She believed the bargaining power had shifted and only fundamentally good businesses which could protect their margins and customers – typically category leaders – would be able to dictate terms to investors.
Veteran investors like Tsang and Dimitra believed that with a flight to quality underway, founders of smaller startups would be the worst affected.
Tsang likened the situation to the post dotcom bust era. Advising founders he said, “You can no longer create a story and hope someone will fund you. You have to restart and streamline operations. Assuming what you have on your balance sheet is your last round, how can you sustain the team and become EBITDA positive?”
He believed low fundraising from VCs and PEs would eventually make things more difficult for startups. And that the austerities needed to survive would go beyond tinkering with unit economics. He said, “If people are trying to price a deal based on page view, or GMV, those metrics are starting to get shaky. The choices before founders are to work on their own, tighten their belts and ride through this winter. Or to look for similar companies that are upstream or downstream, and consolidate. As an investor, we like to see companies merge or have more concentrated resources so they can ride through the winter more easily.”
VC firms will have to resist the temptation to time the market
Drawing from the history of the industry Dmirti said, “We cannot stop investing but can raise the bar on quality. In the mid-90s, a lot of funds took their foot off the pedal in 1997, because the markets were too hot. They missed the growth from 1998 to 2000. By the time the dotcom bust happened, many private investors in VCs had already made their money.” He pointed out that funds of the mid-90s vintage that stopped investing turned out to be the worst performers in an LP’s portfolio. The solution lay in good founders and companies capable of weathering tough times. He said, “Even if good teams fall during bad times, they get up faster and start running again.”
Venture debt was unlikely to play the role of saviour:
Peter McMillan observed that while DFIN had worked with companies considering venture debt, this was a relatively small number. He said, “Debt repayments may seem small compared to an equity exit. But with interest rates rising, it’s still something that has to be paid here and now. It may not be possible if the startup cannot raise another funding round, or doesn’t get the equity or exit it was looking for.”
There was more to China than a simplistic narrative of falling markets and regulatory crackdowns:
When it came to China, Tsang pointed to a dichotomy between the domestic market and the US dollar China focused funds listing on the Hong Kong stock exchange. The former had raised the equivalent of $28 billion in RMB – a 138% increase year on year. The latter saw a 90% decline to $1.8 billion. He said, “Domestic investors are focused on the 1.4 billion population including in the hinterlands and at least up to Q1, that has remained unaffected.”
He believed that the regulatory crackdowns were similar to governments everywhere acting against monopolies. He said, “It’s not the first time we have seen governments trying to break monopolies. Back in the 1980s, Bell was dominant in US telephony – both domestic and international. The US government ordered it to be broken down. Similarly, the government (in China) is trying to prevent some companies from becoming monopolistic, and to preserve data security. We’ve seen that reflected in the public market valuations for China related stocks. Recently, officials said that they will continue to support tech platforms. One can interpret that as the worst, probably being behind us.”
View the video of the session and read on for a transcript of the session, edited for clarity and brevity
Dealmaking in China is muted and investors seem jittery, possibly due to a combination regulatory crackdown on the tech sector, prolonged US-China trade frictions, and the Ukraine crisis. What is your take on dealmaking in China?
Conrad Tsang (CT): There is a sharp contrast in how China is viewed by international and domestic investors. In Q1, the domestic market raised $28 billion in RMB; up by 138% year-on-year. There are still many companies who primarily go to the Shanghai Stock Exchange or the China exchange to raise RMB. On the contrary, in the Hong Kong Stock Exchange, which is used for exit by US-dollar China focused funds, there was a 90% decline to $1.8 billion.
Domestic investors focus on the 1.4 billion population including in the hinterlands. At least up to Q1, that has remained unaffected. But given lockdowns in major cities like Shanghai and Beijing, I won’t be surprised if the numbers paint a bleaker picture in Q2.
Moving to the so-called regulatory crackdown: it’s not the first time we have seen governments trying to break monopolies. Back in the 1980s, Bell was dominant in US telephony – both domestic and international. The US government ordered it to be broken down.
Similarly, the government (in China) is trying to prevent some companies from becoming monopolistic, and to preserve data security. We’ve seen that reflected in the public market valuations for China related stocks. Recently, officials said that they will continue to support tech platforms. One can interpret that as the worst probably being behind us.
When we look at Southeast Asia, the data suggests a sustained appetite for assets despite a challenging global and regional macroeconomic landscape. What’s your view?
Dmirta Taslim (DT): As markets mature in the US and China, investors are looking for more exciting, nascent markets. Even the Pakistani ecosystem has been raising a lot of monies.
Due to regional differences within private markets, you may see a correction a lot quicker in China or the US, but later in the southern hemisphere: India, Southeast Asia and LatAm.
Global investors entering these regions make the business models of regional and local early-stage investors more viable. They can be more bullish since global investors provide a step-up in valuations, Series C onwards. That trend will probably continue for the foreseeable future. But the next six to 12 months will be rocky.
When it comes to India, are mega deals skewing the numbers? Are Indian entrepreneurs facing a sobering new reality from investors who are holding back on signing cheques?
Rishika Chandan (RC): The answer is both yes and no. When you break down the Q1 numbers, 45% of capital was actually towards follow-on funding or mega rounds. The other aspect is the spill-over effect of deals that were perhaps finalised in 2021.
Last year was a mega year for India – the number of deals doubled. As did average deal sizes from $12 million to $25 million. But Q2 and Q3 this year will show us reality. There is a cautionary approach among founders and other funds. Everyone is waiting for the impact of what is happening in the US and China to trickle down.
The other trend is a flight to quality. Category leaders account for a large portion of money that investors want to deploy. The best will continue to raise capital, perhaps even at increasing multiples, whereas the rest of the pack might see a slightly disproportionate negative impact.
Are there any big differences in founder expectations between India and Southeast Asia.?
RC: The exuberance is certainly tempered, depending on the stage of companies. We’ve noticed a higher impact of valuation correction on growth and later stage companies which are more Series C or D onwards. It has not yet reached seed, Series A or B.
When you split this by region, India being a more mature market, you notice a higher impact, just because you have more growth in later stage companies. In Southeast Asia, we are yet to experience the impact or the resetting of founder expectations.
Many founders in the market out to raise capital will face a new reality. Investors — including us — are going to focus more on unit economics and robust business models, rather than growth at all costs.
A lot of the investments through 2021 were driven by non-traditional investors such as hedge funds, PE funds doing tech deals, mutual funds, or family offices. Non-traditional investors put in about $254 billion into the tech space last year. Do you see a pullback from these investors over the next couple of quarters?
Peter McMillan (PM): Non-traditional investors have been part of deals that we’ve worked on globally. A lot of them sometimes have larger pools of capital versus traditional VC funds.
These investors have helped boost later stage valuations. That ends up providing more opportunities at the early stage and the non-traditional investors are probably part of that mix as well.
It’s not surprising since the demand for capital and strong returns have really coupled together to provide a great pathway for them to step outside of what they would usually consider.
There’s definitely still interest and appetite this year, but also concerns about the lack of immediate exits. They are looking for companies that will be winners or best in class and there’s a real flight to quality. The second, third, or fourth player in any particular market is probably not going to get as much funding.
That will probably lead non-traditional investors to step back slightly. It will be interesting to see how much they have to pull back. But from the ones that we have talked to and are working with, there’s definitely still an appetite and they really want to grow.
How do you see DeFi and GameFi going forward?
DT: We have closed some deals in the web3 space. However, we have been focusing a lot more on infrastructure and middleware — the ‘picks and shovels’ businesses.
There is a lot of noise when it comes to the B2C web3. DeFi is very interesting. But if you look at web 2.0, financial services developed over 50 to 100 years and only then was an infrastructure was put in place to serve them. That’s one of the biggest differences between web 2 and web3.
In web3, finance, banks and DeFi have developed before actual use cases, in part driven by huge financial utility funded by investors. Many DeFi platforms offer 20% yield on a token that’s value is debatable beyond its financial utility.
It makes me question what is happening and why. Among the biggest differences between web 2 and web3, is the cold start problem. You have to find a way to give users application utility and network effects. If you are not a DeFi app, can you or your users afford to be on Ethereum?
DeFi’s impact on web3 has also crowded out some of the more useful apps in development.
It’s a little like the difference between Shanghai and Shenzhen. A factory can’t start in Shanghai: rents are so high, that only banks and financial institutions can afford them. The same is happening in the web3 space. We have many Shanghais, but not enough Shenzens to build more application utility. I love DeFi, but it has gone a bit ahead of its time. With the spectacular collapse of Luna, the total value lock has probably dropped by 40% or 50% on the ecosystem.
When it comes to GameFi, I’m a gamer myself. We all want an interoperable world in gaming, where we can put a hundred hours into levelling up our characters or avatars, sell them and move on to the next game.
But the games in GameFi are not really fun to play. I’m there because I’m making money, but I think in the next two or three years, you will see a new generation of really fun games with very good graphics that are built on blockchain. Many of whom will have learnt from the early guys, will build on those models, and create a more sustainable play to earn.
As late-stage funding becomes more difficult, do you see a lot more founders looking at venture debt?
PM: We work with companies looking at venture debt versus equity. But very few of them are on the debt side. Obviously, there are a lot of positives, but it can be more complicated.
With debt, companies are on their own — they have to repay and provide guarantees. Those repayments may seem small compared to an equity exit. But with interest rates rising, it’s still something that has to be paid here and now. It may not be possible if they are not allowed another fundraising round, or don’t get the equity or exit that they are looking for.
That burden is something they are always concerned about. They would much rather take equity.
Even on the debt side, there are still equity warrants attached to many deals. If they do go through, and are successful, it’s nowhere near the cost of the equity, but there are other financing numbers that they have to pay out as a result. It’s a question that can only be answered by individual founders.
Going forward, will we see much less tolerance for high burn without exceptional performance?
CT: After the NASDAQ meltdown in 2002, a lot of tech stocks in the US fell about 80% to 90%. Pretty much like what I was doing 20 years ago, I am coaching the founders. The world has changed — you can no longer create a story and hope someone funds you.
You have to restart and streamline your operations. Assuming what you have on your balance sheet is your last round of funding, how can you sustain the team and become EBITDA positive?
We are entering winter and we don’t know how long it will last. Assuming fundraising is getting challenging for VCs and PEs themselves, that will trickle down to startups and young companies.
It will take more than unit economics to survive. If people are trying to price a deal based on price per page view, or GMV, these metrics are starting to get shaky. The choices before the founders are to work on their own, tighten their belts and ride through this winter. Or look for similar companies that are upstream or downstream and consolidate. As an investor, we like to see companies merge or have more concentrated resources so that they can go through this winter easier, together.
Don’t be surprised to see a lot more acquisitions and M&A happening from this point onwards. Even some of our Southeast Asian portfolio companies like Carsome have done a few acquisitions already. DealStreetAsia will probably report a lot more M&A activities from this point out – primarily stock swaps.
Will it take much longer for funding rounds to close because everybody is in a price discovery mode? Will we also see a lot of creative dealmaking such as M&A between growth stage companies encouraged by investors?
DT: We cannot stop investing but can raise the bar on quality. In the mid-90s, a lot of funds took their foot off the pedal in 1997, because the markets were too hot. They missed the growth from 1998 to 2000. When the dotcom bust happened, many private investors in VCs had already made their money.
If you were a mid-90s vintage fund, and tried to time the market, you would have looked like the worst performing fund in an LP’s portfolio. Because you missed out on a time which accounted for pretty much all the returns of your competitors who had remained invested.
One of the lessons that I learnt is that it’s very hard to time the market. In fact, the private markets are probably harder than the public markets because of the illiquidity premium. As VCs, the benefit of a fund that’s been around for 20 years, is that we have pattern recognition.
We just need a consistent definition of what a good founder looks like. We invest in them through good times and bad, if they are building the right products and have a path to positive unit economics. Even if good teams fall during bad times, they get up faster and start running again.
Coming to M&A, it could go either way. People may have a cash crunch in a slowdown and there could be a lot of bargains. It could be that potential acquisition targets have enough cash to tide them through bad times and so they don’t feel the need to sell. It’s hard to tell right now. But definitely our advice to portfolio companies has been that in the next six to 12 months, if you see anyone that is trading at a discount in the private markets and you have cash on a balance sheet, you should consider an acquisition.
Apart from general advice like conserving cash and extending runway, what’s your framework to founders for navigating times like this?
CT: It varies from sector to sector. But during tough times, the staff look at what’s going on with the public market and think of leaving for more promising startups. Founders should rethink how to hold the team together
A few questions from the audience: Do you have an order of preference between China, Southeast Asia, and India? Which region will see the most growth in terms of tech investments?
CT: It’s hard to generalise. For Southeast Asia, consumer upgrade and consumer related technologies are large growth areas. In China, consumption has tapered a little bit but then you see the investments in deep tech, renewable energies, and semiconductors. They are at different stages of economic or industry development. I don’t know that much about India, but it has a large population like China. Anything consumer related will be very robust.
RC: To add to that, India and Southeast Asia are very sensitive to inflationary pressures. As long as inflation remains in check, these markets will see phenomenal growth in the next 24 months. But if inflationary pressures continue to pinch consumer wallets, there could be a slowdown in spending and then just the overall exuberance dropping.
How do you see the IPO market? SPACs have more or less collapsed. In Southeast Asia companies are trading at record lows. What’s going to be the impact in this region because of the lack of liquidity through IPOs?
PM: The IPO market has struggled. But China itself is up something like 130%. There are markets and venues that are able to provide exit opportunities, maybe not so much from the international investor’s perspective.
I may be optimistic, but I have seen the first green shoots of recovery particularly from the deSPAC side in the US. The pipeline for companies remains solid, certainly in the non-emerging growth sector. That should obviously help to increase liquidity and get the IPO market back on track. We are still seeing companies in Southeast Asia in particular, taking advantage of the SPAC framework from the US and getting their deSPACs up and running. There is still a lot of interest and opportunity to provide an exit onto the stock market.
Couple that with the SPAC frameworks that have been implemented in both Singapore and Hong Kong: they have not taken off as yet, but are another opportunity. Hong Kong in particular is among the biggest stock markets in terms of IPO activity. We have a huge number of deals all primed and ready to go. With the regulatory change in China, and the delisting from the US, the expectation is when and not if. If you read the numbers, there’s over 150 plus maybe even up to 200 deals just sitting there that are in various stages of filing applications onto the Hong Kong stock exchange.
How are we looking at burn rates and what qualifies as a high burn rate? How does a startup balance growth and burn rate?
RC: There’s no direct answer. Is the company profitable at a unit economics level? Is it only fixed costs around staff and talent etc which is causing the burn – a function of creating more growth which could translate into leverage over time?
But if there’s burn on every order and the company is annual contribution margin negative, or is running a loss on every order, that’s a concern. Maybe the business model or product market fit has not been achieved.
The webinar was powered by data from the Deals Barometer, a monthly free-to-read overview, tracking the companies, sectors, and investors at the vanguard of dealmaking across key markets in Asia. For more information and to sign up, please visit the site