Some might deem this conversation to be a little premature but as more and more Venture Capital (VC) money is coming into Pakistani startups and at higher valuations, one has to ask: how do they plan on making returns? Most of these well-funded companies are being built on the premise of blitzscaling, which involves a high cash burn and (supposedly temporary) disregard for profitability to focus on top-line growth. That basically leaves two ways for financiers to make money on the deals. The first is to take the entity public and sell the stake. Alternatively, dilution through mergers and acquisitions (M&A).

Let’s take the first one: very few tech companies to this date have considered listing on the Pakistan Stock Exchange (PSX) as clear from the particularly small number of scrips in the sector, let alone direct-to-consumer or product-based startups. There is obviously a good reason for that since most of these young organisations require lots of risky money which is the domain of venture capital firms, who are often willing to accord head-scratching valuations otherwise unlikely to be perceived the same way by the general public. Just take Airlift’s latest $85 million Series B which put the grocery deliverer at $275m barely a year into operations and a fleet that takes some effort to spot on Karachi’s roads at least. In comparison, Airlink, the mobile distributor and manufacturer, raised $39m in its initial public offering after over a decade of business and a healthy bottom line.

However, the criticism that local markets can’t appropriately value tech companies is getting a little outdated, at least in the case of IT services if not for the product-oriented ones. In fact, over the last year or so, demand for tech scrips has actually exceeded the supply and we need to look no further than the book building of Octopus Digital last week, where investors flocked to bid so fast that the entire issue was oversubscribed by 3x within just the first hour. By the end of the two-day issue period, the total bid volume stood at over an eye-popping 745m shares versus the offer of 27.35m.

Access to capital has become easier as we are seeing many foreign VCs showing interest in Pakistan

A better way is to see the few legit tech stocks available on the market and how their valuations have evolved. This is where it becomes clear that investors are increasingly interested in the sector and are willing to pay for that. According to data from Mettis Global, Systems Ltd — the biggest IT services company from Pakistan — saw its P/E increase from just 6.48 at the beginning of 2019-20 to reach 30.76 by 2020-21 end, before rising further to 44 at the time of writing. It’s a similar story for Netsol. The same treatment might not apply to the “new economy” players as they lack the high margins typical to export-oriented entities.

“Access to capital has become easier as we are seeing many foreign VCs showing interest in Pakistan. However, out of hundreds of startups, the ones able to bag funding mostly have similar offerings like venture-backed companies in India, Indonesia etc. This indicates that VCs are mostly betting on proven models. Due to this, stable companies — like SaaS and IT services — willing to raise money will opt for PSX. Pakistan Software Exports Board is actually promoting it and has created a programme where they are inviting established players and providing assistance and subsidies to list on the public markets,” says Zeeshan Aftab, the co-founder of 10Pearls.

That still leaves with the second option, M&A, to investors to make a return. However, there again, Pakistan hasn’t been the hottest market in any sector, forget tech. One glimpse of hope has come from the Middle East where VC-funded startups with lots of cash are eyeing for regional expansion to help them raise subsequent investment rounds and are on the lookout to eat up smaller players in their sectors.

Two such deals have already taken place and been disclosed recently, first Jordan’s Abwaab buying Lahore-based Edmatrix and last week the Dubai-headquartered TruKKr acquiring Karachi’s Trucksher. Unfortunately, not much was revealed on the price tag of these deals but it’s likely that a major chunk of it was for stock. Both of these startups were quite young, the former founded in 2020 and the latter earlier this year. People in the ecosystem also suggest that there’s keen interest from Southeast Asian players, where again well-backed tech entities could potentially provide an exit route.

Yet again, there’s a but involved. Once those regional VC-backed startups themselves look for their exits, say by listing on stock exchanges around the world, unit economics pressures will eventually mount up and Pakistan might go out of focus. Careem is a great example of this as soon after acquisition by Uber, the company started consolidating its position by shifting energies to high-value geographies away from volume-driven ones like ours.

Local corporates obviously have a role to play here, which they only now seem to be realising. But much of that activity in the coming future is naturally going to be early-stage, instead of exit-oriented, as evidenced by Habib Bank Limited’s investment in Finja or System’s Ltd in Jugnu. 10Pearls is probably among the few companies truly active in the M&A ecosystem and not just in Pakistan, having bought four players since 2020, including Proximity from Costa Rica, New York-based Likeable, San Francisco’s Zen Cloud and Two Dots in Karachi, on top of leading a seed round for m-Khata through its venture arm.

“We hardly see any M&A activity in Pakistan as usually, people want to be independent and aren’t familiar with its benefits and often see it as an attempt to take over their business. If you look at India, all big companies have grown as a result of M&A. Unfortunately, there are no such success stories or a framework to promote this in the country. TruKKr acquiring Trucksher is great news in this regard, which will open the mind of people and startups can now look at competition as an opportunity to grow — not just as competitors,” says 10Pearls co-founder Zeeshan Aftab.

“I think we will see more activity like this. There is always an appetite for M&A and once it starts picking, we will see both VC as well as established businesses actively looking for such opportunities,” he added.

Published in Dawn, The Business and Finance Weekly, September 13th, 2021

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