The asset-light model is a business model where a business owns relatively fewer capital assets compared to the value of its operations. The companies like IndiaMart, Indian energy exchange, etc. are asset-light companies. Hence, in this article, we will be discussing what are asset-light companies and are these companies good options to invest in?
Case of IndiaMart:
- The paying subscription suppliers have increased by a CAGR of 15% from March 16 to March 22 similarly the traffic on their website has increased by 26% from March 16 to March 22.
- The moat maintained by this company has not been maintained by any other competitors.
- These types of companies have two unique features one is high switching cost and network effect moat.
High Switching Cost :
- High switching cost means when the client of the company wants to switch to another company then the cost will be incurred will be very high for example CDSL.
- CDSL is a depository a central body where all the records of investors and their securities are maintained. The customer of the depository is a broker.
- There are only two key depositories in India – CDSL and NSDL. CDSL has a market share of 61%. For depository participants to change the depository could be a herculean task considering the procedural compliances and lack of options in the sector. The early mover advantage here was huge.
- The barrier to entry in this industry will make a huge opportunity for CDSL to improve its revenue. There are over 600 depository participants on CDSL and it operates in a duopoly market.
- The only risk CDSL have is that the charges they charge on the broker are passed on to the customer and these are SEBI (Securities Exchange Board of India) controlled. The moat of CDSL is high mainly because this business is a duopoly. With the idea of investing in shares and mutual funds getting more and more prominence, the number of investors will see an increase.
- CDSL currently has around 600 depository participants as their customers each of which will bring an income to CDSL as more and more investors open their accounts and transact more in the equity markets.
- However, the regulatory risk remains for SEBI allowing other players to venture into this business. The charges are also SEBI controlled in this business.
- The company has been doing certain digital initiatives and system enhancements and has gained a good share from NSDL in the last 3 years.
Network Effect Moat
- The network effect moat is a phenomenon whereby increased numbers of people or participants improve the value of a good or service.
- Indian Energy Exchange is an energy exchange platform that facilitates the buying and selling of electricity through an efficient price discovery mechanism.
- It has a market share of over 95% in the space. Over 7000 participants are registered on the exchange.
- There are only two major energy exchange platforms in India and it can be said that IEX enjoys the monopoly status in this sector.
- The network effect can be seen to be fully played in the case of IEX. If all participants know that all other participants are using a particular exchange, more and more participants will use that same exchange for liquidity and better price discovery. This is the network effect. It is difficult to disrupt this in a company that enjoys such a high market share.
- The one major risk that the business has is the regulatory risk. IEX is governed by Central Electricity Regulatory Commission – This could be a serious hindrance to the growth of the company if there are any regulatory changes proposed by the Commission.
- In the last 3 years, the company’s investment into IGX proved to be a gamechanger for IEX and has paid rich returns.
- Valuation plays an important part in this along with growth and sustainability, high valuation creates an expectation for future growth pricing, if the company can make those growth standards that the market expects from them, then the price of a stock might see a correction, for example, the profit of India Mart was subdued from last 5-6 quarter.
- There is also a need to be sure about the threat to the market share, most of the companies that operate on the light asset model have huge market shares or they are generally early movers. In both the cases, there is a need to identify that is there any other competitors
- Capital misallocation, generally the light asset-based company has a huge amount of cash and the cash must be deployed in the best investment.
What Should Investors Do?
These kinds of companies generally have a high market share but before investing in those companies an investor needs an analysis that must include the valuation and growth, the threat to the market, and also the capital allocation of the company.
Disclaimer: The information here is provided for reference purposes only and should not be misconstrued as investment advice. Under no circumstances does this information represent are commendation to buy or sell stocks or MF.