What is Atoms to Bits

• Globally, value is migrating from Atoms (businesses dealing in physical matter) to Bits (businesses which are digital in nature). This has already played out in a big way in the US. The digital ecosystem in India is right for Atoms-to-Bits to play out here.

Atoms v/s Bits

• Unlike Atoms, Bits deal in intangible assets, enjoy very low cost of replicating their offering, and benefit from network effects. As a result, Bits can scale up very rapidly compared to their Atoms counterparts.

Key success factors for Bits

• Given high initial losses, the success of Bits companies centers around rapid growth in order to achieve critical mass. Their key success factors are –
• 1.Large opportunity size
• 2.Product-market fit
• 3.Wide distribution
• 4.Network effects
• 5.Favorable unit economics
• 6.Operational scalability.

Losses of Bits companies tend to be optical

• Atoms use financial capital to acquire physical assets which reflect in their balance sheet. In contrast, Bits mainly use human capital to self-generate intangible assets (e.g. technology platform), which gets fully charged to the income statement, resulting in optical loss. Cash flow is the leveler between Atoms and Bits financials.

Valuation of Bits

• We suggest 3 valuation methodologies for Bits companies, which can then be averaged to arrive at the final value –
• 1.DCF (Discounted Cash Flow)
• 2.Comparables, with special emphasis on PSG (Price/Sales to Growth)
• 3.Last private equity valuation.

• How to play Atoms to Bits
• Investors should focus on Digital Business Designs
• Whether a business is physical, digital or phygital, the key to success is a Digital Business Design. In their book, How digital is your business?, the authors write, “… you must remember that Digital Business Design is about business first, design second and digital third.” They identify two determinants of Digital Business Design –
• 1.Quality of Business Design and
• 2.Degree of Digitization.
• The matrix below offers a framework for how to play the Atoms to Bits theme. The challenge for investors is to identify:
• 1.Digital Business Designs i.e. Strong business design with high Degree of Digitization;
• 2.Digital Aspirants who are likely to attain Digital Business Design; and
• 3.Dotcoms who are likely to improve their Business Design.
• Bet on digital enablers with great managements
• A second way to play the Atoms to Bits theme is by investing in digital enablers (i.e. IT service providers), run by great managements. These companies will be catering to players in all the above four quadrants, and may well prove to be the biggest beneficiaries of Atoms to Bits

Framework to play Atoms to Bits – Look for Digital Business Designs and Digital Enablers