Have you checked on the financial menu before ordering Zomato IPO?

The listing of the much awaited Zomato IPO will mark the beginning of a new era for Indian stock market as Zomato will be the first-in-trial among many-in-line tech based startups that are looking to raise money from the public.

The company has a fair share of strengths like strong brand recognition, Widespread and efficient on-demand hyper-local delivery network and effective use of technology, but on the flip side it has a problem that the company is not yet profitable which is pervasive in most startups. This has created a polarized opinion in the market on the valuation of the company and whether the retail investors should subscribe to the IPO or hold their temptation to apply for such a delicious opportunity.

Also, we cannot ignore the IPO because its success or failure will set the blueprint for the “acceptability” of these dynamic but loss-making startups in the market.

IPO Issue and Timeline

Backed by Info Edge India Ltd. Zomato is coming with IPO of 123.36 - 130.21 crore shares of which fresh issues of 118.42 - 125 crores and offer for sale is 4.93 - 5.21 crores which summed up to the total IPO size of 9,375 crores. The percent of issue for retail investors stands at 10%, 15% of the issue is for the non institutional portion and the rest 75% is for QIB (Qualified Institutional Buyers).

Company Brief

Started as Foodiebay by two IIT Delhi alumnus, Pankaj Chaddah and Deepinder Goyal,   Zomato is an end-to-end food service aggregator, having a unique scalable technological platform that connects customers, restaurant partners and delivery partners. Customers use its platform to search & discover restaurants, order food delivery, book a table & make payments while dining-out at restaurants, etc.

The company has come a long way from being a young and exciting tech-based startup to a more mature company which is currently valued around 60,000 crore, by comparison you can already place zomato among top 100 listed companies and it is currently ranked among the top 10  Indian startups.

Current Financial Position

Zomato has witnessed a robust growth in its sales from just 466 Cr in (FY 2018) to a staggering 2604.7 Cr in (FY 2020) mainly due to increased nationwide penetration of its services. Although the sales figures have declined, so does the losses in the latest (FY-2021). but one thing has been constant that the company has not been able to achieve “Break-Even” meaning they have not turned into a profitable business yet and continue to make losses. Although profit and loss are major indicators of performance but we need to dive deeper to assess the big picture.

Business Model

On the revenue front, each time you place an order the company earns from the commission it receives from delivery of food from restaurants, the delivery charges levied on customer orders and advertisements of partner restaurants on their app.

The expense side involves delivery cost, discount offer for acquisition of new customers and hefty marketing expense specially on social media. In zomato's case the cost has always exceeded revenue resulting in continued losses.

One important point to consider is that it earns more if the order size is bigger compared to a smaller order size for example; If person A has placed an order of 200 and if we consider a 15% commission then earning will be 30. And if person B has placed an order of 600 then zomato will earn 90 as a commission. And on the expense side the cost of delivery remains more or less the same and if we consider 50 as delivery cost then order B will be profitable for zomato. So, if the average order value improves then it will contribute to the profits of the company.

This has happened lately as the average order value has improved from 264 in April-June 2019 to 395.4 in January-March 2021. An arguable theory suggests that the lock-down has significantly impacted the traditional dine-in restaurant businesses therefore the families have stated to order more as reported order for 3 persons has increased, this has resulted in positive contribution margin (loosely a profit margin) of 4% in the latest quarter from -19% in Q1 of 2020, but the sustainability of such high value orders remains in doubt.

Along with improvement in average order value the company is able to mark higher business due to factors like greater engagement from existing customers (specially on social media), addition of new customers by penetration into new markets, relatively higher commissions and advertising incomes from its restaurant partners. Other than that, to cut the expenses the company has decreased its marketing expenses, reduced the discount offering on orders and was able to lower the delivery cost.

Valuation, Strengths and Weaknesses

Now after understanding the business model and what can increase the profits, we need to justify the price band set for the IPO, But we don't have a similar company listed on the Indian stock exchanges to compare and tell what people can pay for zomato. This will not be a case if... swiggy where to apply for IPO as we would be able to compare it with zomato and see what the shareholders are paying.

Now, one way here is to compare with similar global companies and see how they are priced and with a P/S multiple of 29.9x, zomato is demanding a premium over average global peers and this suggests that the company is overpriced.

But ,those in favor can argue that the surrounding conditions are different as zomato operates in India where the food-tech market in 8-9% penetrated compared to 40-50% in the developed countries like China and USA, and therefore it has more room for expanding its market.

Another argument could be that we cannot value these tech-based startups using the traditional valuation approaches as these are not valued based on profit but are valued based on future potential. And with Strong consumer brand recognition across the length and breadth of India, Technology and product-first approach to business, Widespread and efficient on-demand hyper-local delivery network and Strong network effects driven by unique content and transaction flywheels. The company looks all set to turn into a profitable business over the long-term.
On the contrary, risk and concerns over future unfavorable regulatory actions as the market is currently a duopoly with swiggy and zomato being the two main players.

Emergence of new players like Amazon food which currently operates in Bangalore and have very deep pockets to kill the competition in the long-term as cost of switching between one platform to another is very low for customers.

Reliance on discounts to drive business growth and continued loss making operations are the major concerns on the future success of Zomato.

End Note

The company has a lot of potential to grow in the future, and has shown some glimpses of achieving break-even and going towards profitability in the long-term with average order value increasing to respectable levels that resulted in improved unit economics. But, these improvements are highly likely to be driven by the ongoing covid situation and there are doubts over the post-pandemic sustainability of the business once the socialization restores.

So, there is no denying that the IPO could be a huge success and mark the road-map for upcoming tech-based startups. The retail investors should only invest with keeping in mind the risks in the short and medium term.