Zomato IPO: What's beyond the Hype?

Netizens are all gung-ho! One of India’s most prominent startups, now a household name, Zomato, is finally entering the stock markets! But, are you watching closely?

Most of you know this already. For those who aren’t active on social media... Zomato, a food delivery platform company, is going live with its ₹9,375 Crore IPO on 14th July. At ₹72-76 apiece, you will have to shell out a minimum of ₹14,820 to apply.

InfoEdge, one of Zomato’s earliest investors, is looking for a partial exit with a ₹375 Cr. offer for sale (OFS). The rest (₹9,000 Cr.) goes to Zomato. Besides, when a loss-making company (like Zomato) opts for IPO, it can raise only 25% of the offering from retail investors & HNIs (as against 50% usually).

But that’s not what we want to talk about today. We’re here to lift the veil and help you make an informed decision. Shall we?

At the outset, here’s a bird-eye view of the industry…

The Food Delivery Market

What does this industry sell? Food? Nahh. It’s ‘convenience’. They’re just aggregators fetching you, say, a plate of luscious biriyani from Arsalan, so that you don’t have to. Which brings us to a question- Can they have loyal customers?

Most probably not. You're more likely to be loyal to a restaurant and not a platform. What if your favorite restaurant previously listed in Zo moves to Sw? What if Zo provides you a dish at a 10% discount while Sw at 20%? Will you not switch? Is that even a question? Of course, you will. Thus, in this industry, customer loyalty is hard to build and can’t be considered a strong moat.

Data is of the essence. You have to gauge when and who orders what and why. Only then, you’re selling.

However, it’s a low-margin business. Or rather, margins and revenues don’t have a strong correlation. Because the only way you can scale up sales is by offering value-for-money dishes with lesser commission and deeper discounts, which means taking a hit on the profits.

Plus, the barriers to entry are moderate. Small players come and go, restaurants try their hand at this, and however big a player you may be, as a Mr Muthukrishnan tweets -

Besides, thinner margins is also why the food delivery business isn’t a sustainable affair per se. It makes sense for these companies to have a side hustle as well, say, grocery or pharma delivery.

Anyway, opportunities are immense! Unlike developed countries, the $4.7 Bn Indian online food delivery market is pretty underpenetrated -

In fact, India’s food delivery market is poised to grow at an incredible CAGR of 29% to reach $21.41 Bn by 2026. Almost 5x times in six years!

Enter Zomato. Just because Zo feeds your laziness doesn't mean it's a multi-bagger in the making. You need to watch closely.

Zomato’s Unit Economics

If Zomato delivered a dish to your home, how much did it earn? Was it enough to cover what it had spent to deliver that order? Or was it not? Get all answers inside its Unit Economics.

(Source: The Ken)

Apparently, in 2020, Zomato was losing ₹30.5 per order that it delivered. No wonder, despite revenues of ₹2700 Crores, it was at a loss of ~₹2400 Crores!

Come 2021, Zomato would now gain ₹22.9 per order. While its unit economics improved, its sales revenues fell by 23% to ₹2118 Crores! Why, you ask?

Go up & look closely at why the unit economics improved in 2021. The company tried to increase its profit margins. The commission rate charged from restaurants was hiked (upsetting restaurant partners), delivery charges increased & discounts reduced (losing customers). And that’s why its sales took a hit!

Maybe now you know why profitability and revenues are two opposite equations for Zomato.

Zomato’s Business Metrics

For a food delivery business, Average Order Value (AOV) is of the essence. Because it’ll cost Zomato almost the same to deliver an order of any value, but a higher value order will bring in more revenues, and thus, more profits. Money for Zomato is in how much expensive dishes its customers order.

Zomato’s AOV now stands at around ₹400, a good jump from ₹285 a year earlier. Sure, Zomato has increased the commission charges, thus raising the price of dishes.

You could also attribute it to the fact that people, who ate ‘Meal for 1’ at their workplaces, are now back, working from home, probably ordering higher value ‘Family Thalis’. This could be a reason behind higher AOVs, as Zomato reports that dishes for more than three gained traction last year. But again, Is it sustainable?

Hard to agree. Because once the music of the virus ends, people would return back to their workplace, and the AOV dance might stop.

Let's look at the Gross Order Value (GOV), i.e., the total value of all transacted orders. In the quarter ended June 2020, Zomato reported having made ₹29 per order. But the GOV dropped to ₹1094 Crores, the lowest in two years! When Zomato tried to ramp up sales, its GOV improved in the next two quarters, but then, it made less per order (₹22).

Thus, it is either sales volume or profitability for Zomato. ‘Both’ is not an option.

For more context...

Gross Order Value (GOV) is the product of Average Order Value (AOV) & the number of orders. In 2021, if AOV increased but GOV fell, it's a no brainer that the number of orders must have fallen too. In fact, both the number of transacting users & number of orders plunged by more than 50%!

(Source: The Ken)

Long story short, the company is struggling to figure out a way to ramp up its sales volume while not affecting its profitability. But it’s a distant dream as of now.

It’s been over a decade since Zomato set its foot in the industry. But it hasn’t turned a profit yet. Not even in 2021 when its Unit Economics is positive. The reason being that the food delivery industry requires heavy advertisement & marketing costs, which aren’t even factored in the calculation of Unit Economics.

But, Zo’s problems don’t end here.

Other problems plaguing Zomato

While profitability is the biggest concern for Zomato, low barriers to entry is yet another stumbling block.

India’s online food delivery market is dominated by a duopoly (Zomato & Swiggy). Their take rate (commission charged from restaurants) is around 22% of the order value. This is quite a hefty sum compared to bigger global peers like DoorDash, who charge commission at less than half the rate that Zomato & Swiggy do!

Imagine what would happen if DoorDash entered India? Enticed by lower commission rates, restaurants would switch to DoorDash. Due to lower prices (because of less commission), people will start ordering from DoorDash. And Zomato will lose out business in no time!

As the mighty Amazon is already planning to foray into the industry with a mere 10% take rate (rumored), Zomato & Swiggy must start preparing for that rainy day!

Besides, Zomato’s global stint & side hustles haven’t worked quite well.

Food delivery has a bigger pie in Zomato’s revenues (>80%). While its advertising, grocery & supply segments seem to be laggards. Besides, the Zomato Gold plan received backlashes from restaurants for its exorbitant commission charges. Neither did the rebranded Zomato Pro work well! Zo’s cloud kitchen is a good stint, but it’s yet to be operational on a large scale.

All in all, Zomato is still a company mainly delivering food.

Valuation of Zomato

Post-IPO, Zomato is expected to be valued at a whopping $8.56 Bn or ₹64,365 Crores. With that much, you could probably snap six F&B companies or twenty hospitality companies!

(Source: Twitter)

While public markets value companies based on numbers (& not stories), the private markets look for good narratives. In this case, metrics like profits, cash flows & growth aren’t Zomato’s greatest strengths.

Then, how do you value such a loss-making company? When it’s in the cash-burn stage, making heavy losses, Price to Earnings multiple doesn’t work.

So, probably we should look at sales revenues, i.e., Price to Sales multiple. As Zomato doesn’t have listed Indian peers, let’s look overseas.

DoorDash, one of Zomato’s global peers, recently went public. It is valued at a Price to Sales multiple of 17x. At that multiple of 17x, Zomato should be worth $4 Bn. But it’s nearly double at around $8.56 Bn, which comes out to be 37x P/S multiple. Besides, DoorDash’s quarterly revenues grew 200% and 268% just before and after its listing, respectively. This is a stark contrast to Zomato.

Also, Zomato’s 5-year forward EV/Sales multiple comes around 7x, which is relatively higher than most global peers. As analysts project the CAGR to be a mere 8.5% only, the offering seems a tad bit expensive.

Conclusion

Getting listed will demand an entirely different kind of carefulness from Zomato. There would be compliances and expectations. The company will have to try and deliver quarter-on-quarter growth in revenues and thrive on being profitable while scaling up its sales, which still remains to be a tough nut to crack for Zo. Any divergence from the expectations will show up directly in its share price. Any mistakes would be like shouting it from the rooftop.

However, this will be the inception of a new era for Indian startups. And that’s a feat worth merry-making. Which, by the way, indicates that initially, the IPO might make headlines for the hype-induced listing gains.

But going ahead, everything boils down to how Zomato cracks the equation of profitability and growth, and whether it’s able to really turn a corner. So yes, only time will tell.

Perhaps you’d better off resisting your temptation and remaining on the sidelines till then. What say?