BOTTOMLINE: Why Zomato's IPO has a long way to go before it can deliver


The bright side is that Zomato is seen turning profitable soon. Edelweiss expects it could start turning green in fiscal 2023. But the profits will inch up slowly.

BOTTOMLINE: Why Zomato's IPO has a long way to go before it can deliver
Despite the Covid tailwind, Zomato still has a long road to profitability and that may not leave any value on the table
Food ordering is the new normal. The pandemic may have done many things, but what it has done "good" for the food delivery apps is drive up ordering for delivery versus eating out. And while that may not have led to a surge in the number of deliveries in fiscal 2021, due to lockdowns et al, it has definitely improved the financial health of the participants. In its offer document, Zomato says that its gross order value for the fiscal was down more than 15 percent from a year ago, but this was on a sharper 41 percent drop in a number of orders from 403 million to 239 million. The average order value was actually up near 50 percent to Rs 395 in the fourth quarter of the just-concluded fiscal from Rs 265 in the first quarter of 2020. That’s great for unit economics and profitability. Also, its advertising and sales promotion expenses were down 61 percent, as getting customers was hardly a challenge given the lockdown guidelines. Yet, Zomato posted a loss of Rs 490 crore and a negative operating cash flow of over Rs 1,000 crore. And that's not comforting.
Source: Zomato RHP
The bright side is that Zomato is seen turning profitable soon. Edelweiss expects it could start turning green in fiscal 2023. But the profits will inch up slowly. Also, it will likely burn some of the Rs 9,000 crore it is raising via a fresh issue of shares before it does. To provide context, Zomato shows share premium garnered till March 31, 2021 at Rs 12,856 crore of which Rs 5,600 crore has been eroded due to losses. That leaves the current equity reserves at near Rs 7,600 crore, which will swell to near Rs 16,000 crore post the IPO.
In fact, it has been raising funds at a rapid pace, and a significant bit of it about a year ahead of its public offer.
Source: Zomato RHP
But getting back to the matter of profitability, Zomato won’t be able to return an EBIT of near 10 percent on the Rs 9,000 crore it is raising or a 6 percent on its current equity reserves of Rs 16,000 crore till 2025, if it meets Edelweiss expectations, which might be a tad optimistic. So, if you think you can value Zomato like a traditional company on the basis of current profits, that’s unlikely at least for another 4-5 years.
Besides, the hopes of Zomato’s large market share and a near duopoly in the sector leading to higher profits down the road may be a misplaced notion. Already, restaurants collectively are opposing some practices of food delivery apps. Besides, the business model is now well understood, so any visibility of abnormal profits can draw in new, big money players who can erode such gains (you would have read this in traditional micro-economic theory). And Amazon is already testing the waters.
When investing in equity, the most important factors to consider are a business's ability to generate profits and cash. Here, Zomato stacks up poorly. Here, it is fair to say that I believe in valuing businesses in a classical way, with a preference for delivery in the not very, very long term. I prefer to confine my expectations to what I can foresee, not put money behind what one might imagine.
Let's take a look at a few key metrics and how Zomato stacks up on these. The first is market capitalisation (post money) to sales. Zomato’s number is 32 times, that’s only less than that of its incubating prominent investor Info Edge at over 60 times, among consumer-facing businesses. The picture looks very different on operating cash flows, where it is negative for Zomato, and not changing significantly in the near future.
Even when compared to its global peers, as per an Edelweiss analysis, Zomato looks more than a tad pricey, with most peers valued at between 3 to 11 times.
PeerPrice/Sales (2021)
Delivery Hero9.2
Just Eat Takeaway5.2
Zomato (FY21)32.3
Source: Edelweiss *One year forward
When evaluating any decision, it always pays to weigh the opportunity cost (or the alternatives), so why not in the case of Zomato’s IPO, which has priced its shares at between Rs 72 to Rs 76 per share valuing the company at Rs 64,366 crore (about $8.7 billion).
To give you a sense, you could buy 1.6 Jubilant Foods for the price of one Zomato, or 10 Burger King Indias for the same, or 3 Batas if you will. You could also snap up 90 percent on Info Edge for the same money.
CompanyNos. (x)
Jubilant Food1.6
Burger King10
Tata Consumer0.9
Varun Beverages2
Info Edge0.9
You could even consider alternative combos for the same sum. Try some of these: a Jubilant Foodworks with Bata to boot, a UB (beer) with 4 Burger King Indias, or a Varun Beverages (Pepsi) with 4 Westlife Developments (McDonald's India).
Jubilant Food + Bata
UB + 4 x Burger King
Varun Bev + 4x Westlife
There are clearly some very appetizing options out there if you look hard enough.
Remember how Nasdaq surged 400% between 1995 and 2000 during the technology boom and dotcom rush? In the latter part of this phase, businesses with .com appended to their names managed to raise big sums despite having never made a profit or generated meaningful revenues. It was all about eyeballs and page-views. Like it is about registered users and app downloads today. An interesting wiki fact to consider here is this: "On January 30, 2000, almost 20 percent (12 ads) of the 61 ads for Super Bowl XXXIV were purchased by dot-coms. At that time, the cost for a 30-second commercial cost between $1.9 million and $2.2 million". Sounds familiar?
But the Federal Reserve under Alan Greenspan raised rates in 2000, causing the dot com bubble to burst. Will it be operation redux? Watch the Fed.

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