• WIREMESH

ZOMATO IPO – SHOULD YOU DIAL IN THIS ORDER?

Updated: Jul 13





Dialing in meal orders has now become a way of life. Can the startup which has changed the way we eat now become an even more profitable investment?


Zomato’s IPO size is ₹9,375 crore

Public offer comprises a fresh issuance of equity shares of ₹9,000 crore. It is an offer for sale of ₹375 cr.

Price band is between ₹72-76 per equity share

Lot size is 195 shares (₹14,820)

Subscription opens between July 14 to July 16

IPO share allotment will be on July 22.


Zomato started in 2008 as a restaurant-discovery website – "Zomato". In 2015, it ventured into the food delivery business and is currently the biggest player. Zomato’s biggest competition comes from Swiggy and in the future from Amazon Foods


Zomato is a food tech giant, present in 500 cities. As of December 31, 2020, Zomato has 1,61,637 delivery partners and 3,50,174 active restaurant listings. Zomato also has an exclusive paid membership program – Zomato Pro – which unlocks flat percentage discounts for members at select restaurants across both food delivery and dining-out offerings. It earns through membership fees paid by users. As of December 31, 2020, it had 1.4 million members and over 25,350 restaurant partners in India. Zomato also supplies raw material to restaurants through its subsidiary Hyperpure. This allows Zomato to better forecast demand and therefore source raw materials such as grains, fruits, and vegetables on a larger scale, but it is also an upsell to its restaurant partners – part of the bundle of services aligned with food delivery. The business was started in 2019 and in December 2020, it supplied to over 6,000 restaurant partners across six cities in India.

Zomato’s revenue comes from food delivery, B2B, advertising and subscription. 90% of its revenue comes from India and 85% of that revenue comes from the food delivery business stream


How Does the Food Delivery Business Generate Revenue?

The food delivery business witnessed wild swings in 2021. The first quarter was brutal and saw the lowest number for 2 years. This completely changed in the 3rd quarter which witnessed all time high numbers. The model in India is dine-in, food delivery and takeaway. CLSA has predicted that the market size for the food delivery model will increase to $11 billion by FY26 from $3.5 in 2020.

Apart from Commissions from restaurants which usually is the biggest revenue generator, other verticals like delivery fees, membership fees, listings of restaurants have emerged as revenue multipliers. Zomato’s revenue comes from commissions, advertisement and listings fees.


How Are ZOMATO’s Financials?

One of the most significant claims in Zomato’s prospectus is that the company’s unit economics have now improved. That Zomato now makes more money on each order compared to the money they spend fulfilling that order.

This needs to be closely understood, as some key parameters have taken a beating in the pandemic. A clear dip can be seen in gross order value (GOV), number of active users have fallen Total monetary value of all orders (including taxes and customer delivery charges) tanked — from ~₹2680 crores during January and March 2020, to about ₹1093 crores for the period between April and June 2020 — at the height of the 1st wave of the pandemic.

Transacting users meanwhile also suffered the same fate. Between March 2019 and March 2020, ZOMATO had an average of 1 crore monthly transacting users on the platform. However, after Covid, between March 2020 and December 2020 — there were only 58 lakh monthly transacting users on average. So, let’s look at what explains the disparity?

The average MTU (Monthly Transacting Users), was calculated over a period of 9 months between March 2020 and December 2020 when the numbers tanked because of the sentiments driven by Covid. So yes  transacting users have seen a decline but it isn’t as bad as the numbers project.

The gross order value meanwhile did tank between April and June 2020. But by the end of the year i.e. between October and December 2020, Zomato was already recording its highest number ever — ₹2980 crores during the last 2 months of 2020. Bottom line — Gross order value was back to pre-covid level with some improvement on top. So, these numbers aren’t bad per se.

The AVO (Average Order Value) is a key parameter

Zomato’s cost for sending a ₹75 order and a ₹500 order is pretty much the same. Obviously, their share of the pie is bigger on the ₹500 order due to the percentage of commission thus making the bigger order more profitable. The bottom line is increase the AVO and the path to profitability becomes more clearer. Zomato claims that it has cracked the code. Zomato’s average value has gone up from ₹264 (March – June 2019) to ₹400 during the last 3 months of 2020. This is a 50% uptick in a very short time. The factors contributing to this need to be looked at (Consumer spending, food pricing, Zomato increasing prices) We don’t have enough data to understand this and for that very reason the trend on this could reverse easily


WHY IS ZOMATO STILL POSTING A LOSS?

From reported loss of 107 Cr in FY18, Zomato’s losses further increased to Rs 1,010 crore and Rs 2,386 crore in FY19 and FY20. Till December 2020, that is Q3FY21, Zomato has reported a loss of Rs 682 crore.

Zomato’s employ cost are pretty high (42% of its revenue) There are advertising, sales and outsourced support cost. Advertisement and sales promotion expenses primarily include platform-funded discounts, marketing, and branding costs, discount coupons given to customers, and refunds made to restaurant partners. Outsourced support costs include the availability fee that the company pays to delivery partners as well as support expenses, such as costs related to call centers.

For FY21, Zomato has already raised more than ₹ 5,000 crore from various investors, which boosted its cash and cash equivalents. Currently, the company is sitting on cash and cash equivalents worth ₹ 4,967 crore. Post the IPO Zomato will have an access to cash reserves of +13500 Cr (This will be primarily to fund growth – both organic and inorganic. Zomato clearly has big plans for expansion which means significant advertisement will accompany this.

Zomato themselves don’t see them minting profits very soon. They have hinted in their filings that they expect their costs to increase even further in the coming years.



The Competition

Swiggy is Zomato’s biggest competitor. Amazon is fairly new in the space. But based on its customer centricity and deep pockets it could make up market space in quick time.

Apart from the delivery revenue stream Zomato has looked at revenue multipliers which look in to different aspects of the restaurant space. Swiggy for now is channeling on delivery of everything from grocery to books.

Amazon under the label “Amazon Food” has chosen Bangalore (limited coverage in Bangalore for now) as the base to test its foray in this space. It has built a tab within the main, the tab is only visible to customers who fall in the Bangalore. Currently it is not charging any fee for Prime customers, others have to pay a ₹19 delivery charge. Amazon currently has a network of 2,500 restaurants Vs 15,000 offered by Zomato. Amazon has a loyal following from its prime customers. Combined with the fact that it has deep pockets it could lead to a significant cash burn to Zomato

On the financials, Swiggy leads in terms of revenue due to a higher number of orders and average order size, but Zomato is quickly headed for a turnaround in profitability by virtue of aggressive cost control measures. Its total expenses and employee costs have been lower than Swiggy’s, resulting in lower cash burn.


Conclusion

Based on the IPO numbers Zomato should be valued in the region of ₹63,0000. This straight away puts it in large cap territory. Currently (13th July) it is enjoying a grey market premium of 20%. (This would its valuation at @ ₹75,000. Based on these numbers the adjusted sales of FY21 are at 17 times the adjusted sales. Its Global peers in China and US are valued at around 8.5 Times. So, its valuations are going to be double than its Global peers. There is no case to be made for Zomato based on its valuations. You are going to buying at premium elevated valuations. Zomato has seen a valuation increase of 48% from Dec 2020. You might get an IPO pop of anywhere between 15% to 30% But the real reason for getting in to this company is if you are a long-term investor who is willing to take price corrections and pick the stock when the market presents the opportunity. The investor will also need to check periodically if the company is on the right track. On the bright side Zomato is a Tech-based internet listing. It will have a war chest to continue its cash burn for another 6 to 7 years. Its has shown efficiency in bringing cost down significantly. Its AVO has increased by 50%. The food delivery business is still at a nascent stage with immense upside penetration potential, humongous untapped online opportunity of the adjacent verticals.

I will end this by saying "A sure way to loose money in equities is to buy a great stock at a high price or buy a bad company at a low price"


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Long Term Investor who can take a price correction in the stock

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