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Zomato IPO: Should You Place An Order To Buy Shares?


Finally, one of the most awaited initial public offerings of 2021 is here – Zomato Ltd. The IPO starts on July 14 for three days. Given, the boom in food ordering and investors’ current love for IPOs Gurugram based food-tech giant has upped its issue size. The company will now be raising ₹ 9,375 crore, of which ₹ 9,000 crore will be a fresh issue, while the remaining an offer for sale from the oldest investor – Info Edge (India) Ltd.

Earlier the company had plans to raise ₹ 8,250 crore – ₹ 7,500 crore of fresh issue and ₹ 750 crore of offer for sale.

The IPO would be the largest since March 2020, i.e., when SBI Cards raised close to ₹ 10,000 crore. Should you subscribe?

Zomato IPO will mark the largest Internet listing in India. The company is offering 123 crore equity shares at a price band of ₹ 72 to ₹ 76 for an IPO size of nearly 10,000 cr.  A small portion (265 lakh shares) will be reserved for eligible employees. Now as the company is loss-making, the majority of the portion – 75% – is reserved for QIBs. Of the remaining, 15% will be for HNIs and only 10% for retail shareholders.

The Business of Zomato

Founded in 2008 as a restaurant-discovery website – Zomato, is now one of India’s largest food delivery company. In 2015, when it ventured into the food delivery business, it was a crowded space with half a dozen players – Swiggy, TinyOwl, OlaCafe, Foodpanda, Runnr, and Scootsy.

Zomato has four business segments – two core B2C offerings including food delivery and dining-out, as well as B2B ingredients procurement platform ‘Hyperpure’ and the customer loyalty program, ‘Zomato Pro’. Each segment has different revenue drivers and monetisation models.

Now the company is raising ₹ 9,000 crore, despite having ₹ 6,700 crore in cash and zero debt. It plans to use a majority of the money for organic and inorganic growth. Now given the fact that there are hardly any large players left in the food tech space, this signals forays beyond the core. Zomato is in the midst of rolling out nutraceutical products on its platform and has recently bought a 9.25% stake in Grofers and 9.27% stake in Hands On Trades for ₹ 741 crore.

Grofers operates a marketplace for groceries in India and Hands On Trade is engaged in the business of B2B wholesale trading and providing warehousing services. The parent of both the companies is Grofers International.

However, currently, the food delivery space in India is now a competition between two head chefs – Zomato and Swiggy. And a large new player – Amazon – trying to make its mark.

Zomato IPO: Should You Place An Order To Buy Shares?

Zomato originally launched as a restaurant discovery platform that aggregated information such as menus, dishes, and user reviews. It is the largest food-focused restaurant listing, reviews, and online table reservations platform in India. It earns through restaurants that pay them for enhanced visibility on the Zomato platform. As of March 31, 2021, it had 3.9 lakh active restaurant listings on its platform.

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 March 31, 2021, it had 1.5 million members and over 25,400 restaurant partners in India.

The company also has a subsidiary – Hyperpure – which is in the business of supplying raw materials to restaurants. Hyperpure not only 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 March 2021, it supplied to over 9,200 restaurant partners across six cities in India.

Lastly, the food delivery business in which the company acts as a delivery agent between a user and a restaurant. The company earns through commission from restaurants and from delivery charges which are being charged to the user.

Zomato IPO: Should You Place An Order To Buy Shares?

Along with India, the company has operations in 23 foreign countries – UAE, Australia, New Zealand, Philippines, Indonesia, Malaysia, USA, Lebanon, Turkey, Czech, Slovakia, and Poland. However, the company generates 90% of its revenue from India. However, going forward, given the large market opportunity in India, the company will focus only on the Indian market.

During the FY21, the business of Zomato was impacted due to pandemic as not all restaurants were operational and not everyone was open for ordering food online due to virus scare. In the first quarter, the business slumped to its lowest in the last two years, while in the third quarter it reached to its all-time high. As customers tried to make up for not being able to go out for a meal, online orders in India surged.

The same rhythm seems to have continued even in Q4 for Zomato. Though the number of orders continues to remain lower, the gross order value was the highest-ever which aided the average order value. The company also seems to have witnessed no impact of the second wave of the Covid-19 yet, but that’s still an April+May 2021 thing so data may be available in the days ahead.

Zomato IPO: Should You Place An Order To Buy Shares?

Understanding The Food Delivery Business

The food delivery business in India witnessed contradictory moves in FY21. In the first quarter, the business slumped to its lowest in the last two years, while in the third quarter it reached to its all-time high. As customers tried to make up for not being able to go out for a meal, online orders in India surged.

The Indian foodservice market is largely divided into three channels – dine-in, takeaway, and food delivery. Of these three, the food delivery business is expected to see the highest growth in coming years, according to CLSA. The market size is expected to increase to $11 billion by FY26 from $3.5 billion in FY20. Growing population, increasing smartphone penetration, expansion to new markets, and higher-order frequency from existing customers will aid this growth.

Zomato IPO: Should You Place An Order To Buy Shares?

Commissions from restaurants were earlier the main revenue stream for online food services platforms. However, over the years multiple revenue streams evolved. Along with commissions, delivery fees, membership fees, listing fees for restaurants have also emerged as revenue streams.

In the case of Zomato, when a customer places an online order, the company earns only from the restaurant in form of commission less any Zomato funded discounts. It does not earn from delivery charges, packaging charges, tips, and additional fees. Apart from commission, the company also earns from advertisement fees it charges to restaurants for enhanced visibility in the food delivery business.

Zomato’s Financials

Before getting into the consolidated financials, let us first understand the per-unit revenue and cost economics of Zomato.

Zomato has two major revenue streams for its delivery business – commissions & other charges from restaurants and delivery charges from customers. Against this, there are three major cost heads – delivery cost, discounts offered to customers, and other variable costs.

Over the years, Zomato has aggressively invested in consumer acquisition & retention through heavy discounting as well as undercharging for its delivery service. This meant the platform had weak unit economics, and in fact, a negative unit contribution margin until FY20.

However, recently the company has seen a sharp improvement in the unit economics. This was largely on the back of increased average order value, higher delivery charges, and lower discounts.

Zomato IPO: Should You Place An Order To Buy Shares?

As highlighted earlier, a higher average order value could be on the back of Covid-19. Due to the pandemic, a lot of working individuals returned to their homes which could have eventually led to an increasing number of orders from families. Along with this concern around hygiene and the fact that many small joints were shut led customers to order from restaurants in mid to premium segments.

Increasing delivery charges would have been possible given restrictions on movement due to Covid-19 and consumer preference for convenience. Delivery cost per order might have declined due to better demand forecasting, fleet optimization, and deployment of intelligent dispatch technology which optimize the matching of orders and delivery partners using machine learning.

Over FY20 to FY21, the per-unit economics improved by ₹ 51 – three-fifths was due to revenue improvement and the remaining due to cost reduction. As delivery charges are a complete pass-through, the only other revenue component left is commission and other charges which are usually a percentage of average order value.

This means that sustaining a higher average order value is crucial for the company to generate profits.

However, the sustainability of the same is not yet clear. Even the management on the analyst call said that it is very difficult to predict how the average order value will pan out in the future.

Here the rise in commission and other charges is because of higher per order value – could be on the back Covid-19. Due to the pandemic, a lot of working individuals returned to their homes which could have eventually led to an increasing number of orders from families. Along with this concern around hygiene and the fact that many small joints were shut led customers to order from restaurants in mid to premium segments. This coupled with lower discounts and a cut in availability fee helped the company earn roughly ₹ 21/order in FY21.

Then, why the company is still posting a net loss?

It is because of the costs associated with employees, marketing, and other fixed operating costs.

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.

Material cost includes expenses incurred for the purchase of goods that it sells to restaurant partners through the B2B platform, Hyperpure. Given the fact that the material cost has doubled, revenue from this business stream might have also grown exponentially. However, we do not have a revenue break-up to give further details on the same.

Below we have given two types of profit and loss accounts of Zomato. The actual one to show how the company fared in Q4 and the common size to understand which expenses tend to increase for the company with higher sales.

The revenue run-rate for the company in Q4 is pretty similar to what it would have done in a quarter of FY20. However, it is the sharp reduction in two expenses – advertisement and outsourced support costs – which has led to lower losses. If the company maintains these cost levels, then as the business scales up, it can achieve profitability.

Compared to 9MFY21, in Q4, the company witnessed an increase in its advertisement and outsourced support costs.

Zomato IPO: Should You Place An Order To Buy Shares?

Large cash pile

The company’s balance sheet size is ₹ 8,704 crore. Of this, a little more than two-thirds is cash. This is because Zomato has raised substantial equity capital over the years. Despite improved unit economics and lower cash burn, Zomato has been on a fund-raising spree in FY21, with close to ₹ 4,800 crore of equity capital raised in 9MFY21 and another funding round of around ₹ 1,800 crore in Feb-21.

Adjusted for cash and cash equivalents and goodwill, Zomato has a fairly asset-light balance sheet.

Add to this another ₹ 9,000 crore, its cash balance would swell to nearly ₹ 16,000 crore.

Zomato IPO: Should You Place An Order To Buy Shares?

Compared to FY20, the company has halved its cash burn FY21 on the back of cost controls. On average in FY20, Zomato’s monthly cash burn (cash flow from operations before tax) stood at 176 crore, which reduced to 86 crore in FY21. The current cash balance of the company can support this current rate of cash burn for at least 15 years.

Peers: Swiggy and Amazon

The biggest competitor of Zomato in the food delivery business is Swiggy, while the newest is Amazon in India. However, both are unlisted.

Though Zomato and Swiggy earn most of their income from food delivery, they share different strategies. While Zomato is aiming to be present in every aspect of a restaurant business, Swiggy is focusing on just the delivery of literally everything.

Zomato offers an online discovery of restaurants, table bookings, food and health supplements delivery, a membership that offers discounts on both dine-in and food delivery, and B2B raw material supply for restaurants. Swiggy on the other hand is focusing on the delivery of food, grocery, books, alcohol, meat, medicine, and pick-up and delivery of any other items. It also has a membership plan which offers free food delivery and a couple of other limited offers.

Coming on to Amazon, which recently started its food delivery operations in Bangalore. Amazon India reportedly started the test marketing of food delivery last year under ‘Amazon Food’. First, it started food delivery only for its employees in Bangalore. And now it has expanded to one-fourth of the Bangalore region and has a network of 2,500 restaurants Vs 15,000 offered by Zomato.

Food delivery is through a tab built-in the flagship Amazon app, visible only to customers who are located in the delivery regions. It is not charging any delivery fee to a Prime member, and for a non-prime member, it is charging a marginal ₹ 19, which is lower than the competition. Moreover, it waives the packaging fees.

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.

Zomato IPO: Should You Place An Order To Buy Shares?

Valuations: Do they matter?

Traditionally, price-to-earnings is the way to value a company. But, when it comes to companies like Zomato, one has to shun the traditional ways of evaluating value. This is because a company like Zomato is still in the phase of growing and burning cash. Profitability could still be some time away.

Globally, food delivery companies are valued on revenue metrics as most of them are loss-making even in mature markets. Zomato is priced at a premium to global peers given the huge growth potential in the Indian market. Even the last round of funding was done at a premium to these global players. Compared to the last funding round (February 2021), at the upper-end of the price band – 76 – the company is already asking for a premium of 31%.

Zomato’s valuation largely hinges on the ability to sustain and fortify the leadership in the Indian market.

Zomato IPO: Should You Place An Order To Buy Shares?

Our View: Solid Tech Company narrative with big challenges and opportunities

With several casualties in the past as rivals tried to undercut each other, the Indian food delivery market was a tough nut to crack. However, now when the food delivery industry attained a decent equilibrium in terms of competition (duopoly market), which also meant little to no reason for survivors – Swiggy and Zomato – to significantly undercut each other, a global giant – Amazon – entered the market.

Though at this moment, Amazon’s operations are limited to one-fourth of just one city, it would look to scale up operations in coming months, quarters, and years. Not that three players can not enjoy healthy growth in a vast market like India, but for a newcomer, the only way to scale operations is to undercut its rivals. At least, that is what history has taught us.

Amazon with its deep pockets could well choose Reliance Jio’s route of grabbing a larger pie of the telecom market. Not that it will offer free food like Jio offered free services during initial years, but it can well choose to offer higher discounts to customers and make restaurants prioritise Amazon orders by charging them lower commissions.

Amazon’s key focus in India remains its Prime membership and food delivery could be another angle for entry into the Prime ecosystem. Currently, under Prime membership of ₹ 999/year, Amazon is offering unlimited movies, TV shows, music, and free delivery of products ordered online.

Like Swiggy and Zomato, who understand delivery well and have a loyal customer base, even Amazon understands delivery well and has a loyal customer base in India.

No doubt, offering higher discounts to customers and charging lower commission rates to restaurants will lead to losses in the food delivery vertical. But it can afford to do the same owing to additional benefits from increasing Prime membership and deep pockets.

Increasing competition from Amazon, will definitely lead to another prolonged period of cash burn and pose a risk to Zomato’s road to profitability.

In FY21, based on per order economics, the company earned around ₹ 21. Also, its losses were lower. All this was possible, on the back of higher average order value, lower discounts, lower marketing spends, and a cut in availability fees. But how long will lower costs and higher-order value sustain, is the key question here?

Also, if the company expects these cost economics to sustain, then why despite having a cash balance of nearly ₹ 6,700 crore, it is raising another ₹ 9,000 crore from primary markets? Is the company preparing itself for another disruption?

Another thing to consider is ancillary revenue opportunities. Every person buying on Zomato has demonstrated an intent to transact – which is different from a window shopper. This fact, and the fact that the company has data on where a person orders, what she orders often, whether it’s likely the person has children, and so on give it valuable insights into potential opportunities to upsell and even cross-sell new solutions or products.  Swiggy for instance has an insta-delivery service for document couriers or for in-store purchases of non-food items too – this is a logical extension of a system that has last-mile delivery. Currently, restaurants sponsor the advertising in-app, but there’s scope for using the Zomato platform for branding and reach – from a local brand providing offers to specific locations, to an IPL team selling merchandise to its home city along with meals and so on.

Zomato also now offers support for cloud kitchens (link) where a brand can set up operations very quickly in multiple cities – with Zomato providing infrastructure for real estate, kitchens, licenses, and marketing. There are inefficiencies at the restaurant end that they might eventually fulfill also – such as the hiring of chefs and operational staff, packaging, process, fuel, and raw materials.

In terms of technology, Zomato has used tech extensively in operations, sales, marketing, and automation, which has excellent operational leverage in the longer term. Their collection of data and the ability to crunch it to generate sales, and perhaps scale further, is well known. Further, they don’t own the motorbikes their delivery people use, they don’t own the restaurants (for the most part), and thus keep their fixed assets relatively low. As a technology-led company, valuations tend to get a fillip. Plus, of course, there’s the first-mover premium – you don’t have a listed competitor in the market yet.

In FY21, Zomato pulled up its socks and reported unit profits. However, sustainability is the key question to which there is no easy answer. An investor who wants to invest in Zomato has to go by the narrative of Zomato’s future growth potential, and not profits. It cannot expect the company to start generating profits and start paying dividends immediately.

The potential for growth is immense in the food delivery business, but it might not be profitable always. For instance, as the company expands in tier-2, tier-3, and tier-4 cities, customers’ willingness to pay a premium for convenience could also be lower in such markets, unless the platform provides some discounts.

The potential for generating profit is immense if one starts charging customers rightly and keeps discounts lower. However, that will not be the case. Currently, commission and other charges are a percentage of order value. Hence, the higher the order value higher the profitability for Zomato. Given the competition and conflict with NRAI, the company might have to cap the charges at a certain threshold. Because beyond a certain point, if the commission and other charges collected by a food aggregator were to materially exceed the sum of discounts offered to consumers and cost of delivery, then there is a strong incentive for both consumers and the restaurant to remove the aggregator and transact directly.

Zomato as it is now and with the cash on its book has the potential to not only grow its new businesses – Hyperpure and nutraceutical products, but also enter various adjacent businesses like sourcing and delivering groceries, meat, alcohol, medicine, and pick-up and delivery of any other items. Entering these new ventures could lead to further cash burn. But again, all these businesses individually have a great potential to grow.

Thus, we think investors counting on the long-term possibilities and not on the listing gains can subscribe to this IPO. But do be prepared for some volatility along the way.

Other Suggested Reading:

What makes Amazon, Amazon!

Your window to the startup world: Inside Info Edge

Adani Group Explainer

PowerGrid InvIT: Should you invest?

Lodha Developers IPO: Should you invest?

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Zomato IPO: Should You Place An Order To Buy Shares?

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