Zomato – Should the investors be hangry?

Updated: Dec 2, 2021

Company Name – Zomato Limited (Zomato)

Current Share Price – INR 136 (Nov 9, 2021)

Market Cap – INR 107,090 cr

1. What is interesting about the stock?

We, at SocInvest, support start-ups whole heartedly – partly for being a start-up ourselves (self-fulfilling prophecy!). Start-ups are critical for innovation and employment generation in our country. They provide fly wheel effect to the development of the country and its education system. However, the key question which is debated in this article is – Should I invest in Zomato? [Disclaimer - I have worn the hat of a public investor and so analysis could be very different for a private investor (venture capitalist)].

Love the candid talk of the management – “The IPO decision was because we didn't have any other choice, honestly! We saw a 90% drop in business after the first Covid-19 wave, and the company had six months of money left in the bank. The remainder of the funding from Ant Financial (existing investor) was not coming through (due to changes in FDI rules). While we were talking to many investors, nothing was materialising. An IPO was a desperate contingency plan, where we said it is okay if we are grossly undervalued at even $500 million, but we really need to raise $50 million.”

We will come back to this. Let’s start with the basics first.

Zomato is a technology platform connecting customers, restaurant partners and delivery partners, serving food delivery or restaurant industry. Zomato has four main business lines:

  1. Food delivery business

  2. Restaurant listing business

  3. B2B delivery to restaurants (Hyperpure)

  4. Venture capital investment in future areas of growth or adjacencies of the current business

India’s food delivery sector has witnessed considerable consolidation over the past few years as several competitors such as UberEats, Foodpanda, Tinyowl and Scootsy have either been acquired or have shut their businesses. Swiggy remains a well-funded competitor with total fund-raise of c. USD 3 bn till date. This is comparable to Zomato’s post-IPO cash balance of c. USD 1.9 bn.

Based on Technopak research, India’s total food service industry size was USD 57 bn in FY2020, which is projected to grow at a 9% CAGR over FY2020-25 to achieve a size of USD 87 bn by FY2025. Within this, the organized players (standalone, chains and restaurants in hotels) will grow at a 15% CAGR over FY2020-25; these are the relevant restaurants for delivery companies and their fast-paced growth implies healthy Gross Order Value (GOV) growth for delivery companies as well. Food delivery companies accounted for ~6% of the overall food services industry in FY2020. Changing consumer behavior with reduced dependence on home-cooked food, increasing consumer disposable income, and higher adoption within Tier 2/3/4 cities is expected to drive the growth of food delivery companies at a CAGR of 25-30% for next 5 years!

Wow, that’s an attractive growth rate. Should we invest?

Thamba! Let’s dig deeper.

As Prof. Ashwath Damodaran says in his analysis – Corporate Life Cycle, there are six stages of a company:

  • Stage 1 – Start-up: Have an idea for a business that meets an unmet need in the market

  • Stage 2 – Young Growth: Create a business model that converts ideas into potential revenues & earnings

  • Stage 3 - High Growth: Build the business, converting potential into revenues.

  • Stage 4 – Mature Growth: Grow your business, shifting from losses to profits

  • Stage 5 – Mature Stable: Defend your business from new competitors & find new markets

  • Stage 6 - Scale down your business as market shrinks.

Each stage is characterized with mix of story (narrative) and actual financial & operational performance. Initially, the company is all about story and as the company moves from Stage 1 to 6 the focus on story reduces and moves towards actual financial & operational performance. We believe that Zomato is somewhere in Young Growth or High Growth stage. So, financial & operating performance should start to matter for the company.

Venture Capital investors invest in many startups with the expectation of bumper return (20-100x) in some start-ups, mediocre return (5-10x) in some startups and total failure in the remaining. The typical venture capital investor tracks the financial & operational information of the startup with a hawk-eye, tracking improvement and movement from one stage of the company to next.

Public market investing (mind you – investing and not trading) relies on more stable returns with less volatility.

I was having a discussion with a friend, one of the leading poker players in the country, about how poker is similar to investing in the stock market. Both in poker and stock market investing, one has to calculate the probability of winning/bidding based on the cards dealt to him/her. Over a long period of time, the luck element evens out for most players/investors (it still hasn’t for me.. maybe I am a bad player!). Regular results (esp. operational metrics in a young or mature company) help investors to work out probability of winning in the dealt hand – otherwise it is like playing blind (trading).

But, Zomato has taken a stance – “We are adamant that we will not let our IPO change anything, and we aren’t going to morph into a QSQT business (‘quarter-se-quarter-tak’).” I can understand the rationale of not sharing the detailed operational metrics or having investors’ call – such information can be used by the competitor (Swiggy) in a hyper-competitive environment. One question still pops up – Sure, but how should we invest and hold the Company’s shares in the absence of critical information like operating metrics?

2. Key Historical Financials

Company adjusted EBITDA has come down further to a bigger loss of INR 310 cr in Q2FY22 vs a loss of INR 170 cr in Q1FY22:

  • Reduction in Food delivery contribution margin by c. INR 62 cr

  • Higher employee cost – c. INR 33 cr

  • Increase in marketing spend – c. INR 40 c

Operating metrics of food delivery business (c. 88% of revenue in Q2FY22) is key to understand Zomato’s performance trajectory. I have tried to construct the operating metrics based on the available information and some assumptions (highlighted in yellow – these are based on historical trends). [Disclaimer - Operating metrics may be totally off due the inaccuracy in assumptions – Bhul Chuk Maaf].

(INR bn = INR 100 cr; Revenue restaurant has been assumed to c. 16% of AOV based on historical trends; take rate – commission rate)

Contribution margin had improved significantly in FY21 vs FY20 due to

  • Higher Average Order Value (AOV)

  • Lower delivery cost (its typically an absolute number driven by efficiency – not linked to the AOV)

  • Higher delivery charges & lower discount

Observation on Q2FY22:

  • Average monthly users (MTUs) have accelerated in Q2FY22 vs Q1FY22 and FY21

  • AOV seems to have fallen (c. 5%) in Q2FY22 – may be due to entry in cohort A cities (underpenetrated cities by Zomato). Good part is that Zomato has been able to broadly maintain high AOV even after the COVID period

  • Contribution margin per order is on a downward slide (INR 21 -> INR11 -> INR5):

  • Primarily driven by increase in delivery cost – could be competition for delivery partners, lower delivery efficiency in cohort A cities and higher fuel prices

  • Increase in discount – which had fallen in 2021 due to COVID as there was no option for the customer other than home delivery; discount has again picked up due to higher competition with Swiggy and dine-in opening up again

Increase in competition for delivery partners, higher fuel prices, end of COVID period and focus on growth (roll-out in cohort A cities) is leading to lower contribution margin. Some of these elements may not be temporary. Hence, profitability is still quite a few years’ away for the Company based on these operating metrics.

3. What is my view on company valuation?

Zomato currently trades at a Price/Adjusted Revenue (Annualized Q2FY22) ratio of c. 20x. Phew! I still remember the annualizing concept (used frequently in venture capital domain).

Lot of people and research analyst are using DCF valuation for Zomato. My two cents – DCF valuation is an art and can be used to justify any valuation (especially with a company in high growth phase and no profitability benchmarks).

As the brand is well-known, there will always be investor interest in the Company, so till we get Swiggy or some other similarly well-known player listed, Zomato will stay in the conversation of investors.

But, should you invest or trade in it? Take a call..

4. What are the risks to the investment analysis?

Whole analysis is garbage – should be thrown in the dustbin!

I am hangry – let’s order something..

Wait.. What – Rivian is valued at more than USD 100 bn after listing today.. and it has expected revenue of less than USD 1 million in the current quarter .. now we are talking..

About the Author

I have over 15 years of experience in venture capital, private equity and investment banking in India and Middle East across a wide variety of sectors. I was last working with Majid Al Futtaim Holding (MAF), a leading conglomerate in Middle East, to look after investments, M&A and venture capital. I have prior experience in India with Tata Capital (Private Equity), Merrill Lynch (Investment Banking or IB) and Ambit Corporate Finance (IB). I bring the long-term ownership mindset to the analysis.

I graduated from the MBA program of the Indian Institute of Management Lucknow (2005) after completing the Bachelor of Technology program at the Indian Institute of Technology, Kharagpur (2002).

I am an Insignificant Investor in the public market and co-founder of SocInvest.


I have no stock, option or similar derivative position in any of the companies mentioned since last 30 days, and shall not initiate any such positions within the next 5 days. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from SocInvest). I have no business relationship with any company whose stock is mentioned in this article.

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