Company Name – Zomato Limited (Zomato)
Current Share Price – INR 65 (May 24, 2022)
Market Cap – INR 51,139 cr
[Updated for Q4FY22/FY22 results]
1. What is interesting about the stock?
We, at SocInvest, support start-ups wholeheartedly – partly for being a start-up ourselves (self-fulfilling prophecy!). Start-ups are critical for innovation and employment generation in our country. They provide a flywheel 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?
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 the restaurant industry. Zomato has four main business lines:
Food delivery business
Restaurant listing business
B2B delivery to restaurants (Hyperpure)
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 a total fund-raise of c. USD 5 bn till date. This is higher than Zomato’s fundraise of ~USD 2 bn.
Based on Technopak research, India’s total foodservice 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 the 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 of – 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 the market shrinks.
Each stage is characterized by a mix of the story (narrative) and actual financial & operational performance. Initially, the company is all about the story and as the company moves from Stage 1 to 6 the focus on the 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 returns (20-100x) in some start-ups, mediocre returns (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 the 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 with him/her. Over a long period, 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 the 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-take).” I can understand the rationale for 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 220 cr (EBITDA - INR 450 cr) in Q4FY22 vs a loss of INR 270 cr (EBITDA - INR 489 cr) in Q3FY22:
Increase in Food delivery contribution margin by c. INR 40 cr
Operating metrics of the food delivery business (c. 85% of revenue in Q4FY22) are key to understanding 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 to the inaccuracy in assumptions – Bhul Chuk Maaf].
(INR bn = INR 100 cr; take rate – commission rate)
Contribution margin went down in FY22 vs FY21 due to:
Reduction in customer delivery charges (INR 28 to INR 25)
Increase in delivery cost (INR 46 to INR 56)
Observation on Q4FY22:
Average monthly users (MTUs) have accelerated in Q4FY22 vs Q3FY22
AOV improved ~4% in Q4FY22 vs Q3FY22
Take rate (including delivery revenue) seems to be coming down
Contribution margin per order increased in Q4FY22 vs Q3FY22 (INR 4 -> INR7) but is still lower than FY21 (INR 22):
Higher AOV seems to be driving the increase in contribution margin
Delivery cost has stabilized in the last three quarters
Company has employee costs, losses in other businesses and overheads to cover before becoming EBITDA (adjusted or unadjusted) positive. 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 Q4FY22) ratio of c. 10x. Phew! I still remember the annualizing concept (used frequently in the venture capital domain).
A lot of people and research analysts 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 the 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. Blinkit (Grofers) acquisition has shown weakness in the corporate governance standards.
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 24 bn today after listing at USD 100 bn.. 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 the Middle East across a wide variety of sectors. I was last working with Majid Al Futtaim Holding (MAF), a leading conglomerate in the 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 in the 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.