The much anticipated Rs 9,300 crore initial public offering of food aggregator Zomato is set to open for subscriptions on Wednesday. The public issue is being seen as a landmark for the country’s startup ecosystem as well as capital markets, given that it's the first of the new generation tech companies to go public on the domestic bourses.
But at a valuation of close to Rs 60,000 crore at the upper end of the Rs 72-76 price band, one begins to wonder if Zomato is really worth that much.
Food delivery platforms globally have been attracting investor interest, what with their growing demand as COVID-19 forced people indoors and cutback on restaurant visits around the world over the last one year plus. In December 2020, US-based startup Doordash hit the market and its stock surged 80 per cent on debut.
Zomato is a restaurant listing platform, table booking and food delivery platform rolled into one. It also offers supplies to restaurants under Hyperpure.
Zomato operates in a market, which is practically a duopoly, with Swiggy the only other player of similar scale. Also, food delivery as a market is still in pretty early stages here.
In India, the food delivery users as a percentage of total population is just 3.7 per cent. Food delivery users as a percentage of internet users is also very low at 9 per cent. In comparison, in the USA, the same figures are 31.8 per cent and 36 per cent respectively. Even in neighbouring China, food delivery users as a per cent of total population is 31.5 per cent, while food delivery users as a per cent of internet users is as high as 50 per cent, according to research.
So, companies like Zomato and Swiggy have a huge potential to grow here.
“Restaurant food or food service contribute only 8-9 per cent of food consumption market versus 54 per cent, 58 per cent for the US and China, respectively. According to Redseer, India has an addressable food service market of $65 billion (Rs 4.5 lakh crore), set to grow to Rs 7.7 lakh crore in 2025 as millennials depend less on home cooked food/kitchen set-up with rising disposable incomes and spending,” points Rashesh Shah, analyst at ICICI Securities.
But, one must also consider that the company is still not making profits, and is unlikely to do so for quite some time, although its losses have come down and revenue over FY2018-FY2021 has grown at a compounded annual growth rate of 62 per cent.
In the year ended March 2021, it reported a net loss of Rs 816.4 crore, compared with a net loss of Rs 2,385 crore a year ago and Rs 1,009 crore in 2018-19.
Sneha Poddar, research analyst at Motilal Oswal Financial Services, says at 25 times its FY21 enterprise value to sales, the valuation appears expensive compared with average of 9.6 times for global peers and 11.6 times for Indian quick service restaurants. However, valuing such early stage businesses on plain vanilla financial matrix may not give the right picture and may look distorted, according to Poddar.
“Zomato with first mover advantage is placed in a sweet spot as the online food delivery market is at the cusp of evolution. It enjoys couple of moats and with economics of scale started playing out, the losses have reduced substantially,” noted Poddar.
Also, in a highly competitive market, that includes not just its rival Swiggy, but also cloud kitchens like Rebel Foods, restaurants offering their own deliveries as well as branded quick service players like Dominos, Pizza Hit and McDonalds, among others, Zomato has gained market share to become the category leader in the food delivery space in terms gross order value, according to analysts.
Info Edge India, Uber, Alipay Singapore Holdings and Antfin Singapore Holdings are among the major investors in Zomato.
“With Zomato-like companies, unlike your usual stock investments, you are not paying for a share of earnings or its ability to compound in the foreseeable future. Instead, you’re paying for a slice of a fast-growing business in a growing consumer segment that you didn’t have access to in the listed space until now, in the hope that the investor fancy for such ‘new-age’ business models will hold up,” points Bhavana Acharya co-founder of PrimeInvestor.in.
Acharya notes that valuations of cash-burning start-ups have been powered by generous funding by global private investors in recent years, who have had access to ultra-cheap money thanks to near zero interest rates in the developed markets.
Investors can’t ignore the risks ahead of Zomato. Earlier this year, e-commerce giant Amazon began its food delivery service in Bengaluru. With deep pockets, Amazon has the potential to disrupt the market as and when it expands to other cities.
“Amazon benefits from its balance sheet size and low customer acquisition costs. Any aggression by Amazon beyond the initial attempt could push profitability further down for the domestic food delivery industry,” said Rishit Parikh of Nomura Securities.
Restaurants have also been at loggerheads with food delivery platforms, particularly Zomato, over its promotions and offers in the past. A restaurant industry body recently approached the Competition Commission of India citing anti-competitive practices followed by food aggregators. Several restaurants have also been promoting direct delivery model.
In the near-term, the possibility of a third wave of COVID-19 has the potential to disrupt the business, too.
Zomato has also announced plans to expand into grocery delivery once again and it has also invested in only grocery app Grofers. How this expansion pans out for Zomato will have to be watched out as well.
Still, Shah of ICICI Securities urges investors should subscribe to this issue.
“This new-age digital platform offers strong growth potential, which at present is evolving on the back of favourable macroeconomics, changing demographic profile, rising adoption of tech infrastructure,” the analyst said.
Himanshu Nayyar, analyst at Yes Securities, also says investors could subscribe to the IPO as some listing gains can be expected.
“While the current frenzy should deliver some listing gains, we would await more clarity on capital allocation plans, competitive activity and unit economics over the next few quarters to provide a more nuanced fundamental view of the company,” he said.
Nomura also remains bullish on the food tech space, given the large and under penetrated market and the ability of companies like Zomato and Swiggy to drive significant network effects. The industry’s monthly active users are expected to reach 348 million by FY30 and monthly transacting users at 87 million, said Parikh of Nomura. Average order value as well as ordering frequency is also seen rising.
So, if you are confident of the growth potential in the food tech space and see it growing many fold in coming years as researchers do, Zomato could be a stock to ride the boom on. But, if strong profitability is your key criteria in stock market investments, then perhaps, this stock may not be for you.
