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


Boosted by the pandemic-fuelled boom in takeaway, the operator of one of the biggest food delivery operations in India – Zomato Ltd. – plans to go public anytime soon.

The Gurugram based food-tech giant could be one of the first Indian unicorns (startups valued at $1 billion or more) to go for an IPO. The food delivery company has already filed its DRHP with the regulator – SEBI – for an initial public offering of ₹ 8,250 crore.

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

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.

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 December 31, 2020, it had 3.5 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 December 31, 2020, it had 1.4 million members and over 25,350 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 December 2020, it supplied to over 6,000 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.

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

The company has not provided a clear break-up of how much revenue it earns from the above-mentioned four business segments. However, it is pretty much widely known that it generates nearly 85-90% of revenue from the food delivery business.

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.

As discussed in the food delivery business, it earns from restaurants in form of commission and advertisement. The delivery charge is a pass-through. However, over and above the delivery charges, the company also pays an availability fee to its delivery executive. Then on the cost side, there are discounts offered and additional charges which comprise payment gateway charges, support cost, restaurant partner refunds, and other variable spends on account of activities like delivery partner onboarding, delivery partner insurance, SMS, etc.

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

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 ₹ 23/order in 9MFY21.

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.

Zomato’s employee costs are nearly 42% of its revenue, which is also because of ESOPs given to its employees. Excluding ESOPs, it would come down to 34%.

Advertising & sales and outsourced support cost as a percentage of revenue have reduced in 9MFY21. However, till FY20, on an absolute basis, it has been increasing. In 9MFY21, due to lower discounts, lower advertising spends, and cut in availability fees, the amount has proportionately reduced.

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

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.

In the first nine months of FY21, Zomato 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.

Most of this cash has been parked by the company in liquid mutual funds. The cash value per share stands at close to ₹ 7.5, while the book value per share is close to ₹ 9.5.

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

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?

Offer Details and Valuation

The company plans to raise ₹ 8,250 crore – ₹ 7500 crore of fresh issue and ₹ 750 crore of an offer for sale. Of the total fresh issue, the company can ₹ 1,500 crore by undertaking a pre-IPO placement, while the remaining would be through the IPO route.

The offer for sale is by Info Edge (listed as NAUKRI) which has been a large shareholder of Zomato for many years. It owns 18.7% of Zomato (pre-IPO) and will offer shares worth ₹ 750 cr (we don’t know how much stake will be offered). worth shares. Info Edge’s ownership will be locked for one year after the IPO as per SEBI rules.

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

With this IPO, Zomato will have a war chest of close to ₹ 12,500 crore (assuming it doesn’t burn its existing cash balance) as compared to ₹ 13,000 crore raised by the company from various investors since 2008.

The company intends to use these funds, for its organic and inorganic growth plans.

At least 40% of the funds raised will go towards organic growth which includes marketing and sales promotions, improving the delivery network, and technology infrastructure which could lead to new customer acquisitions. Of the remaining, the majority chunk will go towards acquisitions which will enhance geographical presence, expand service offerings and delivery capabilities.

As per the DRHP, in February 2021, the company raised close to ₹ 1,800 crore from various investors by issuing them convertible preference shares. In April, these were converted into equity. Going by that valuation, Zomato is currently valued at close to ₹ 38,634.

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

There is no indication from the company about valuations. If the company is valued at Rs. 60 per share, which we believe might be the lowest it might consider, it would be valued at a post-IPO level of Rs. 50,000 cr. This is a large cap by Indian standards.

Our View: Too Early To Call, But Solid Tech Based Company

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 9MFY21, based on per order economics, the company earned around ₹ 23. 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 ₹ 5,000 crore, it is raising another ₹ 7,500 crore from primary markets? Is the company preparing itself for another disruption?

Another thing to consider is: ancilliary 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 fulfil also – such as 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.

Well, right now, the company has just filed its DRHP. Till the time it comes out with an IPO, a lot of things might change. However, if one plans to invest in Zomato in the future, then the most important thing to track would be Amazon’s expansion in the food delivery business.

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?

This article is for information only, and should not be considered as a recommendation to buy or sell any stocks. Stocks discussed might be part of Capitalmind Portfolios

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