Zomato: What Next After A Blowout IPO And Stellar Stock Market Debut

Stocks of online food delivery platform Zomato made a stellar debut on stock markets with market valuation crossing Rs. 1 lakh-crore-mark.

Post listing, Zomato has become one of the top 50 most valued publicly traded companies. At Rs.1 lakh crore market capitalization, the company is being valued at a 40x revenue multiple. In order to justify these valuations, Zomato must continue growing at high rates, while simultaneously focusing on lowering losses, a very tough endeavour.

The IPO is probably an added strain on the company, as public markets are more focused on numbers rather than rosy growth narratives.

When compared to listed global peers like Softbank-backed Doordash, which operates in the USA – a relatively mature market with more paying power, Zomato’s valuations look overly-optimistic.

DoorDash is still unprofitable but trades at 15 times its revenues, whereas Zomato trades at 40 times its revenues. DoorDash has also managed to grow at a much higher rate during the Pandemic period, compared to Zomato. These facts indicate that the markets might be expecting too much from Zomato.

Zomato, and other loss-making digital companies, have often highlighted the contribution margin figures in their IPO Prospectuses to showcase their minimal profitability. Contribution margin figures only take a few major operating costs into consideration, which might paint a much rosier image of the business and its unit economics.

Zomato has managed to lower its delivery costs which contributed took up around 76 per cent of its total income in FY20 to around 24 per cent for FY21, by passing on costs to customers. While this is a great measure towards lowering losses, it is also a point of weakness.

Every new entrant in the food aggregation business has subsidised food packaging costs, delivery costs and offered higher discounts to gain customers. Therefore, it is quite possible that if a new entrant tries to compete with Zomato, it will be forced to subsidize these costs for customers. The current duopoly status of the industry is because Zomato and Swiggy are the last men standing, and not because these businesses have any inherent advantages. The businesses still remain vulnerable to competition.

Zomato’s customer demographic is another major problem. Its main customer base mostly consists of college students or young working professionals looking to have a good meal at low rates. The customer base has no loyalty and will shift to whichever platform offers lower rates and higher discounts. However, with the lockdowns, Zomato’s user demographic and habits have probably changed. A sudden 33 per cent increase in the average order value, right after the lockdowns, indicates this change.

With the lockdowns, it is likely that Zomato’s primary customer base has moved back from metropolitan cities to their homes in Tier-1 or Tier-2, or has continued working from home along with roommates. Therefore, most of the current orders come from either families or roommates ordering together. The trend will probably see a reversal once offices reopen, and people start moving back to cities. If the AOV falls back to older levels, contribution margins will fall back into the negative territory. Growth in order volumes will only benefit the company if the average order size is above a certain threshold. If the order sizes are too low, it is likely that the company will have negative scale economics and will lose money as the numbers of orders grow.

Zomato has also launched HyperPure, a business focusing on supplying vegetables to restaurants. While it has managed to scale using its restaurant partner network, the margins are abysmally low (gross margins of 2%) because it is a commodity business. It is quite unlikely that the business will contribute to meaningful profits in the near future.

Zomato’s subscription program – Zomato Gold, which was rechristened Zomato Pro with much lesser benefits, has continued losing customers. Zomato Gold was scrapped after widespread protests against the one-sided profit sharing structure of Gold. Several hundred restaurants had left the Zomato platform following the Log-Out campaign. Today, chain restaurants and some large standalone restaurants are building delivery fleets and offering incentives for customers to order directly from their sites or apps. Other businesses such as grocery delivery, advertising among others are either dead or contribute to a very minuscule percentage of profits and revenues.

Zomato and Swiggy are the last men standing in the food delivery business. Swiggy can continue burning money as it remains a private company backed by Softbank. In contrast, Zomato, which could not secure Softbank’s funding, will be forced to cut back on the burn rate and focus on profitability. With deep-pocketed competitors like Amazon eyeing the market, it is likely that the 22% commission rates and passing on of delivery charges will become a point of contention between the incumbents and the new entrants.

Given Zomato’s relatively restricted access to capital in the future and its high burn rate, it is advisable for investors to remain cautious. Even profitable companies in traditional with multiple times the revenues and profits are valued much lower than Zomato. Indian retail investors, who are extremely excited to buy into a tech unicorn, might fall for the glitter surrounding the IPO. However, it pays to always remember that good businesses are not always good investments. And Zomato has not yet proven that it is a good business.