The once famed Zomato has seen a dramatic change of fate over the last couple of years.
It was cheered for years, for being a pioneer in the food-tech space, taking Swiggy head-on in delivery, successful rounds of funding with valuations stepped up each time, and also being the hope for start-up listings in India.
However, the performance of Zomato’s stock on the market was nothing short of dismal. Recently, it hit rock bottom, just like any person would after all this rejection. From it’s all-time high of Rs. 169, it is down to less than a fourth at a mere Rs. 41.
Now that it reached the popular Mr. Aswath Damodaran’s fair value, the large question has been: Should one buy Zomato?
High High Hopes for a Living 🚀
Zomato's story was a promising one. It was the first of the Indian darling startups to go public, with a private valuation of US$ 5.5 billion. In one of the largest IPOs in more than a decade, it planned to raise Rs. 9,375 crore for 123 crore shares at a price of Rs. 76 per share.
Despite the economic uncertainty caused by the pandemic, the IPO was 38 times oversubscribed, with institutional investors making large bets. The stock even rallied 120% from its IPO price of Rs. 76 to Rs. 169 during 2021.
And it all kind of made sense
The markets were at an all-time high, recovering from COVID
The rally had gone on for nearly two years
The markets had seen a record number of new retail investors starting to invest
Optimism was at a high, and valuations reflected just that
IPOs were flooding the markets, and investors were welcoming them with open arms
Amidst this apparent success and blockbuster listing, the company continued to report mounting losses.
Flash in the Pan 🍳
As 2022 began, Zomato fell faster than a sack of potatoes that it can deliver. A month down in 2022, and the stock had already fallen below Rs. 90 after which.
In the December 2021 quarterly results, Zomato reported a slowdown in the value (in Rupees) of food ordered on its platform (GOV- Gross Order Value).
In the March 2022 quarter, net losses tripled, and the stock price had reached Rs. 60. By July 2022, the stock was as cheap as chips, with a share costing as little as Rs. 40.
What Went Wrong?
1. On a Knife’s Edge 🍽
With global inflation unsettling markets, high growth + capital intensive companies’ stocks lost value in 2022. Inflationary pressures first manifest themselves in risky assets such as money-guzzling tech startups. Fuel costs and wage inflation have also exacerbated the situation for Zomato.
Capital flees the market during such tumultuous times. This means that investors are leaving India, as evidenced by FPI outflows, and moving towards safer assets. Those who choose to remain invested in Indian equity pick companies which are larger, profitable, financially stable and less frothy on valuations.
It’s not like the IPO has been the advent of unprofitability for the company - It was always losing money. An important lesson has been that companies get viewed differently in the private and public markets.
What makes for vanity and success in the private markets can be a disaster in the eyes of the public markets.
2. Crying over Split Milk 🥛
Many investors, including Zomato insiders, have decided to take their ball home. Typically, founders, employees and early investors have a lock-in period on their shares after an IPO.
All investors who held equity prior to the IPO were effectively barred from selling their shares for a year. This lock-in period ended on July 23, 2022, causing the shares to tank to an all-time low right after.
This includes all pre-IPO investors, such as angels, venture capitalists, acquisitions, and employees - rushing like a herd to exit the field that is Zomato.
For example, Uber, which received Zomato stock when it sold UberEats to Zomato in an all-stock deal, sold all of it’s holding in a block deal. This amounts to 7.8% of Zomato’s total shares. Even Tiger Global, who possessed 5.1% of Zomato, sold half of their stake!
3. Financial Performance 📈
Zomato’s financial performance has been dismal ever since it got listed. There has been a steady decline in metrics post the pandemic. The pandemic was a good situation for the company; more users, more demand, much better pricing power (both from customers and from restaurants), and much lower costs.
And FY22 didn’t look bad from a peripheral glance. Zomato’s Gross Order Value (GOV) increased by 126% to Rs. 21,300 crore - that’s amazing. Compared to last year, Zomato saw a more than doubling of
The number of cities it delivers in (455 to 1,000+)
Food delivery orders (24 crore to 54 crore)
Average monthly transacting customers (68 lakh to 1.5 crore)
However, this doesn’t excite investors. Why?
1. GOV is not equal to revenue. Revenue for Zomato equals the amount of commissions they get from restaurants, packaging charges and delivery charges, minus any discounts they offer. While their GOV increased by 126%, revenue only increased by 81%; the difference:
Either discounts increased (higher CAC - customer acquisition cost)
Or commissions charged to restaurants reduced (possibly because of competition)
2. Then there’s contribution margin, which declined from 5.2% in FY21 to 1.7% in FY22. The contribution margin simply is the sales value for each delivery minus the variable cost to fulfil that order. The reduction was on account of:
Higher delivery costs (Zomato has started charging customers higher, but also end up paying higher to delivery partners, thanks to more deliveries and higher fuel costs)
Higher discounts, lower commissions from restaurants and higher delivery costs don't go too well. The markets have been anticipating profits, and a disappointment there has taken away massive value off the share price.
4. Half-Baked Ideas 🎂
Zomato’s growth has come in sporadic bursts given it’s active acquisition strategy. Future growth prospects become unreliable as it becomes unclear how much of the revenue growth is organic and how much is acquired. There's also the lingering question of whether this acquisition-fuelled growth is affordable.
The acquisition of Blinkit for Rs. 4,500 crore, a quick commerce player, management hopes will increase order density and lower cost per delivery. However, in the short term, it has delayed Zomato's path to profitability by a year or more as it’s losses continue to mount. This transaction had been in the works since Zomato invested in Grofers (now Blinkit) in June, 2021 and loaned them money in March, 2022.
In late 2021, the company made a series of investments in startups in adjacent business sectors such as Curefit, ShipRocket, and MagicPin. Despite management's claims of "tremendous strategic value in the long term," these investments served as distractions and emptied its coffers with no visible benefits.
And then there was the whole fuss around 10-minute delivery, which was supposed to revolutionise how food delivery in India works. But Zomato’s plan felt the heat as customers didn’t seem to excited, and concerns around the safety of delivery partners became the highlight.
Will Zomato Deliver? 🚲
As much as we’ve enjoyed making puns throughout this blog, we need to decode the conclusion.
If you’re one who bought in at the IPO, the road has been tough so far. First the stock doubled, and then dropped to a fourth of its value.
We see a case for improvement in profitability as:
The average order value increases as customers spend more on ordering and order more often
Customers get used to paying for delivery, and Zomato is able to scale it to an extent that the delivery cost is covered by the delivery charge
Repeat customers increase and Zomato doesn’t have to spend the same amount of money as earlier in user acquisition (discounts)
But then there are risks:
A new entrant like Amazon can aggressively offer more commissions to restaurants while also cutting the delivery charge (by leveraging Prime)
The quick commerce business has yet to prove its worth and will further widen losses, at least in the near future
That said, Zomato has been part of the Disruptors portfolios since the last 10 months. We feel the pain, but have been holding on to the position despite value erosion. The stock currently stands aligned with our aim to create value for our users over the long-term.
In the long run, we see improvement in profitability for Zomato, and potential valuation re-rating.