Will the feeding frenzy on Zomato’s IPO turn into a bad meal for its investors?

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It speaks of the faith that investors have in the prospects of the food delivery platform, Zomato, or heir opportunism, that they placed bids for equity shares 38 times more than it had offered. Such investor confidence in a loss-making company is quite touching. As the first such company to tap the public, it is a trend setter for other digital start-ups, some of which are valued at over a billion dollars, and a few like Paytm, at multiples of that amount.

These companies are all internet-based. They use algorithms to connect customers with businesses. They are light on physical assets and are invariably loss-making. As a category they have come a long way from their internet based, search-and-serve predecessors like Naukri-com and MakeMytrip.com that made their debuts with public offerings in 2006 and 2010 in India and the United States, respectively. Both were either profitable or on the verge of profitability when they listed on the stock exchanges.

Foodiebay Online Services, the company that owns Zomato, spent Rs 89.4 to earn Rs 58.9 in 2020 from food delivery. But the loss of Rs 30.5 has turned into a profit of Rs 20.5 in the last financial year. This excludes marketing, branding and other fixed operating costs which are quite large. Whether this pre-IPO turnaround in unit economics will sustain is hard to say.

Business model

This is a business where more begets more. The more meal suppliers — restaurants and take-away services — get listed, the more customers the app will attract, which in turn will persuade more meal servers and suppliers to get listed on the app, till an inflexion point is reached after which the cost of delivering an order get progressively reduced and profitability rises. But Zomato is not there yet. It made a loss of Rs 816 crore in the year ending on 31 March, 2021 – equal to about 40% of its revenue of Rs 1,994 crore. In the previous fiscal the loss at Rs 2,384 crore was 92% of its revenue. The company’s return on net worth — share capital and long-term debt — is a negative 10%.

But Zomato is the category leader. It is a familiar name to those who have money to spare. The pandemic brought it closer still as more people ordered meals home, and frequently. Its prospectus says it is present in 525 Indian cities and towns, has nearly 3.9 lakh restaurants listed and it is the most downloaded food and drinks app in India for the past three years. Rising population, urbanisation and prosperity will accentuate the trend of eating out. With offers and campaigns, the company can get people to order more and cook less.

The utility of the app to users increases as its footprint expands. The total value of food ordered through Zomato in 2020 more than doubled to Rs 11,221 crore over the previous year, but shrank to Rs 9,483 crore in the last financial year. The number of orders doubled to 403 million in 2020 but fell to 238 million last year. However, the average value of orders rose from Rs 278 to Rs 397. Profitability will be higher or the loss lesser as the average order value increases.

There are many things working in favour of Zomato, but till the inflection point is reached, Zomato’s sales growth will depend on ability to bear losses. Private equity investors sink money in unlisted companies in the hope of exiting through an IPO with a windfall. Public investors will not be as patient or deep-pocketed. Zomato could have waited till it became profitable but the current easy money conditions were too good to pass up. An opportune moment for the company may not be so for investors.

Points to note

Observers point to similar companies in the United States that have not done well. GrubHub, which got listed in April 2016 on the New York Stock Exchange (NYSE) at $26 a share, is quoting at $15.80. From a profit of $24 million on revenue of $254 million in the listing year it delivered a loss of $156 million on revenues of $1.82 billion in 2020. DoorDash, which opened last December on the NYSE at $182, or 78% above its offer price, is quoting at $167. Last year it made a loss of $461 million on revenues of $2.89 billion. In the first quarter of this year, its loss was $110 million on revenue of $1.08 billion.

Info Edge, the company that owns Naukri.com was profitable when it listed in 2006. Its pre-tax profit was Rs 39 crore on an income of Rs 147 crore. It was oversubscribed 53 times and opened at Rs 320 a share. It is now quoting at Rs 5,102. Though Naukri.com, its flagship portal, has been posting lower profits, and those like Jeevansathi.com and 99acres.com are loss-making, the share has been propped by investments in startups like Zomato and Policybazaar.com. In 2020, Info Edge earned Rs 319 crore in net profit on revenue of Rs 1,273 crore.

MakeMyTrip was making losses at the time it listed in August 2010. In that financial year it posted a profit of $2 million on revenue of $61 million. It opened at $14. It is now quoting at $28.75 though it has been making losses since 2013. Its revenue in 2019, a pre-pandemic year, was $312 million.

Another bubble?

None of these companies have been able to replicate the success of Infosys, which went public in 1993 and listed on the Nasdaq in March 1999 (a year after Cognizant). Writing in his book, Kautilya Today in 2002, Jairam Ramesh said: “Indian venture capital companies behave like bankers, fearing failure in a business where success means a failure rate of 70-80%. It is said that true venture capitalists are vulture capitalists.” Ramesh was part of the team that shepherded the 1991 reforms. He wrote after the dot.com bubble had burst.

Is the feeding frenzy among Indian investors over a food delivery company an example of blind greed or keen foresight? It is institutional investors, corporate investors and wealthy individuals who are more exuberant about Zomato than retail investors and its employees. Have they been blindsided by greed and carried away by the momentum or is it a business they intend to hold on to?