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Zomato Ltd IPO – Subscribe for listing gains

Expect listing gains despite punchy valuations; competitor actions, M&A strategy, unit economics key monitorables 

We see a lot of excitement around the Zomato IPO given it’s the first large consumer tech company getting listed. Key players in the food tech industry like Zomato and Swiggy and have been able to create multiple competitive advantages like last‐mile delivery infrastructure, customer data, strong brand and convenience/choice driving network effect. While the metros and Tier 1 opportunity has been well captured, there is enough potential in the Tier 2,3,4 cities. We expect better trends in customer adoption and ordering frequency given efforts in changing health perceptions on food ordering, while demographics remain favorable. The COVID pandemic has impacted revenues but improved unit economics which could be difficult to sustain going forward. While clarity is still awaited on use of IPO proceeds on M&A, it could be a combination of foray into grocery, dark kitchens, nutraceuticals etc. While we see strong investor interest despite punchy valuations at 25x FY21 EV/sales given the uniqueness of the business model, the path to profitability is still not clear. While growth potential and a cash rich balance sheet offer immense growth potential, its difficult to value the stock on conventional parameters. Hence, we would advise to subscribe for listing gains only and would wait to see multiple legs of the story unfold before coming up with a more nuanced fundamental view.

Underpenetrated market provides long growth runway but competition heating up – The growth opportunity in online food delivery is quite large given the food service market is expected to grow at 9% CAGR from CY19‐25, where restaurants have only 8% share of food consumption and online food delivery is only 8% of that, vs 40‐50% markets like US/China. While the two leading players Swiggy and Zomato have the first mover advantage behind them, emerging competition from the likes of Amazon, NRAI and aggregators like DotPe and Thrive should be closely watched.

Unit economics getting better but aggressive investment plans would delay profitability – While EBITDA losses have reduced substantially over FY18‐21 with revenue growing at 62% CAGR and contribution margin turning positive, maintaining that trajectory might be difficult given the need for continued investments and higher marketing costs and discounts. With the company prioritizing growth (both organic and inorganic), the path to profitability remains unclear especially in new areas like cloud kitchens and grocery which are hyper‐competitive.

Strong brand, consumer connect, restaurant and delivery network – The company has aggressively spent on marketing and technology upgradation to create a strong brand in more than 500 cities in India. The company has consistently been gaining market share in the last four years with strong growth in app downloads, monthly transacting users, restaurant listings and active delivery partners.  In addition to the food delivery business (80% of revenue) and dine‐in business (15% of revenue), the company is now diversifying into other areas like B2B ingredient supplies (Hyperpure), grocery (investment in Grofers) and nutraceuticals.

Valuation and view ‐  The IPO is expected to generate lot of interest given the company uniqueness, large opportunity size and some evidence of scale economies, but the valuations look really expensive on conventional parameters at 25x FY21 EV/sales vs 10x for global peers and 12x for Indian QSRs, with the path to profitability also unclear. 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 on the company. Out of Rs 93.8bn IPO proceeds, Rs 90bn will come to the company out of which Rs 67.5bn will be utilized for organic and inorganic growth initiatives. Key risks going forward would be emerging competition from well‐funded groups and NRAI, losses from new investments and diversification initiatives.

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