Is Zomato priced beyond perfection?

The food delivery major’s IPO is a final attempt to drum up cash in its elusive quest for profitability


Never before in investment history have investors been so excited about loss-making technology firms. The dot-com boom pales in front of this liquidity frenzy. During that madness, the Nasdaq topped out at 5,133 in March 2000 to bottom out at 1,109 in October 2002. It would take 15 years for it to regain that peak but since then, it hasn’t looked back. Then, the trillion-dollar denomination was reserved for the GDP of G-7 countries. Now, you have Apple, Amazon, Microsoft and Alphabet roaming the planet with a trillion-dollar valuation. 

Indian start-ups are having their own unicorn party of late. Many have crossed the billion-dollar valuation mark, but those zeroes are no good until they have been wire transferred. Food delivery major Zomato is in the process of doing just that having filed for an IPO to raise $1.1 billion. Its post-listing valuation might be well over $5.4 billion at which it raised its latest round of funding. As per Tracxn, arch-rival Swiggy’s last round valuation was $4.5 billion. Part of a duopoly, Zomato and Swiggy lord over the food delivery space in India having survived the earlier shakeout, courtesy deep venture funding. Over the years, Zomato and Swiggy have raised $2.15 billion and $2.42 billion, respectively. Those billions have been deployed to build a customer base through seamless technology and generous discounting. 

Venture investors are willing to shell out very high multiples for these businesses because they have huge operating leverage. As volume grows, margins grow exponentially as the fixed costs do not grow at the same pace as revenue. Profitability has been a distant dream but the promise of operational leverage kicking in keeps drawing in new investors. The multibillion-dollar question then: why hasn’t it kicked in yet?

Have cash, will burn

In its IPO prospectus, Zomato declared 9MFY21 revenue of  Rs 13.01 billion compared to FY20’s  Rs 26.05 billion. Net loss for the same period was  Rs 6.82 billion and  Rs 23.67 billion, respectively. It is perplexing why, despite releasing the DRHP on April 28, Zomato did not disclose its full year financials for FY21 and left Q4FY21 out.

Amid the COVID-19 disruption, Q1 and Q2FY21 were not so great but the company says Q3FY21 gross order value (GOV) of  Rs 29.81 billion was the highest in its history. For 9MFY21, it also showed positive contribution of  Rs 229/order as compared to loss of  Rs 305/order in FY20. FY21 financials may not be strictly comparable to FY20 but Bhavin Shah, founder, Sameeksha Capital, feels Q3FY20 can be compared to Q3FY21 because of near-similar operating environment. He points out despite it being a record-breaking quarter, GOV growth for Q3FY21 versus Q3FY20 has just been 7%. 

That being the case, how has contribution improved so drastically? Well, through a rise in commission and customer delivery charge and a corresponding fall in delivery cost, discounts and other variable costs (See: Dressing up for the IPO). But while calculating this, the management has excluded costs associated with marketing, branding and other fixed operating costs. 

Advertising and sales promotion expenses, which primarily include platform-funded discounts (to the extent, not netted off revenue), marketing and branding costs, customer appeasement costs and refunds made to restaurant partners, have also reduced from 48.8% of total income in FY20 to 22.44% for 9MFY21. Outsourced support costs, which include the availability fee that the company pays to delivery partners as well as support expenses such as costs related to call centres, were also down from 76.34% of total income in FY20 to 26.57% for 9MFY21. Overall, they were 125% of total income in FY20 as compared to 50% for 9MFY21.

In the run-up to an IPO, a certain amount of dressing up of financials is always taken for granted. But, has Zomato indeed turned the corner? The more fundamental question is if the business is scalable from hereon without corresponding increase in costs. If it is, only then will operational leverage work its magic. There is a limit to which you can cut cost, be it discounts, delivery commission or ad spend.

“Food delivery, in most cases, is a negative economic order quantity business. During the pandemic, the average order size had gone up to  Rs 400 because people were ordering not only for themselves but for the entire family. The upsurge in average order value from  Rs 270 is a temporary phenomenon and the commissions which look quite high are actually not enough to sustain the delivery costs,” says Kapil Chopra, chairman, EazyDiner. 

Off the menu

Though Zomato claims to be present in 24 countries, the revenue skew is clearly towards India with 90%. UAE’s contribution is about 7% but Zomato sold it to Delivery Hero in March 2019. The rest of the world’s revenue is about 4%. Clearly, the wide presence and millions spent on acquisitions have not paid off and the Zomato management is either winding down or selling off most of the overseas units. Going forward, the focus will solely be on the Indian market.

Even in India, bulk of the revenue comes from the food delivery business which had 161,637 Active Delivery Partners during the month of December 2020. As of December 2020, Zomato has presence in 526 cities with 350,174 Active Restaurant Listings of which 132,769 restaurants were Active Food Delivery Restaurants during the month. In FY20, that number was 131,233 restaurants every month. Monthly active users (MAU) hit a high of 41.5 million in FY20 but for 9MFY21, that number was 29.6 million. 

Mohit Gulati, managing partner, ITI Growth Opportunities Fund, who has been monitoring the online food delivery business since its TinyOwl days, says, “The reach of 500 cities is vanity metrics. In tier-3 and tier-4 cities, restaurant food is a novelty, unlike in tier-1 and tier-2 cities where it is a necessity for those who are time-starved or who don’t want to be stuck in traffic getting to the restaurant. 90% of the volume must still be coming from the top 25-30 cities.” Gulati invested in Grab in 2013 before it was acquired by Jio in 2019. All of Jio’s logistics is now powered by Grab.

By themselves, the numbers in the DRHP might come across as majestic but Active Restaurant Listings is defined as “Unique restaurant partners listed on our platform in India, including those that are temporarily closed”. Then, Active Food Delivery Restaurants is defined as “Unique restaurant partners that received at least one order in India”. And, MAU is “Number of unique devices (laptops, mobile phones etc.) which have recorded at least one visit to a page/screen on Zomato’s website /mobile application in India in that month”.

MAU might have shown a fall in 9MFY21 but the more worrisome fall is in Monthly Transacting Users (MTU) — “Number of unique transacting customers identified by customers’ mobile number that have placed at least one order in India in that month”. MTU declined from 10.7 million in FY20 to 5.8 million for 9MFY21 (See: Flashing red). The DRHP does not go into detail on which are the top cities that contribute the most to revenue and what are the trends prevalent there. 

Shah opines, “While contribution margins have improved, it feels like growth has suffered and this is where the disclosure is piecemeal. The disclosures in DRHP appear to be very selective and a lot of details are missing. They seem to be only highlighting what they want to highlight. As per some channel checks, Feb 2020 to Feb 2021 year-on-year growth may have been very muted; the company should explain the reasons for that.”

The Zomato management may sound optimistic given the record Q3FY21 quarter but given the drop in MTU, is the company hitting a growth wall in the core business? Even if volume were to pick up, food delivery is manpower heavy and that would add to existing minimum guarantee payments and rising fuel costs.

Zomato’s biggest lever is its delivery force, and route optimisation coupled with increase in order  volume has pushed down cost per delivery in 9MFY21. But this option seems maxed out as the company claims, “Our delivery network collected food from our restaurant partners and delivered it to customers with a median delivery time of less than 30 minutes in FY20 (delivery time calculated from the time the order is placed on our mobile application to the time the order is delivered to the customer).” 

The Zomato management did not respond to a query on how the FY20 median time has been calculated and for which cities. Neither founder Deepinder Goyal nor many venture investors with existing/past investments in Zomato and Swiggy responded to a detailed questionnaire sent by Outlook Business

The lockdown might have facilitated faster delivery in FY21 for metro cities but assuming that to be status quo going forward seems far-fetched. Shah says trying to increase the delivery per trip in an already optimised fleet operation will jeopardise customer satisfaction. “The moment you try to do that, you might end up increasing the delivery time and the customer would want their order to be delivered first. In Zomato’s case, you can track your order, so that option is pretty much constricted,” he adds.

Chef’s discretion

The fear of a growth stall has sent the management in search of new areas like institutional catering, ingredient supplies through Hyperpure and nutritional and dietary supplements through Fitso. For its entry into institutional catering, it acquired TongueStun but it has already taken a write-off there. 

According to the prospectus, the number of customers buying Zomato Pro subscriptions have also reduced significantly as a result of the pandemic. Pro is just Zomato Gold members being carried over with free monthly extensions.

The growth in dine-in revenue that Zomato could be banking on through Pro could also come a cropper. Restaurants were happy to sign up for being “discovered” by new customers through Gold but soon realised it to be an unworthy proposition. Not only was their bottomline mauled, there was barely any retention as most flocked for the 1+1 offers. So, they are unlikely to embrace Pro once dine-in gets back to normal. 

Dine-in also has a formidable competitor in EazyDiner. Chopra says, “EazyDiner has a clear lead on Zomato and Swiggy because both are delivery-focused players. Swiggy Super does not focus on eating out and Zomato Pro is built as a delivery-first product although it also lists some restaurants.” According to a pre-COVID NRAI report that estimated the entire food services market at $61 billion, 75% of the business in India was dine-in, 14% was takeaway and 11% was delivery.

Given its weak footing in dine-in and strong footprint in food delivery, Hyperpure is where Zomato is pulling out all the stops as it fits the management’s vision of “better food for more people”. Hyperpure did report sales of  Rs 1.24 billion for 9MFY21 but at the end of the day, it is a commodity business like grocery. 

Zomato exited grocery delivery in less than six months as Zomato Market turned out to be unviable due to the muscled players already operating there. While Zomato may have exited then, it is reportedly in talks with Grofers for a buyout. Grofers is still trying to find its feet against the biggies of grocery retail and Zomato buying it would be a desperate move to widen its offering and replicate the Swiggy model which is already offering hyperlocal delivery through Instamart and Genie.

Having experienced the kitchen ingredients trade at close quarters, Gulati mentions, “Hyperpure is 3-4% gross margin business with zero entry barrier. Reliance, Flipkart, Amazon do upward of $1.5 billion of grocery GMV on their own platform. Don’t you think they have the wherewithal to strike bulk deals with restaurants or the entire HORECA chain?”

The DRHP has no mention of Zomato Market. Instead, it says, “Our Hyperpure services were least impacted due to COVID-19 as the demand for organised grocery remained high due to supply chain disruptions during the pandemic.” If demand for organised grocery remained high, clearly Zomato Market did not resonate with retail customers. 

In the customer’s mind, Zomato still continues to be a food delivery platform and if it couldn’t scale up in ancillary activities like grocery delivery, does the Zomato brand really have a moat? “In terms of pure delivery, there is no moat. Logistics is a commodity business where Shadowfax, Dunzo and Grab are better placed than Zomato because they deliver everything including food. Their riders are better utilised and better incentivised,” says Gulati.

Further, Hyperpure’s growth is dependent on the very same restaurant ecosystem towards which Zomato has been accused of being adversarial. Zomato and Swiggy have built multibillion dollar valuation on the back of the same restaurants which are barely breaking even. Swiggy, too, charges between 10-30% commission but they route higher volume.

“The food delivery platforms have cashed in on the lack of unity among restaurants. Now that their survival is at stake, the restaurant owners are pushing back. They might as well team up with Amazon or Reliance who have a 200 million-300 million customer base, for a reasonable margin,” says Gulati.

The pushback on the part of the restaurants is now becoming increasingly vehement. They are exploring alternative channels for both discovery and delivery. To improve their cost structure, the NRAI has teamed up with DotPe to get customers to order directly. They would rather pass on sustainable discounts to their customers directly than be forced to do so by an aggregator who also charges a high flat commission. 

This trend gathering momentum will force the aggregators to lower the commission charged by them to restaurants for passing on orders. Besides, if Amazon goes pan India with the 10%, it is charging restaurants in Bengaluru, then Swiggy and Zomato will have to eventually lower their take rate. In the past, volume growth has largely been a function of high discounts. Now, if you are operating on low commission yourself, your incentive to offer discounts gets hit. 

The other thing that is possibly being overlooked is that food habits are hard to change. Zomato and Swiggy may offer discoverability and reach to old and new restaurants but even those who order frequently have their favourites, be it McDonald’s or biryani. Rebel Foods has done well to cater to this stickability and build specific food brands around it. While it does get about 50% of its orders through Zomato and Swiggy, it might just be a matter of time before its own ordering apps get pushed aggressively.

Twist of taste 

The Zomato management might just get away with sketchy disclosure in the DRHP but dodging the newest entrant in the food delivery space might not be that easy. The competitive landscape in the top cities will undergo a sea change once Amazon Food gets aggressive with its already competitive take rate and delivery charge. They have begun by running a pilot in Bengaluru and have already expanded to 62 pin codes across 2,500 restaurants.

Amazon getting aggressive would mean that in order to protect its revenue, Zomato might have to rollback the incentives that it has reduced or the discounts that it has done away with. That happening will again spill more red ink on an already shaky bottomline. Discounts are what essentially has grown the business. If discounts drop, as seems to be the case with Zomato, the customer might as well use Swiggy or even Amazon. 

“New competition will not just be from Amazon. It could also come from Reliance or Flipkart who are already doing groceries and will offer it as an add-on to their existing customers. They already have a massive delivery fleet in place which they want to optimally utilise in the off-peak hours,” says Gulati.

Restaurant deliveries are largely focused from 12.30 pm to 3 pm and 7 pm to 10 pm. Compared to Zomato, the other delivery companies such as Amazon, Grab and Dunzo offer a much better proposition to the riders which translates to more salary and incentive. More orders delivered means more commission for the riders. Falling volume at Zomato could translate into an exodus of riders to rival platforms and trying to retain them would mean higher incentives.

Along with Swiggy, Goyal is aware of Amazon’s impending aggression and the IPO might be just what the CFO must have ordered. The $1.1 billion IPO will increase Zomato’s cash hoard to  Rs 131.12 billion and establish a benchmark valuation for Swiggy. That cash hoard will help in acquisitions in the food delivery business as well as growing Hyperpure. While consolidation looks like a real possibility, Goyal already has allies in Uber and Delivery Hero who are prominent shareholders in Zomato. 

In fact, every now and then, the market is abuzz about Swiggy and Zomato exploring a merger. Gulati says that seems improbable. “I do not see Zomato and Swiggy merging because in terms of ideology and culture, they can never work together. The merger will also be a death knell as today, there is an unsaid fight between the aggregators and restaurants. The ‘monopoly’ will try to squeeze them further and restaurants could move en masse to other platforms,” he adds.

Chopra, though, believes, “More than chasing market share in dine-in, Zomato might continue to build muscle on the delivery side. That business will continue to get even tougher with Swiggy improving its fleet utilisation through Genie. Food delivery on a standalone basis cannot be profitable considering the current average order value. Any player who wants to be profitable in that segment would need to look at various segments.”

Grand entrée

Zomato, in its present form, is a business built on deep discounting. That is what most of its user base has got accustomed to. Their loyalty is to the discount and not to the delivery platform. Sure, it is sitting on a mound of food preference data not having shared customer details with partner restaurants and it has market share. But, what good is that market share if it can’t lead to profitability? 

At the other end, Swiggy is extending its platform as one of convenience rather than just food delivery. It has raised another $800 million to dig in for the long haul. Far from the gaze of public investors, Swiggy might just have more room to manoeuvre than Zomato. Unless, of course, Zomato decides to jettison the IPO and tweak its strategy at the behest of venture investors.

“In order to be profitable, the average order value (AOV) has to be upward of  Rs 600. At AOV of  Rs 400, the restaurant makes a gross margin of less than 15-18%. They cannot cover all their costs at that margin. Either the aggregators need to drastically reduce their take rate or the restaurants need to see doubling of AOV. With the reduction in take rate being a distinct possibility, Zomato will move further away from profitability. Not now, they might not get there in the next five years,” points out Gulati. 

According to CLSA’s April 2021 Online Food Delivery report, the take rate for the biggest player, Meituan, is 14% (See: Unsustainable Commission). So, there seems no reason why, in the Indian market, it can sustain at 20-30%. Slowing economic growth is also going to severely test the pie-in-the-sky projections for increase in food delivery volume. CLSA is projecting the market to grow to $11 billion in the next five years. “Combining our proprietary on-the-ground analysis and regional expertise, we find this to be one of the fastest growing segments in Indian ecommerce, set to deliver a 21% CAGR over FY20-26 CL, with upside from more frequent usage,” state analysts Chirag Shah and Nitin Gupta in their report. 

Since inception, the colour of Zomato’s bottomline has matched its logo as it has burnt cash faster than the government has plundered the RBI’s reserves. Burning cash, however, has not been only Zomato’s prerogative. Even Swiggy lost  Rs 38 billion in FY20, in addition to  Rs 23 billion in FY19. “A company should be valued on profitability. At EazyDiner, we were nearly profitable even during the pandemic. Zomato and Swiggy, on the other hand, are presently focusing on revenue growth. That said, both are well-run companies with organisational depth and would have a game plan for delivering profitability as they go ahead,” says Chopra.

So far, venture capital has been funding Zomato’s cash burn. That burden is now being shifted to public shareholders via the IPO (See: Not much at stake). In an earlier interview to Outlook Business, regarding the listing of Zomato and PolicyBazaar, Info Edge CEO Hitesh Oberoi had said, “If we see them doing well over five-ten years, why should we cash out?” While the earlier plan was that the existing investors won’t exit, there has been a shift in perception with respect to future valuation. Else, how would one explain Info Edge offloading  Rs 7.5 billion worth of Zomato stock through the IPO? Even Goyal participated in the recent secondary sale and sold stake worth $32.4 million.

Goyal’s low holding of 5.5% could be a cause for concern for public investors as he has pretty much driven the company with backing from Info Edge. With Zomato going public, the stake will get even higher for the biggest shareholder which derives a considerable part of its valuation from Zomato. Though the company has not given a price range for the IPO, speculation is that it would be valued anywhere between $5.5 billion-7 billion. At the higher end, that would be 20x FY20 sales.

Shah feels Zomato is grossly overvalued, taking into account its current financials and that it does not deserve the multiple the bigger players get where operating leverage has started to kick in. “The biggest company in the space, Meituan, is trading at 14x sales and is profitable. If you look at DoorDash, it is around 16x sales and Grubhub, it is about 4x sales. DoorDash and Grubhub are almost 10x and 6x larger than Zomato in revenue. If you consider Zomato’s FY20 revenue of $350 million as a base, since FY21 revenue has shrunk, 4x sales gives you a valuation of $1.5 billion,” he explains.

Attributing a ‘scarcity premium’ of 8x FY20 sales, Gulati pegs Zomato’s fair value at $3 billion. He believes that fair value reflects incoming competition and unfavourable domestic macro which will lead to stagnant AOV. This fear is also reflected in CLSA’s forecast where the overall market is projected to grow to $11 billion in 2026 with AOV of  Rs 289 despite doubling of active users to 58 million (See: Stagnant realisation).

Gulati’s fair value is not only lower than the projected market cap of $7 billion that Zomato is expected to list at; it is even lower than the $5.4 billion valuation in the last funding round. “Unfortunately, we are in a different world today where storytelling and narrative play a bigger role than revenue and P/E multiples. Lead managers will hype up the scarcity premium of ‘India’s first pure food tech startup’,” reminds Gulati.

Shah and Gulati’s skepticism aside, the entire start-up ecosystem is counting on a grand public market entry for India’s e-commerce posterboy. Goyal has kept pulling the funding rabbit out of his hat and this positive reinforcement goes back a long way.

During his school days, in his hometown Muktsar, Goyal wasn’t particularly good at studies. Until the eighth standard, he was in the bottom two of the class. He used to fail and there were times when his dad had to talk to the principal to promote him to the next grade. Then, in the first semester exam of his eighth standard, something unexpected happened. 

In the examination hall, one of his teachers helped him with the answers to all the questions. He stood third in a class of 36 students from the 35th spot he was accustomed to. Suddenly, he was looked at in a new light and as someone who would go places rather than the good-for-nothing that he was perceived to be until then. 

He liked that love and wanted more of it. So, for the next semester exam, he stole money from his father and went to bribe the printers in Muktsar for the question papers. They asked him to bugger off and with no way out, Goyal had to actually study very hard for the first time in his life. He stood fifth. He could live with that outcome and started believing that he indeed had what it takes. He still believes it to this day.