Zomato IPO: Key questions answered
If the food tastes good, then you don’t mind paying extra, right? Well, something similar could be said about the much-awaited and talked-about initial public offering of Zomato, which is open for subscription from July 14 to July 16.
The Rs 9,375 crore share sale comprises a fresh issue of equity shares of Rs 9,000 crore and an offer for sale of Rs 375 crore by existing shareholder Info Edge. The price band for the offer is Rs 72-76 per share.
Zomato, which is an online restaurant aggregator and food delivery service, reported revenue of Rs 2,486 crore in FY20 and its loss widened to Rs 2,451 crore. Although it is a lossmaking company and its valuation is higher than its global peers, how should such entities be valued and why should investors pay a premium for its shares?
Moneycontrol spoke to experts who proposed their own ways of valuing companies when traditional methods such as earnings and P/E fail.
Companies like Zomato, which are tech-based platforms, need a huge amount of investments at the start, but that said, there are plenty of growth opportunities because the market is still underpenetrated, experts suggested.
“Platform-based companies like Zomato require significant initial investments to drive network effects. Hence, focusing on initial cash burn is futile considering that unit economics are evolving,” said Pranav Kshatriya, VP for institutional equities at Edelweiss Securities. “On the other hand, key parameters that need to be taken into account while evaluating platform-based companies include total addressable market and long-term unit economics.”
Kshatriya added that a stronger network effect acts as a barrier to entry in platform-based businesses, leading to near-monopolies of such platforms.
“Investors should pay close attention to the growth in the number of orders, especially versus Swiggy, the trajectory of average order value, and unit economics,” he said.
Tech-based platforms need to be measured in terms of market share and revenue growth as they are not making any money right now and there is a scarcity premium.
Zomato will be the only food delivery tech platform in the listed space in India and hence it will command a premium that investors are ready to pay.
“These kinds of companies will need to be measured on price to sales, price to book, EV/Ebitda and EV/revenue basis,” said Jitesh Ranawat, head of institutional sales at Marwadi Shares. “The Street is well aware that it’s a lossmaking business and would be discounting the growth in revenue considering it generally chases revenue to grab market share and increase penetration.”
Ranawat added that the food delivery platform is the major source of revenue and loyalty programmes like the Gold membership, which were affected because of COVID-19, contribute roughly 10 percent of revenue as of now.
What other experts recommend:
Prashanth Tapse VP Research at Mehta Equities
The Zomato kind of business model will take another one to two years to generate sustainable profit as the industry is still in a nascent stage and needs huge cash-burning cycles to acquire new customers to stay in the business for a long time.
Being the first-of-its-kind business model debuting in the capital markets, I can try valuating them based on market cap-to-sales multiples or enterprise value-to-sales multiples, which is globally the standard way to look at such businesses in the initial stages, where losses are in net levels.
Based on this, investors can compare one-to-one and take a holistic, long-term view. I also advise investors to try to measure operating performance metrics such as growth in monthly average users (MAU), gross order values (GOV) month on month, and the monthly deliveries trend, which give a better month on month picture to get a good hold on understanding business viability.
Gaurav Garg, head of research at CapitalVia Global Research
Startups first take a loss because they need to expand their business and the pandemic had a negative influence on their operations. In the case of Zomato, it has been expanding its company into other verticals, which means that expenditure would be larger and may result in losses in the initial years.
Valuing a startup, particularly a tech-based company, is challenging for investors because certain data such as financials may appear to be bad as the companies may have posted a loss for years.
On the other hand, other factors such as demand for the company’s products/services and how they are disrupting old businesses with new ideas may encourage investors to put their money into the firm.
Customer acquisition costs, valuation, revenue and competition from other players (such as Amazon and Swiggy) are a few aspects to consider for a tech-based firm.
Disclaimer: The views and investment tips expressed by experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
