The initial public offering (IPO) season is back, but with a different vibe. This time, internet-focused startups are selling shares to the public. Kickstarting this era is Zomato, the food delivery company.

Zomato was founded in 2008 as a listing website for restaurants, and crossed the $1 billion (Rs 7,400 crore) valuation mark in 2015. Now, Zomato is launching its IPO hoping to woo Indian investors to put money in the new age of internet companies. But this IPO comes at a high valuation and questions about Zomato’s future in a market that is about to become more competitive. It also raises the question - what metrics should investors be looking at for heavily funded but loss-making internet businesses? 

Info Edge will remain the largest shareholder post the IPO

Zomato is a professionally managed company with no promoters. Its CEO Deepinder Goyal holds a 5.5% stake in the company, and another 4.1% is held by employees.

Info Edge is the largest shareholder in Zomato, holding a 18.5% stake. Ride-sharing company Uber Inc holds a 9.1% stake as a result of merger of Uber Eats’ India division into Zomato. Other investors include - Alibaba Group’s Alipay and Ant Financial, Sequoia Capital, and Delivery Hero.

Zomato’s plans to raise up to Rs 9,375 crore through a fresh issue of up to Rs 9,000 crore and an offer for sale (OFS) of up to Rs 375 crore by Info Edge. The price band is Rs 72-76 and at the upper end, Zomato will be valued at Rs 60,000 crore.

Info Edge holds 124 crore shares which it acquired at an average price of Rs 1.1 per share. It will sell its shares at a 65x profit of Rs 374 crore. Post the IPO, Info Edge’s stake in Zomato will drop to 15.1% from 18.5%.

Investors expecting internet companies to acquire near-monopoly status in their respective markets tend to pay a premium for shares. Taking the upper end of the price band at Rs 76 per share, Zomato is priced at nearly 26 times its FY21 revenue. This is higher than international peers like GrubHub, DoorDash, Uber, and Lyft.

Out of the fresh issue, 75% or Rs 6,750 crore will be used to fund growth initiatives and Rs 2,700 crore on customer acquisitions through advertising and building Zomato’s technology infrastructure. And around Rs 4,050 crore will be used for international expansion and acquisitions. However, the management said its priority will remain expanding India operations.

From restaurant listing to food delivery and more

Zomato started as a restaurant discovery platform in 2008 and earned commissions from restaurants. In 2015, it expanded into food delivery where companies like Swiggy, Delivery Hero’s Foodpanda, Scootsy, and TinyOwl were already present. By the end of FY21, it had 3.8 lakh listed restaurants and 1.6 lakh food delivery restaurants.

In Q3FY18, Zomato launched Zomato Pro (previously called Zomato Gold), a paid membership program for food delivery and dining. As of March 2021, Zomato Pro members numbered 15 lakh. In FY21, revenues from Zomato Pro subscriptions was Rs 57 crore, down 34% YoY. In Q3FY19, Zomato set up a subsidiary Hyperpure, which supplies ingredients to partner restaurants in India. At the end of March 2021, Hyperpure had 9,225 partner restaurants across six cities. Hyperpure’s FY21 revenues were Rs 200 crore, up 86% YoY.

The primary revenue source (75-80%) for the company is food delivery through commissions from restaurants, and delivery charges from customers. A small portion of revenue (7-9%) comes from commissions from restaurant listings.

In January 2021, Zomato acquired Fitso, a sports facilities provider, for Rs 80 crore. This is its first acquisition outside food services. In March 2021, Zomato launched health and dietary supplement products which include nutraceuticals and immunity-boosting supplements. In May 2021, Zomato acquired a 9.3% stake in Grofers for $100 million (Rs 744 crore). Grofers had a 13% market share in the e-grocery market in FY21.

In a call with analysts, Zomato’s chief financial officer Akshant Goyal said the company will pilot its grocery delivery platform soon. In Q1FY21, Zomato forayed into grocery delivery as food delivery orders fell due to the lockdown. However, it shuttered grocery delivery when its food delivery business recovered in Q2FY21. In 9MFY21, 90% of Zomato’s revenues came from India, up from 59% of revenues in FY18. 

FY21 revenue declines due to Covid-19, advertising costs fall

In FY21, consolidated revenues were Rs 1,993 crore, a 23% decline YoY. This was because of the national lockdown in Q1FY21 that led to restaurants shutting down. Total orders in FY21 stood at 23.9 crore, a fall of 41% YoY.

Due to supply chain problems caused by lockdowns, restaurants were unable to source supplies from the unorganized market. Hence, they used Hyperpure, which helped Hyperpure’s revenues to jump 86% YoY to Rs 201 crore in FY21.

In FY21, Zomato’s net losses were Rs 816 crore, a 66% fall YoY as advertising costs and payments made to delivery partners fell by 61% and 72%, respectively. The company laid off over 500 employees (13% of its total workforce) and enforced a 50% pay cut in H1FY21 due to insufficient demand. This included employees on direct payrolls and not Zomato’s delivery partners who are independent contractors.

In FY20, Zomato reduced spending on advertisements and payments to delivery partners. In FY21, these expenses were 29.6% and 26.4% of its annual revenue. 

Total orders still below pre-Covid levels

While the company’s FY21 revenues fell by 23% YoY, Zomato’s average order value steadily grew. In Q4FY20, Zomato’s average order amount value (AOV) was Rs 286. In Q1FY21, during the national lockdown, the AOV jumped 32% sequentially to Rs 328. This continued in Q2FY21, as order numbers rose. 

In Q3FY21, due to higher demand in the festive season Zomato’s AOV was Rs 407, the highest quarterly AOV ever. As many states enforced lockdowns and curfews to curtail new year celebrations, people took to food delivery platforms. During peak hours on December 31, 2020, Zomato received over 4,200 orders per minute, with a gross merchandise value of Rs 75 crore, up 60% YoY.

The growth in AOV was also backed by a higher volume of orders. This led to steady growth in its gross order value (GOV) during FY21. GOV refers to the total value of all orders placed including discounts and fees. In Q3FY21, GOV reached pre-Covid levels of Rs 2,981 crore and in Q4FY21, it rose by 11% sequentially to hit its highest GOV or Rs 3,313 crore. GOV is similar to Gross Merchandise Value (GMV), a measure of total goods sold by e-commerce companies including discounts and fees. 

Investors should be concerned about low order volumes in Q4FY21, 20% below pre-Covid levels. This is after the recovery in H2FY21, where total orders surged by 91% against the first half of the year. While AOV grew by 41% in FY21, total orders dropped by 41% to 23.9 crore. 

As food delivery was permitted during the second wave, the company expects total orders placed in Q1FY22 to not be as hard hit as it was during the first wave. However, its restaurant listing business was badly impacted.

Zomato’s average monthly active users (MAU) in FY21 was 3.2 crore users, a drop of 22% YoY. The average monthly transacting users (MTU), users who placed orders, in FY21 was 68 lakhs, a 36% fall. Only 21% of Zomato’s active users placed orders in FY21, down from 26% of active users placing orders in FY20.

Unit economics turns positive in FY21

Zomato’s unit economics turned positive in FY21 because it increased restaurant commissions and delivery charges by 44% and 76%, respectively. Unit economics measures the contribution margin of a single unit of a product sold, or service rendered. Contribution margin is the value of a company's sales less variable costs.

From every single order executed, Zomato earns Rs 60-70 as restaurant commission. The delivery charge is Rs 20-30. From this total, it pays off delivery costs, reduces discounts, and other variable costs. The amount left over after deducting the cost is Zomato’s contribution margin. 

In FY20, Zomato was making a contribution loss of Rs 30.5 per order. In FY21, due to an increase in commissions and delivery charges, the contribution margin was Rs 20.5 on every order.

Zomato’s food-delivery competitor, Swiggy also increased restaurants commissions in FY21. This prompted the National Restaurants Association of India to approach the Competition Commission of India stating that Zomato and Swiggy have violated competition laws by charging exorbitant fees from restaurants. 

Debt remains low, cash flows in the red

In FY21, the total debt was Rs 1.4 crore, down by 7.2% YoY, with a debt-to-equity ratio of 0.02 times. However, its biggest liabilities are long-term lease payments. In FY21, lease payments for property leased for a period of up to nine years was Rs 53 crore, comprising 57% of long-term liabilities. 

In FY21, operating cash flows were a negative Rs 1,018 crore. This was lower by 52% against the previous year. Capital expenditure in FY21 was Rs 5 crore, 77% less than the previous year. This capex was spent to increase property leases and enhance software infrastructure.

While the company is not generating cash at an operating level, it has decent cash reserves. In FY21, cash on its books (including investments in mutual funds) was Rs 3,700 crore, a 3.7X rise YoY. This cash reserve and the Rs 9,000 crore it will raise from the IPO gives it enough gas in the tank for expansion.

Food delivery duopoly to be tested by Amazon

According to Redseer, in 2020, the addressable food services market in India was worth Rs 4.6 lakh crore. The food services market is expected to be worth Rs 7.7 lakh crore in 2025, a compounded annual growth rate of 23%. The growth is expected to go to organised and digital players like Zomato, and away from the unorganised sector and home-cooked foods. The driving force for this growth will be an increase in food ordering due to higher disposable income and greater reach in smaller cities. 

Zomato and Swiggy dominate the food delivery market (90% market share). The rest is taken by individual restaurant companies’ delivery channels. Other food delivery companies have either shut down (TinyOwl, Ola Cafe, Foodpanda) or been acquired by Zomato or Swiggy (Runnr, Scootsy, Uber Eats).

In March 2021, Amazon India launched food delivery for select areas within Bangalore, partnering with 2,500 restaurants. Amazon charges a 10% restaurant commission per order, compared to Zomato and Swiggy’s commission of 22-25%. Amazon is also planning to bundle food delivery perks with Amazon Prime subscription plans, to lure more customers.

Zomato: Growth expected but at what price?

Over the years Zomato has entered all forms of food services from restaurant listings to groceries. Post the IPO, Zomato will have a Rs 13,000 crore war chest to fuel expansion into newer businesses.

Zomato’s initial aim will be to push order volumes to pre-Covid levels (target of 10 crore quarterly orders). Since AOV is already above pre-Covid levels, higher order volumes will add to its top line. Zomato cut advertising and delivery expenses by over 60% in FY21 without impacting its AOV, possibly leading to operational efficiencies. However, at 26 times its FY21 consolidated revenue, Zomato is richly valued.  

Zomato’s IPO is undoubtedly one of the biggest and most exciting Indian IPOs this year. But investors should weigh whether it is worth their while to pay a high price for a business that has never made a profit