Zomato IPO | 'Don't see major listing gains as issue already priced 30% above last round of funding'

Also, valuations should not consider only the current profitability, but also the growth prospects, the strength of the franchisee, management’s ability to create a long-term sustainable and profitable business.

The nature of the business is such that losses in the initial few years are imperative leading to unfavourable unit economics.

Q) There is a saying “stock prices are slave of earnings". We know that cash burn is necessary for companies like Zomato to build/grab market share. So, what is Street discounting?
A) Zomato has managed to showcase positive unit economics in FY21 on the back of higher AOVs and lower discounts. We are building in slight deterioration on this front for FY22 as average order value (AOV) may decline and discounts may increase.

However, we expect strong order growth over the next few years. In FY20, the company fulfilled 400 million orders, which dipped to 240 million in FY21.

We expect orders to increase to over a billion on the back of new customers coming to the platforms and increasing ordering frequency.

Overall, we expect Gross Order Values to grow 4x from FY21-25. Over the long term, we do expect the company to generate EBITDA margins close to 25% as revenue growth remains steady and the need for investments fall as businesses mature.

Q) Do you think the stock could double on listing day? Or at least we could see a pop of over 50%?
A) The stock is already priced at a 30 percent premium to its last funding round a few months ago. Although we have a target price higher than the top-end of the issue price, doubling or 50 percent gains seems very optimistic. However, short-term demand and supply and is difficult to predict.

Q) How do you peg Zomato with respect to global peers? Do you think it is expensive?
A) Zomato’s valuations are certainly not cheap when compared to its global peers. Valuation at 19.7x FY22E and 13x FY23E price to sales at the higher end of the price band is higher than the 1-year forward P/S of its global peers which trade at 2-12x.

However, Zomato is growing much faster than the other players and has a longer growth runway.

Q) What is the valuing criteria for companies like Zomato which is one of the first unicorns hitting D-Street? How can investors measure their performance?
A) The success of capacity-based businesses depends on economies of scale, the efficiency of operations, distribution etc., and unit economics are fairly straightforward.

However, platform-based companies like Zomato require significant initial investments to drive network effects.

Hence, focusing on initial cash burn is futile considering unit economics evolve. On the other hand, key parameters that need to be taken into account while evaluating platform-based companies include total addressable market (TAM) and long-term unit economics.

Stronger network effects act as barriers 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.

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