After a successful IPO, Zomato debuted on bourses with stellar gains.
India's leading food delivery company made a stellar debut on Dalal Street on July 23 as the stock opened at Rs 116 on the NSE, a 52.63 percent premium to its final offer price of Rs 76. The listing price on the Bombay Stock Exchange was at Rs 115, up 51.32 percent.
This perplexing response to Zomato must have caught many value investors by surprise who found the valuation of the company unjustified.
Regret minimisation framework
"In X years, will I regret not doing this?"
This is the basic question Amazon's founder Jeff Bezos asked himself when the idea of opening an online bookstore came to his mind.
Known as the 'regret minimization framework', it is a decision-making mental model - a way to think, respond and decide on things of everyday life.
Also read: Zomato crosses Rs 1 lakh crore m-cap after stellar debut with nearly 53% premium
After the entry of Zomato into the equity world, many veterans of Dalal Street who found the exuberance around the company's IPO irrational must be thinking if they made a mistake by avoiding it.
The company has been loss-making; its valuation is not in sync with its performance and analysts were correct in pointing their fingers at the company's rich valuation.
But you can't judge a fish by its ability to climb up a tree. Zomato is an internet-based firm that is expected to burn capital in the initial years. There are examples - Google, Amazon, Facebook, etc. - which turned profitable after many years of investments.
Also read: 12 stocks have seen listing gains of over 50% since 2020
"In the aftermath of its IPO in 1997, some investors concluded that Amazon had to sell practically every book on earth for its then market-cap to be justified," Brokerage firm ICICI Securities pointed out.
"(1) Under-estimation of strength of business models, (2) steady profitability and/or (3) over-estimation of valuations – in case of Google, Apple and Amazon – have been a key regret for Berkshire Hathway (elaborated in annual letters)," ICICI Sec said.
"Post dot com, many US analysts called out multiple false-positive tech bubbles. Nevertheless, the weightage of tech in the S&P 500 increased from mid-single digits during the 1990s to nearly 28 percent today. US tech is now worth more than the entire market-cap of Europe."
ICICI Securities sees the likelihood of similar evolution of some of the Indian companies, given the addressable markets and the scalability in many segments, such as food-tech, fin-tech and e-commerce, etc.
The losses and cash burn are the key reasons for the pessimism of investors around these IPOs. However, this is largely due to spends such as marketing, advertising & promotions, discounts, cash backs, etc. which are targeted at driving customer adoption and branding, the brokerage firm highlighted.
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"These front-ended investments should create strong moats and drive back-ended benefits in the form of brand recall and network effect for several years to come," ICICI Sec said.
"While profitability and cashflow are great sanity metrics, they are better applied on businesses in steady-state. Near-term sales or margins (FY22 or FY23E) do not fully reflect the steady-state revenue or profitability potential of the business. Nor do near-term multiples give a correct picture of the valuations," the brokerage firm highlighted.
The current realities may not portray a clear picture of what is in store for such firms going ahead.
Globally, rich valuations of internet companies have been surprising value-conscious investors from time to time. But we perhaps need a different lens to assess the prospects of a company like Zomato. The bumper listing hints at it.
Know All IPO-Related News HereDisclaimer: The above report is compiled from information available on public platforms. Moneycontrol advises users to check with certified experts before taking any investment decisions.