What is the valuation that Zomato could command?

Zomato has been on a stellar growth trajectory with revenues jumping about 5.5 times from Rs 500 crore in FY2018 to Rs 2,750 crore in FY2020 thanks to the trend of online ordering picking up strongly. The food delivery platform has filed its Draft Red Herring Prospectus (DRHP) with the market regulator.

According to the DRHP, Zomato is a loss-making entity at both the EBITDA (earnings before interest, taxes, depreciation and amortisation) level as well as the net profit level. Its operations are still in a ramp-up mode while advertisement and sales promotion expenses are high to increase consumer awareness and lure them to order online through this platform. Zomato has been aggressive in advertising as well as providing discounts on food to increase the popularity of home delivery.

Advertisment and sales promotion expenses accounted for about 88 percent and 49 percent of revenues in FY2019 and FY2020.

Also, outsourced support cost (likely third party delivery) accounted for a significant chunk of revenues. These factors have contributed to losses at the operating level.

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How does Zomato compare with international peers?

In the international markets (both in the US and Europe) where the trend of home delivery is more entrenched compared to India, companies have been making losses both at the EBITDA as well as the net level. However, given the relatively higher scale of operations (as compared to Zomato), the extent of losses is less. This can be attributed to lower expenses on advertising and sales promotion. Also, the operating efficiencies of the business have improved over a period of time. 

Has the COVID-19 pandemic changed food delivery business?

The lockdowns and curfews imposed by various nations over the last year to curb coronavirus infections have strengthened the trend of ordering in food. Revenue growth for some companies in the US and Europe grew as much as 5.8 times in calendar year 2020. The table below has details.

Future projections indicate strong growth momentum

As per data from Reuters, future projections for the international home delivery players indicate continued strong growth momentum (revenue CAGR of 35-40 percent likely) for the home delivery companies. With the COVID-19 overhang still on and the people unwilling to step out of houses, the trend of home delivery is likely to remain strong in the medium term.

How COVID-19 impacted Zomato?

India too imposed a severe lockdown during the first wave of COVID-19 (as compared to other nations) in the beginning of FY2021. There was a national lockdown for about a month. Even in the unlocking phase post the national lockdown, there were significant restrictions on restaurants which continued to remain shut till September - October 2020. Even home deliveries was not permitted for a significant part of the lockdown.

This had significant impact on the company. Zomato’s revenues in 9MFY21 period were about half of the revenues in FY2020 (pre-pandemic) period.

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However, Zomato was able to significantly reduce the losses. Zomato’s losses in 9MFY21 period were one-tenth of the losses reported in FY2020. The main reasons were significantly lower advertisement expenditure which dropped by 77 percent in 9MFY21 period as compared to FY2020. Also, greater efficiency in operations (reliance on outsourced support dropped by 83 percent) led to lower losses for Zomato.

In India there is no listed peer for Zomato. We have therefore compared it with international rivals.

We have used the EV (enterprise value)/Sales matrix for valuation comparison given that Zomato as well as most of the international peers are loss making. However, forecasts indicate continued strong traction in revenues as well as improvement in profitability in the medium term post the COVID-19 pandemic.

On pre-pandemic sales levels, the international peer group is trading at average EV/Sales of 18 times. Zomato has recently raised about $250 million from reputed private equity funds such as Tiger Global, Fidelity Management, Kora Management and Bow Wave Capital. As per media reports, the deal valued Zomato at $5.4 billion (about Rs 40,500 crore) which is about 15 times EV/Sales for FY20. Given the huge growth potential for the Indian market and valuation gap with the international players, we can expect the IPO to be priced at a steep premium to the recent funding.