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© Sunil Matkar ‘Zomato a strong player, but investors must note these 7 unanswered questions before investing’

Vishal Chandiramani, Managing Partner- Products & COO at TrustPlutus Wealth (India) feels the novelty factor may lead to a pop in the price of Zomato post listing. However, thereafter, the stock may trade in a range waiting for triggers such as the path to profitability.

Companies like Zomato are perpetually in growth mode and growth in gross order value and/or price to sales are better valuation metrics for such firms, he said, adding investors eventually will need to see a path to profitability for such firms and can then decide on whether such companies can form a part of long term portfolios

Edited Excerpts:-

Q: Zomato IPO opened for subscription on July 14, with a price band of Rs 72-76 per share. Do you think the issue is reasonably priced on the basis of current financials and expected growth?

Since some of the new age consumer tech companies do not make money for an extended period of time, conventional valuation parameters such as Price to Earnings (P/E) or Enterprise Value to EBITDA (EV/EBITDA) are not applicable to such companies. These companies are in a hyper growth mode and are globally valued using a benchmark such as Price to Sales (P/S) or a percentage of the Gross Order Value. Given the reported financials of Zomato for FY21, the issue is being priced at a significantly higher multiple to the global peer set.

Q: Zomato is currently trading at a premium of 21-26 percent in the grey market. Do you expect the premium to increase in coming sessions and the listing price to be more than 50 percent or double over issue price?

It is possible that the novelty factor may lead to a pop in the price of the issue post listing. However, what may happen thereafter is that the stock may trade in a range waiting for triggers such as the path to profitability.

Q: Why did the Zomato increase its fresh issue size to Rs 9,000 crore from Rs 7,500 crore earlier? Is it getting strong demand from investors or any other reason?

It is possible that the investor demand based on the road shows was strong. Globally, liquidity is in abundance and available at a cheap cost and money is trying to chase growth. India with its large and untapped market place offers an opportunity for growth.

Q: Do you think it is a multibagger story? Should one hold it for long term or sell on listing day?

While Zomato is a strong player in what has become a duopoly market, there are several unanswered questions from an investors stand point. Some of these questions are as follows a) What is going to be the impact on food delivery volumes once cities open up b) Unit economics is driven by average order value – how will average order value behave as Zomato expands into the next tier of cities c) What will be the impact on demand with increase in delivery charges d) Will Zomato continue with discounts to drive order volumes and its impact on unit economics e) Take out rates are at 15-16 percent versus global average of 10-12 percent – how will restaurants react and will they press for lower rates; some restaurants are already going direct to consumer f) There is a growing threat from Amazon’s desire around food delivery – how will this impact profitability g) Competitors like DotPe are already reaching out to merchants with offers of much lower payouts and helping restaurants go online.

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Q: Will the Zomato IPO see a stellar subscription during July 14-16, and what could be subscription levels?

As discussed above, given the novelty factor and the abundant liquidity, the issue may see a stellar subscription.

Q: Zomato constituently posted loss but revenue has been growing every year. What is your view and do you expect the company to turn profitable in coming years? What is you take on the company in comparison with global peers?

Well, in FY21, the revenue degrew; however, the fourth quarter was a strong quarter in terms of revenues. As we have discussed above, the path to profitability is unclear given industry dynamics especially with well-heeled competitors resorting to large scale discounting to attract customers. When compared with global companies, the average order value is much lower, the take out rates are higher and penetration levels on food delivery in India are yet lower when compared with global benchmarks.

Q: What is the valuing criteria for companies like Zomato which is one of the first unicorns hitting D-Street? How can investors measure the performance of tech-based companies?

As we have discussed above, consumer tech companies cannot be valued basis traditional valuation metrics. These companies are perpetually in growth mode and growth in gross order value and/or price to sales are better valuation metrics for such firms. Investors eventually will need to see a path to profitability for such firms and can then decide on whether such companies can form a part of long term portfolios.

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