The non-obvious takeaways from

Zomato’s IPO prospectus

The pandemic was meant to be boom time for food
delivery giant Zomato. However, while average order
value has spiked and contribution margins have turned
positive, a closer look at the numbers reveals a company
with falling revenue, shaky unit economics, and no clear
path to profitability. Could Zomato's public listing dream
turn into a nightmare?

Sumanth Raghavendra, 5 May 2021

Zomato recently filed its draft red herring prospectus in anticipation of a $1.1 billion listing on India's
bourses later this year
While the company now boasts a healthier average order value and contribution margin, revenue and
users have dropped
Zomato's US-based peer DoorDash, was valued at a revenue multiple of 17X. A similar multiple would peg
Zomato below its current valuation of $5.4 billion
Its decision to list in India rather than overseas might have a lot to do with these shaky foundations

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Last week, food delivery startup Zomato filed its Draft Red Herring Prospectus (DRHP) as a precursor to an Initial
Public Offering IPO) in India. The company is said to be tendering shares worth $1.1 billion (Rs 8,250 crore), which
includes a primary issue of $1 billion and secondary shares of $100 million.

In February, Zomato had raised $250 million in funding at a post-money valuation of $5.4 billion.
A media report quoted an analyst who opined that Zomato may be “looking at an IPO valuation of at least $6.4
billion”. Considering the fact that $6.4 billion is the arithmetic sum of the previous valuation of $5.4 billion and $1
billion in new primary funding, one hopes that this analysis was not the aforementioned analyst’s day job.

Jokes apart, it would come as no surprise if Zomato’s management and investors will be hoping for a valuation that is
meaningfully higher than that of the last private funding round and will eventually get it to the coveted decacorn
valuation milestone of $10 billion. This would make Zomato the highest valued foodtech startup in India and one of
the highest valued Indian startups in general.

There is one impediment to this decacorn dream. Unlike private markets, the public market values companies on
numbers rather than narratives. Metrics around profitability, growth, and free cash flows are critical. These aren’t
necessarily Zomato’s greatest strengths. Zomato declined to respond to a detailed questionnaire sent by The Ken.

So how does Zomato measure up when it comes to these metrics? What else does the prospectus tell us about Zomato
and the market? What are the other imperatives and challenges for Zomato around its public listing?

Let’s take a look.

Pandemic pop?
There is a school of thought that posits that now is the “best time” for Zomato to go public. The main driver for this
bullishness is a belief that the pandemic has turned out to be a great tailwind for the company. Like many other e-
commerce companies worldwide, the dynamics around work from home and general trepidation around venturing
out should be a boost for Zomato’s food delivery business.

This argument is largely made on the unit economics figures that the company has published.
There are two aspects highlighted here.

First, the AOV, or Average Order Value, has risen sharply post the pandemic. From Rs 278 per order in the year ended
March 2020, Zomato’s AOV stood at nearly Rs 400 ($5.4) per order in the first nine months of the year ended March
2021. This is important because of a general rule of thumb that for a food delivery business to make money in India,
this Rs 400 figure is a milestone that needs to be breached. Any lower, and it is practically impossible for the numbers
to add up.

Second, the contribution margin—the difference between the revenue and the variable costs for each delivery
order—has turned positive. While this figure has previously been negative for Zomato, it has grown from -Rs 30 (-
$0.4) per order in the year ended March 2020 to Rs 22 ($0.3) per order for the nine-month period from March 2020
to December 2020.

While this evidence seems like proof that the pandemic has benefitted Zomato, celebrating this as proof of
profitability is both premature and hollow.
For one, having a positive contribution margin is only a step towards profitability. It is no guarantee of actually
getting to such a state. The financials for the nine months ending December 2020 reveal that despite having a positive
contribution margin, the company ended up in the red, reporting a loss of Rs 682 crore ($92.3 million) for this period.

Even though the unit economics improved, it came at the cost of Zomato’s topline. For the nine months ending
December 2020, the company reported a topline of Rs 1,368 crore (185.3 million). Annualising this takes it to Rs
1,824 crore ($247 million), a 33% fall from the previous fiscal year, which saw a topline of Rs 2,743 crore ($371.6
million). The number of monthly transacting users also fell sharply—from 10.7 million to 5.8 million. This indicates
that only a little over half of Zomato’s transacting users were retained in this period.

Public companies are normally valued on the basis of profits. The common metric to value these companies is
the price-to-earnings figure—a multiple assigned to the bottomline. Given that Zomato is not a profitable company,
we need to look at other metrics. If you look to the west, Zomato’s peers are companies like DoorDash in the US and
Deliveroo in Europe. Like Zomato, DoorDash is a loss-making startup that recently went public. The valuation metric
for companies like DoorDash was not its earnings multiple but its revenue multiple—multiplying the topline by a
certain figure. For DoorDash, this multiple is 17X.
Applying the same multiple to Zomato gives us a valuation of around $4 billion. This is significantly lower than its
$6.4 billion minimum target and a far cry from decacorn status. To get to a $10 billion valuation, the company needs
to be valued at a whopping 40X multiple.

But even this 17X multiple has a catch.

One reason the market granted a 17X multiple to DoorDash, despite the company making losses, is that the company
is on a tear. DoorDash’s revenue grew over 200% quarter-on-quarter over the two quarters immediately prior to its
public listing. In the quarter preceding its listing, revenue soared 268%, largely because of the pandemic. This stands
in sharp contrast to Zomato, which saw its revenue decline over the comparable period. This indicates that the
dynamics and drivers for the food delivery market in the US are clearly significantly different from those in India.
Expecting Zomato to be accorded the same valuation multiple as DoorDash is a stretch.

A silent slide
But there is something even more alarming about Zomato’s numbers. In the quarter ending June 2020,
Zomato reported contribution margins of Rs 29 ($0.39). This quarter saw the company’s lowest Gross Order Value
(GOV) in two years—just Rs 1,094 crore. In the subsequent two quarters, the GOV went up but the contribution
margin for the entire nine-month period fell by 35% to Rs 22 ($0.3).

This is alarming for two reasons. It shows the business could potentially have negative scale economies. As the order
volumes grow, the company will progressively lose more money. This leaves it stuck between a rock (of growth) and
a hard place (of profitability). It has to make a Hobson’s choice between its topline and bottomline.

The second reason has to do with the management’s handle on the topline-bottomline dynamic. In a mid-Covid
performance report last year, Deepinder Goyal, Zomato’s founder and CEO, had averred, “In July 2020, we estimate
our monthly burn rate to land under $1 million, while our revenue should land at ~60% of pre-Covid peaks ($23
million per month). We expect to make a complete recovery in the coming 3-6 months while continuing to maintain
tight control on costs/profitability.”

He further added, “While Covid-19 has impacted the size of our business, it has accelerated our journey to
profitability”.

However, the nine-month period from March to December 2020 shows a whopping loss of Rs 685 crore ($92.7
million). This implies a monthly loss of nearly $10 million.

Considering Zomato lost only $12 million for the quarter ended June 2020—~$4 million per month—when the
pandemic was first seen, for the six-month period from July to December 2020, monthly losses have shot up to more
than $13 million per month.

This is in direct contrast with Goyal’s claim that “net Ebitda for this business segment is expected to improve” with
growth in order volume. It is not clear if Zomato consciously decided to change its burn targets for this period in the
interim. If it didn’t, there is a big divergence in what the company expected in terms of profitability targets and what
actually happened.

The bad news for Zomato doesn’t end there. The story gets worse when you take a deeper look at the unit economics.

One reason why the AOV has gone up is that the pandemic has changed the demographic profile of Zomato’s
customers. As people work from home, a number of individuals relocated from metros like Bengaluru and Mumbai
back to their tier-2 and -3 homes. These people are possibly no longer prolific users of Zomato the way they were
when they were living on their own. The customer base left is, by default, larger (families) and richer. This is probably
why the AOV went up—it is a symptom of the market thinning out rather than the result of Zomato actively figuring
out a way to improve these metrics. As the market grows, these unit economics will no longer work and these
contribution margins will deteriorate.

As the chart above shows, Zomato’s take rate is a whopping 22% of the order value; DoorDash’s corresponding figure
is roughly only half as much. Zomato’s figure is so high because of the pandemic-induced market as well as the fact
that it is in a duopoly situation with Swiggy (which has pegged its own take rate in the same range). Once any
competitor comes into the picture, these numbers will fall drastically as restaurants will partner with companies that
charge lower commission and customers no longer willing to pay for delivery as they do right now.

Already, Amazon is waiting in the wings and will probably launch its service in a full-fledged manner in the near
future, once the dust settles on the pandemic. This will probably have a catastrophic impact on Zomato’s numbers—a
double whammy on both unit economics and market share.

Side hustles
Given that Zomato seems to have a number of challenges in its food delivery business, its other business lines become
increasingly vital.

This is how the company reports its revenue segment breakup.

What is telling about this graphic is that Zomato’s journey from a full-stack diversified foodtech company to a food
delivery startup is complete. Food delivery makes up well over 80% of its topline. Zomato’s original advertising
business line, which was hugely profitable, is barely a footnote and has been folded into some other marginal
segment.

Other initiatives such as BASE, Zomato’s restaurant software business, seem to have vanished. Moonshots such as
grocery delivery, which Zomato experimented with in the middle of the pandemic last year, have been given a quiet
burial, notwithstanding the enormous market potential touted for online grocery in India.

Then, there is Hyperpure, Zomato’s business-to-business play, procuring vegetables and other supplies for
restaurants. This segment seems to have gathered traction, with Rs 124 crore ($16.8 million) of reported revenue in
the nine months from March 2020 to December 2020. The downside is that this is a notoriously low-margin
business—Zomato reports that its cost for purchasing these goods was Rs 119 crore ($16.1 million), implying that
the company’s gross margin for this segment was barely Rs 5 crore ($677,000). While this business line could bolster
Zomato’s revenue figure, it is largely insignificant in terms of net margins.

Finally, there was Zomato’s Gold debacle. The membership offering, once Zomato’s crown jewel, was scrapped in
mid-2020 after widespread backlash from restaurant partners. The plan’s asymmetric risk-reward dynamic, where
Zomato cornered all the upside with this revenue going straight to its profit pool while restaurants were left bearing
the costs, enraged restaurateurs, who threatened to leave Zomato’s platform altogether.

Gold was replaced with a plan called “Pro”, which offered a much lower tier of benefits. The company reported that
the number of Gold/Pro customers dropped from 1.7 million in March 2020 to 1.4 million in December 2020.
However, this number masks the fact that a large portion of the remaining customers are folks who either inherited
the legacy plan without paying anything additional or were granted membership for free through a partner. While
Zomato declined to comment on The Ken’s questions on the actual number of paying Gold/Pro customers, the
revenue break-up statement above shows that the programme did little to boost the company’s numbers.

Duopoly Dynamics
If Zomato is not doing particularly well on topline or bottomline, perhaps its position as one half of India’s foodtech
duopoly could provide some succour. After all, Zomato’s acquisition of Uber Eats in India by diluting 10% of the
company should count for something.

In its filing, Zomato does highlight its market strength, claiming that it “has consistently gained market share over the
last four years to become the category leader in the food delivery space in India in terms of GOV”.

But to validate this point, the company has chosen a rather bizarre graphic, which we’ve reproduced below.

Why is this bizarre?

For one, it doesn’t present information in a clear and simple manner by presenting market share data around
absolute figures or even straightforward percentage terms. Instead, it uses a convoluted market indexation baseline
in an attempt to show market share and growth.

The surprising thing about these numbers is that it doesn’t match up to Zomato’s own GOV numbers presented
elsewhere in the filing. The table below, for instance, shows that Zomato’s market growth in the first nine months of
the year ending March 2021 is far lower than what the graphic claims. Given that this prospectus is a formal
document that will be analysed by public investors, it seems rather unconscionable to present numbers that are not
consistent.
The bigger issue is that by presenting this supposed strength in such an obfuscatory manner, Zomato is
demonstrating a lack of confidence in its market leadership position. Indeed, by most analyst estimates, Swiggy has a
marginal lead over Zomato in terms of market share.

But while it is clear that this duopoly has given Zomato the opportunity to charge a higher commission/take rate, as
explained above, this is an ephemeral advantage that will disappear once a formidable third player such as Amazon
enters the race. The other aspect to bear in mind here is that even though Zomato and Swiggy are, at the moment, the
last men standing, the food delivery market is one with zero loyalty. Customers are not deeply connected to one
player over the other and use both interchangeably. This is unlike, say, the cola wars, where companies like Coca-Cola
and Pepsi each had loyal user bases built on moats of both products as well as brands.

Pragmatism over patriotism

While startup media might have framed the foodtech market as a battle between Swiggy and Zomato, the latter’s
decision to file for an IPO means that the narrative now shifts. Swiggy can still continue to grow topline and burn
hundreds of millions of dollars per year by virtue of being a private startup. Zomato, however, must work under a
different set of rules as a public company.

One question that comes up often is why Zomato chose to list in India as opposed to exploring US markets like the
Nasdaq, as other Indian companies have chosen to.

The answer might lie more in pragmatism rather than patriotism.

From the points above, it is clear that if Zomato goes head-to-head with the likes of DoorDash, it will come off a poor
second in terms of valuation and valuation multiples. This is unlike, say, Flipkart, which could list in the US with the
narrative that a bet on Flipkart is a bet on Indian e-commerce in general; Zomato doesn’t have the same narrative
ballast given that it is a much smaller company in a much smaller niche.
The India story might have worked if Zomato had positioned itself as learning in one country and taking it to the
world, expanding to international markets like what companies like Ola aspire to do. Unfortunately for Zomato,
though, that story is also dead. Zomato was one of the earliest Indian consumer startups that spread its wings
overseas. However, it might have done so prematurely. Faced with brutal markets and deep-pocketed competitors,
the company retreated from large markets like the US even after making sizeable acquisitions.

Put all this together and it is clear that India was the only recourse left for a public listing. Here, the company could
hope to leverage the fact that it is a household brand and hope that this translates to some kind of premium on
multiples in the public market, even if its metrics do not bear this out.

Finally, there is the SoftBank question. It is no secret that Zomato has pitched for a mandate from SoftBank for a long
time now. However, when SoftBank eventually chose to bet on Swiggy instead, Zomato no longer had the option for a
SoftBank-sized “private IPO” round.

SoftBank’s bet on Swiggy after considering both companies also means that it is now very difficult for Zomato to
attract private investors. New investors will be wary of taking on SoftBank’s might, and existing investors such as
InfoEdge, Alibaba, and Sequoia Capital are unlikely to have the risk appetite to invest additional funds into Zomato.

In fact, InfoEdge has already announced that it would be tendering shares worth $100 million as a secondary sale in
the public issue. And it would come as no surprise if Alibaba also gradually exits the company, given the geopolitical
tensions between India and China.

Zomato’s management was prudent about the many unknowns of listing in India. This is why it raised a large
amount—totalling $660 million—across multiple tranches over the last nine months. While there are some usual
suspects like Tiger Global in this investor list, many names here are new to India and especially new to Indian
startups. These include large funds such as Kora and D1, which are generally pre-IPO or IPO investors. It would come
as no surprise if many of these investments were contingent on Zomato listing in public markets within a certain
interval.

But it is now clear that the second wave of the pandemic is going to be a lot worse than the first. It is also likely to
affect Zomato’s business far worse than the first wave. This time around, there is fear and foreboding in the air; and
in such an environment, it is quite unlikely that people will even consider ordering food from the likes of Zomato.

Once Zomato lists, it faces many new challenges. The recent ruling by market regulator Securities and Exchange
Board of India (Sebi) on institutional ownership limits on companies that don’t meet profitability requirements but
have still chosen to list is one bugbear. However, the bigger challenge will be to convince institutional investors that
there is a path to profitability and demonstrate progress quarter after quarter. This cadence is not for the faint-
hearted.

While that battle is still to be fought, there is one win that seems far more easy to pocket. For the first time, Indian
retail investors will have an opportunity to invest in an Indian startup with a well-known brand, something that has
been beyond their reach thus far. There is also the fact that Zomato is one of those rare unicorns that was backed by
another Indian startup, InfoEdge, which still remains its largest shareholder. This second-generation graduation
ceremony is, in a sense, a rite of passage for the Indian startup ecosystem; and despite what the numbers point to, it is
a milestone worth celebrating.

The initial listing might go well enough as there will be curious individuals who will want to get a piece of the pie. But
after that honeymoon period, Zomato will have to live quarter to quarter and deliver profit or growth consistently. A
daunting challenge at the best of times, much less in the uncertain times of today. Like everyone else in the country,
Zomato will need a huge dose of luck to emerge unscathed.
Lead image credit: Kranich17/Pixabay

• Deepinder Goyal