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ZOMATO: An IPO for the Ages

July 14 2021 | Reading Time: 11 minutes

About the Company 

Zomato is a technology-based food delivery company that started its journey as a content and discovery plat form for restaurants. Customers use this platform to search and discover restaurants, read or write reviews,  view or upload photos, order food delivery, book a table, and make payments while dining out at restaurants.  The company serves its customers right from the start of a dining out option to its logical end of serving food at  their very doorstep. 
Zomato has consistently gained market share over the last few years to become the leading player in its  segment. Currently, the company is operating in a duopoly in the food delivery space in India. The company has  been growing faster than the industry in terms of GOV growth.
As it is coming up with IPO, there is buzz among investors for it. The interesting fact is that, after IPO, valuation  of zomato is expected to be around Rs 65,000 crore. It is higher than combined market cap of all listed QSR  players. Jubilant (Rs 42,000 crore), Westlife (Rs 7,900 crore), Burger King (Rs 6,400 crore), BBQ (Rs 3,400  crore), and Speciality (Rs 300 crore).
Low Food Services Penetration Provides Huge Headroom for Growth 
India’s total addressable foodservice market is estimated at $32B–35B in 2020. Out of this, only 8–9%  is online food delivery market as compared to ~45–50% penetration in China and the U.S. The under  penetration leaves a huge runway of growth for the online food delivery segment in India. Zomato is  focused on winning market share from home-cooked food. We believe increased hygiene measures adopted  by restaurants post-COVID will help in the transition of consumers from Home cooked food to restaurant food  at a faster pace.
Increasing Internet & Smartphone Penetration in India to Drive the Number of Users
The internet &  smartphone penetration in India is far lower than in China today. With the availability of cheap data, high-speed  4G connections, and affordable smartphones, digital penetration in India is slated for rapid growth in the  coming years. Internet penetration is expected to reach 68% (~970M–1B users) by CY25 while smart phone penetration will reach 56% from the current 49%/36%.

Scale-up in Business to be Led by Strong Networks 
Zomato‘s richly curated content attracts a large number of customers organically. These customers enhance the  restaurant listing content by adding their reviews and photos on Zomato, which starts a virtuous cycle of new  customer acquisition. More customers on the platform increase the number of food orders for the restaurants, in turn, leading to more restaurants becoming available for food delivery on the platform.
It also increases the choices available to customers, leading to growth in customers and delivery orders, which  reduces cost and prices.

Continues to Build a Strong Consumer Brand Recognized Across India  
Zomato has been expanding at a fast pace and is already present in 525 cities. It will continue its rapid  expansion plan into tier 1 and tier 2 cities, which have shown promise in terms of the number of orders. Despite lower AOV’s (Average Order Value) than metros, these cities help increase the number of orders and  provide economies of scale.
Food Delivery, Dining-out, and Hyperpure to remain in Focus 
Zomato, through its platform, allows transactions between the consumers and restaurants partners enlisted  with the platform and receives commission income on such transactions from the restaurant partners. Zomato  collects a delivery fee from customers, which it pays to the delivery partners without recording the same in its  Income statements. 
Customers use dining-out offerings to search and discover restaurants, read or write reviews, view and upload  photos, book a table, and make payments while dining out at restaurants. 
Zomato Pro is an exclusive paid membership program, which unlocks flat percentage discounts for its custom ers at select restaurants across both food delivery and dining out offerings. The customers become pro mem bers by paying Zomato a membership fee. As of December 31, 2020, the company has had 1.4M Pro Members and over 25,350 Pro Restaurant Partners in India.

Zomato, like other online food-delivery platforms globally, is transforming its single-purpose app into a  multi-use “super apps”. Zomato is looking at a foray into the online grocery segment and has recently acquired  a ~9% stake in Grofers for ~Rs 7.5B. 
Hyperpure is a farm-to-fork supplies offering platform for restaurants in India. Zomato sources fresh, hygienic,  quality ingredients and supplies directly from farmers, mills, producers, and processors to restaurant partners,  helping them make their supply chains more effective and predictable and improving the overall quality of the  food being served. It is already supplying to 9,225 restaurants.

Revenue Mix across Segments 

Revenue Mix          FY20 FY21 
Delivery Revenue (Rs M) 17,575 15,003
(% of Sales) 0.67 0.75
Dine Out Advertising (Rs M) 6,213 2,358
(% of Sales) 0.24 0.12
Zomato Pro (Rs M) 879 575
(% of Sales) 0.03 0.03
Hyperpure(Rs M) 1,380 2,002
(% of Sales) 0.05 0.1
Total Sales (M) 26,047 19,938

Zomato– A Highly Dependable Delivery System 

Key in the System: Restaurant Partners 
Restaurants are the foundation of Zomato’s business, and the success of restaurant partners is critical to  Zomato. As of March, there were 389,932 Active Restaurant Listings on the platform in India, of which 148,384  restaurants were also Active Food Delivery Restaurants. Zomato does not have its own kitchen and has  refrained from entering in the same as it does not want to compete with its restaurant partners. 
As of December 31, 2020, there were 350,174 Active Restaurant Listings on the company’s platform in  India, of which 132,769 restaurants were also Active Food Delivery Restaurants during December 2020.
Benefits Aided by Restaurant partners 
The restaurant market in India is highly fragmented, with only 6.2% of the value being driven by chain restaurants and the balance being standalone restaurants, according to RedSeer. This makes Zomato’s role as an  aggregator even more important as they help the growth of the industry by giving restaurant partners, both  small and large, the ability to market to, engage, and acquire customers without them needing large teams with  sophisticated digital marketing and branding expertise or their own delivery infrastructure. 
Listing of restaurant partners on the online discovery platform is free. This helps restaurant partners increase  demand for their offerings for both food delivery and dining out. 
Leveraging the company’s large fleet of delivery partners, restaurant partners can get their food delivered to  customers reliably and quickly, without having to invest in their own delivery capabilities, driving incremental  orders for their food and thereby increasing kitchen utilization and improving operational efficiencies. 
Large Network of Delivery Partners
Zomato “Delivery partners” are the backbone of the food delivery business and a critical part of Zomato’s com munity. Zomato provides employment opportunities to 169,802 Active Delivery Partners (March 2021). Delivery partners carrying and dressed in distinctive Zomato-branded attire enable the company to offer a consistent experience to their customers, increase brand awareness, and build positive brand affinity from which we believe the company could benefit with lower customer acquisition costs. 
Despite high attrition amongst delivery partners due to tough competition and delivery service being viewed as  a part-time career, Zomato has not faced any difficulty in onboarding new delivery partners and has been able  to increase its fleet with ease when needs arise. 

Zomato’s Unit Economics Turn Positive this Year 
Zomato has transformed the food delivery industry and has emerged as a category leader by both  organic growth and acquisitions. These acquisitions have helped them in staying ahead of the industry in  terms of GOV growth. Despite strong competition from not only Swiggy but also cloud kitchens like Rebel  Foods and branded Food Services players (QSR’s like Dominos, McDonald’s, Burger King, and Pizza Hut, etc).  Zomato has gained market share to emerge category leader in terms of GOV. 

COVID-19’s Positive Impact on Food Delivery 
The COVID-19 pandemic disproportionately affected the food services industry in India as lockdowns were  implemented and people became reluctant to eat restaurant food due to the fear of catching the virus.  
In the first quarter of fiscal 2021, the company saw a significant impact on its business, and the food delivery  business in India hit its lowest in terms of GOV in a quarter in two financial years. However, since then, the food  delivery business in India has recovered strongly, with GOV growth of 91.6% and 42.3% in the second and  third quarters of Fiscal 2021, respectively, over the immediately preceding quarters. Zomato’s GOV in the third  quarter of fiscal 2021 was ₹29,810.0M, which was the highest GOV that we have achieved in any quarter till  December 2020. 

A Dual Policy of Growth and Unit Economics a Focus for Zomato 
The company has made significant investments in marketing and promotions to accelerate customer adoption  of food delivery in India and promote Zomato’s brand. As a result of an increase in the share of repeat  customers, advertisement and sales promotion expenses per order have reduced over time. Zomato’s advertising and promotion expenses as % total income reduced from 88.43% peak in 2019 to 22.44% in 9M  fiscal 2021.

Contributions Turned Positive on the back of Improvement in Economics 
Zomato has been able to increase its commissions to Rs 62.8 from Rs 43.6 per order on the back of  increased delivery demand as dine-in has remained impacted for the entire FY21. Its contribution also  turned positive to Rs 20.5 from a loss of Rs 30.5 despite the lesser number of orders at 238.9M versus  403.1M in FY20. As the business achieves scale, it shall be able to optimize costs such as delivery fees, ad  spends, and discounts. 
Significant investments in marketing and promotions to accelerate customer adoption of food delivery have  contributed toward category creation and resulted in customers coming back to the platform organically for  repeat purchases. 

Key Downside Risks for the Company 

Profitability to Remain a Key Concern 
Zomato is currently incurring heavy losses and is likely to continue incurring losses due to the heavy marketing spends it is required to incur for customer acquisition and higher delivery costs being paid as the delivery  business is yet to achieve scale. 
Take Rate Sustenance Important for Zomato 
Zomato charges take rates of ~20–25% which are higher than global peers. Zomato has been able to sustain  these rates as dine-in has been impacted due to the COVID-19 pandemic. Once dine-in is back, maintaining  these rates will become difficult, and Zomato’s ability to maintain these rates will be crucial. 
Rising Risk from Competition 
The entry of Amazon into the food delivery business can impact Zomato’s operations, as Amazon has the  technological expertise to succeed in the segment. Likewise, competition from restaurants’ own apps like  Domino’s, McDonald’s will also impact Zomato’s revenues. 
Risk of Food Delivery Market Remaining Underpenetrated 
Despite trends from China and the U.S. indicating huge headroom for growth, India’s market has always  favored home-cooked food, the inability to cultivate a habit of ordering food online will impact Zomato’s  long-term growth plans.

What if IPO not allotted? 

Missed IPO is Not a Missed Opportunity. Companies making initial public offerings (IPO) draw a lot of investor attention. Zomato may attracted a very  high number of applications. But the shares are allotted to a few investors, and that also does not exceed Rs  15,000 in value. To cash in on the gains made by a newly listed stock, some investors, who don’t receive an  allotment, try to buy it later or remain unsure about taking a position. 
At William O’Neil, we have a set of rules to take entry into a newly listed company. We advise investors not to  buy a company’s shares on the day or during the week of its listing. For IPO stocks, there is no history of a  price-volume action, so it is difficult to gauge the top. When it comes to investing in IPO stocks, new issues  don't play by the usual rules. 
Look for a base formation after a listing. Firstly, there should be a massive gain as the stock goes public and  before it runs down after hitting resistance. A classic IPO base is a short and shallow area of consolidation that  occurs right after a company’s IPO. 
The framework of a good IPO base is simple: 
  • The decline from a peak to low usually doesn't top 20%, but after a good gain on a listing day, the more volatile  markets can have a decline of up to 50%. 
  • The length of a base is often less than  ve weeks and can be as short as seven days. 
  • On a listing day, the closing should be in the upper half of the day’s range. 
  • During base formation, the stock price should not undercut the IPO price. 
  • In an IPO base, the pattern should typically start within 25 days of the stock's  rst day of trading. 
  • The standard pivot (entry point) is at the highest point on the left side from where a base pattern started to  form. 
In addition to these points, the other important aspect is volume. At breakout, the volume should be very high,  and accumulation should be good just before a breakout (on the right side of the base). However, the volume of  the first two-three days generally tends to be very high and should not be set as a benchmark. 
The conviction becomes strong if the stock is among the leading industry groups. For India, we have 164 industry groups. Ideally, we prefer stocks among the top 40 industry group rank. 
What next after the breakout? 
From our study of different base patterns like cup-with-handle, double bottom, flat base, etc., we found that the  highest success rate is of an IPO base. But, there may be a few stocks that fail after they break out from the IPO  base. Ideally, after the breakout, we would not like to see a stock breach the pivot price and go back to the base.  At last, our stop-loss rule of 8% can come at a rescue. If the odds are not in your favor, do not try to fight the  market. Exit the position at a maximum loss of 8%. If there is growth potential in the company, the stock will  rebound and give you another entry point in the future. 

What do you think? Please email us any questions or comments.

Disclaimer: Information contained herein is not and should not be construed as an offer, solicitation, or recommendation to buy or sell securities. It is for educational purposes only.For more information, see our Legal disclosures here.

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