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The Indian capital markets had its watershed moment of the last decade when a homegrown startup filed its IPO in the Indian exchanges. To add to the cherry on the top, the IPO did extremely well and was significantly oversubscribed (We had commented about the same here prior to the IPO “Zomato IPO expected to do well given the investor interest, but doesn’t seem like a multi-bagger story”). Now that the initial excitement has settled, its important for us to analyze the business from the lens at which we view growth. The genesis of the article comes from multiple of our investors asking us to explain why Zomato has not been a part of our portfolios.

Before analysing the business, I would want to take a moment to acknowledge and mention the scale at which Deepinder Goyal has built the business – this is capitalism at its very best, where a visionary entrepreneur has created jobs, income and significant shareholder wealth in his journey. This is primarily the reason I believe the IPO will be looked back as the watershed moment for the capital markets of the last decade. However, as public market investors, it’s our job to analyse the business from here and visualise the levers for growth.

Zomato fits very well into our GPCG framework, where we are looking at Growth business (though the cash flow of the business is not positive), with reasonably sound Corporate Governance. However, one needs to go deeper into the business to build our framework and thesis around the business.

The thesis & the network effect

Zomato’s business model is based on the premise that, over time, the demographic user base shall dine-out / order-in more than they will cook at home. More importantly, the platform created as a result of this will ensure seamless logistics and connectivity (and convenience) for the end consumer. Currently, the ratio of the restaurant spends as a % of total food spends in India is 8-9%. This is in stark contrast to developed markets like USA and China where it is between 45-47%. It is estimated that Zomato has 30 million average monthly users, which is less than 5% of the population in India with access to an internet connection. Food delivery as a service in India has a path for scalability under the right macro-economic circumstances.

The network effect of Zomato potentially comes into play, with the 30 million users where the business can look at increasing the revenue spend on the platform.

In order to quantify this, we want to be wearing an aggressive hat to determine how the companies cash flow can evolve over the next 3 years.

The Numbers

In our analysis, we want to break down the underlying unit economics of the business, factor in aggressive growth and analyse the environment where the business turns cash flow positive (to reiterate, our emphasis is not to look at the bottom line – PAT – positive but cash flow positive). The levers of the business today revolve around:

1. Average Order Value: Clearly the business will want to grow this over time.

2. Take Rate: The cut the platform takes out as revenues (this is the pricing power of the platform).

3. Total Orders: This gives an estimate of the penetration across markets.

Zomato 1

Around these assumptions, we look at Zomato generating a USD 1bn revenue run rate in the next 3 years, alongside maintaining cash flow profitability as well (Currently the run rate is 1/3rd of the estimate 3 years from now).

The Capital Allocation

While we compare the digital businesses in India to the ones globally, the biggest difference has been the capital allocation. I do not believe it’s rocket science that Uber Eats in India was a loss-making business, but more importantly, had a significantly lower market share to Zomato. As a promoter, the intent of acquiring Uber eats by Zomato was a lucrative one to eliminate competition and to acquire market share. However, the issue happens around the structuring of the deal.

Prior to the lockdown, Uber had sold its business to Zomato for equity in the latter. Equity has been the biggest asset an entrepreneur owns – while one can spend money to buy market share, to dilute your equity to buy market share will always be a questionable one unless the entrepreneur believes the equity is expensive (or if they are using equity to buy the management team and the promoter). In less than a year, Uber ensured the value it derived out of its loss-making sale has more than tripled.

In contrast, Facebook did something similar when it bought Instagram for a valuation of USD 1bn – through a mix of cash and stock. It was a smart move done to buy market share but was predominantly done through a cash transaction rather than an all-equity deal.

Our Framework

At Itus, we have evaluated business with the lens of growth. This coupled with Corporate governance (which ties in closely with capital allocation) has been the pivotal focus around what we want to pay for the business. In our most optimistic scenario, we look at a valuation of USD 15-20 bn for the business, however, the capital allocation track record has not been something we would be a fan of. We would rather wait on the sidelines to watch the company execute rather than own equity today. At the end of the day, not all networks are created equal.

P.S: Apart from Zomato’s delivery business, they provide services like reservations, dine-out payments and Hyper pure (B2B delivery of supplies to restaurants), which they currently operate in 6 cities to 9,225 restaurants. We believe that these services are auxiliary to the delivery business as they can ensure the stickiness of restaurant partners. Moreover, these have a potential of higher growth rate and adding additional levers to the revenues (our assumptions factor in this growth).



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