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Case Valuation The-Zomato-Ipo-Bet-On-Big-Markets-And

The document discusses Zomato's IPO, which opened to public investors on July 14, 2021, highlighting the company's potential in the growing Indian food delivery market despite its current modest revenues and significant losses. It outlines Zomato's business model, which includes transaction fees, advertising, subscriptions, and raw material sales, and compares the Indian food delivery market to those in other countries, emphasizing the factors that limit its growth. The author also critiques Zomato's prospectus for being overly complex and filled with unnecessary information, while noting the importance of macroeconomic factors in the company's future valuation.

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0% found this document useful (0 votes)
113 views1 page

Case Valuation The-Zomato-Ipo-Bet-On-Big-Markets-And

The document discusses Zomato's IPO, which opened to public investors on July 14, 2021, highlighting the company's potential in the growing Indian food delivery market despite its current modest revenues and significant losses. It outlines Zomato's business model, which includes transaction fees, advertising, subscriptions, and raw material sales, and compares the Indian food delivery market to those in other countries, emphasizing the factors that limit its growth. The author also critiques Zomato's prospectus for being overly complex and filled with unnecessary information, while noting the importance of macroeconomic factors in the company's future valuation.

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© © All Rights Reserved
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Musings on Markets
My not-so-profound thoughts about valuation, corporate finance and the news of the day!

Thursday, July 22, 2021 Twitter

Tweet
The Zomato IPO: A Bet on Big Markets and Platforms!
Zomato, an Indian online food-delivery company, was opened up to public market investors on July Total Pageviews
14, 2021, and its market debut is being watched for clues by a number of other online ventures in
India, waiting in the wings to go public. The primary attraction of the company, to investors, comes 20,397,007
not from its current standing (modest revenues and big losses), but from its positioning to take
advantage of the potential growth in the Indian food delivery market. In this post, I will value
Zomato, and rather than just make a value judgment (which I will), I will also tie the value per share Follow by email
to macro expectations about the overall market. In short, I will argue that a bet on Zomato is as
much a bet on the company’s business model, as it is a bet on Indian consumers not only acquiring
more buying power and digital access, but also changing their eating behavior. Get new posts by email:

Setting the Stage


Enter your email
As a lead in to valuing Zomato, it makes sense to look not just at the company’s history, but also at
its business model. In addition, since so much of the excitement about the stock comes from the
potential for growth in the Indian food delivery market, I set the stage for that analysis by Subscribe
comparing the Indian market to food delivery markets in other parts of the world, as a prelude to
forecasting its future path.

History and Business Model


Subscribe To Musings on Markets
Zomato was founded in 2008 by Deepinder Goyal and Pankaj Chaddah, as Foodiebay, in response
Posts
to the difficulties that they noticed that their office mates were having in downloading menus for
restaurants. Their initial response was a simple one, where they uploaded soft copies of menus of Comments
local restaurants, in Delhi, on to their website, initially for people in their office, and then to
everyone in the city. As the popularity grew, they expanded their service to other large Indian cities,
and in 2010, they renamed the company "Zomato", with the tagline of "never have a bad meal". Search This Blog
The business model for the company is built upon intermediation, where customers can connect to Search
restaurants on the platform, and order food, for pick up or delivery, and advertising. Along the way,
the company has transitioned from an almost entirely an advertising company to one that has
become increasingly focused on food delivery, and in 2021, the company derived its revenues About Me
primarily from four sources: Aswath Damodaran

1. Transaction Fees: The bulk of Zomato's revenues come from the transactions on its I am a Professor of Finance
platform, from food ordering and delivery, as the company keeps a percentage of the total at the Stern School of
order value for itself. While Zomato's revenue slice varies across restaurants, decreasing Business at NYU. I teach
with restaurant profile and reach, it remains about 20-25% of gross order value. It is worth classes in corporate finance and valuation,
primarily to MBAs, but generally to anyone
noting that Swiggy, Zomato's primary competitor in India, also takes a similar percentage of
who will listen.
order revenues, but Amazon Food, a new entrant into the market, aims to take a smaller
portion (around 10%) of restaurant revenues. View my complete profile

2. Advertising: Restaurants that list on Zomato have to pay a fixed fee to get listed, but they
can also spend more on advertising, based upon customer visits and resetting revenues, to My web site
get additional visibility.
http://www.damodaran.com
3. Subscriptions to Zomato Gold (Pro): Zomato also offers a subscription service, and
subscribers to Zomato Gold (now Zomato Pro) get discounts on food and faster deliveries.
The service was initiated in 2017 and it had 1.5 million plus members in 2021, delivering Popular Posts
subscription revenues of 600 million rupees (a little less than $ 10 million, and less than 5%
of overall revenues) in 2021. The ESG Movement: The
"Goodness" Gravy Train
4. Restaurant Raw Material: In 2018, Zomato introduced HyperPure, a service directed at Rolls On!
restaurants, offering groceries and meats that are source-checked for quality. While direct Last year, I wrote a post on
measures of revenues from HyperPure are difficult to come by, the revenues that the ESG and explained why I
was skeptical about the
company shows under traded goods (which include HyperPure revenues) suggests that it claims made by advocates about the
accounts for about 10% of the total revenues. benefits it would bring to ...

In conjunction with the other services it offers to restaurants, including consulting and data, China's Tech Crackdown: Its
it suggests that while food delivery and advertising are the company's primary revenue about Control, not
Consumers or Competition!
generators today, it has ambitions extending into the broader food business. Zomato has grown at
For the last two decades,
exponential rates for much of the last decade, with a surge in the number of cities that it serves in China has been the
India, especially in the last few years, from 38 in 2017 to 63 in 2018 to more than 500 in 2021, dominant story for both the
extending its reach into smaller urban settings. global economy and capital markets, as the
country's immense gr...

Sounding good or Doing


good? A Skeptical Look at
ESG
In my time in corporate
finance and valuation, I have
seen many "new and
revolutionary" ideas emerge, each one
marketed as the sol...

The Zomato IPO: A Bet on


Big Markets and Platforms!
Zomato, an Indian online
food-delivery company, was
opened up to public market
investors on July 14, 2021,
and its market debut is being wa...

A DIY (Do-It-Yourself)
Valuation of Zomato
Just over a week ago, I
Revenues did drop in 2020, as COVID restrictions put a crimp on the restaurant business, but the valued Zomato ahead of its
market debut, and as with
quarterly data suggests that business is coming back. Along the way, the company has expanded
almost every valuation that I
its business outside India, with the United Arab Emirates being its biggest foreign market. That do on this forum, I heard from ma...
revenue growth has been driven partly by acquisitions that the company has made along the way:
Inflation and Investing: False
Alarm or Fair Warning?
As we approach the mid
point of 2021, financial
markets, for the most part,
have had a good year so far.
Looking at US equities, the S&P...

Data Update 2 for 2021: The


Price of Risk!
Investors are constantly in
search of a single metric
that will tell them whether a
market is under or over
valued, and consequently whether...

Interest Rates, Earning


Growth and Equity Value:
Investment Implications
Source: Crunchbase The first quarter of 2021 has
been, for the most part, a
good time for equity
To fund these acquisitions and other internal growth investments, the company has been reliant on markets, but there have been surprises.
venture capitalists, who have supplied it with capital in multiple rounds since 2011: The first has been the...

Disclosure Dilemma: When


more (data) leads to less
(information)!
In the last few decades, as
disclosure requirements for
publicly traded firms have
increased, annual reports and regulatory
filings have bec...

The Rise of SPACs: IPO


Disruptors or Blank Check
Distortions?
For decades, the process
that companies in the United
States have used to go
public has followed a familiar script. The
company files a pros...

Blog Archive
Source: Crunchbase
▼ 2021 (17)

These capital infusions created a diverse ownership structure at the company, even prior to its ► September (2)
going public: ► August (1)
▼ July (2)
The Zomato IPO: A Bet on Big Markets
and Platforms!
Disclosure Dilemma: When more (data)
leads to less...

► June (1)
► May (2)
► April (1)
► March (1)
► February (2)
► January (5)

► 2020 (30)
► 2019 (27)
► 2018 (35)
► 2017 (28)
► 2016 (48)
► 2015 (50)
► 2014 (44)

Source: Zomato Prospectus ► 2013 (36)


► 2012 (49)
The share of the equity owned but the original founders of the company has dropped dramatically
► 2011 (55)
over time, as the company has had to raise capital to fund its ambitious growth agenda, and
Deepinder Goyal owns only 5.55% of the company's shares, prior to the IPO. Uber's ownership in ► 2010 (45)
Zomato is a result of Zomato's acquisition of Uber Eats India, where Uber received a share of ► 2009 (60)
Zomato's equity in exchange. As revenues have grown, the business model for the company has ► 2008 (42)
been slower to evolve, as the company has reported extensive losses along the way, as you will
see in the next section.

The Market

Zomato's business model is neither innovative, nor groundbreaking, resembling other online food
delivery companies in other parts of the world, like DoorDash, which had its initial public offering in
2020. The allure to investors comes from Zomato's core market in India, and the potential for
growth in that market. To get a measure of this potential, I start by comparing the size of food
delivery markets in India to the food delivery markets in China, the United States and the EU.

Zomato Prospectus and Other Sources for EU data

The Indian food delivery market is small, relative to markets elsewhere in the world, and especially
compared to China, the only other market of equivalent size in terms of population. There are
three reasons for the smaller food delivery market in India, and they are highlighted in the table
above:

1. Lower per-capita income: Eating out and prosperity don't always go hand in hand, but you
are more likely to eat out, as your discretionary income rises. Thus, it should come as no
surprise that the number of restaurants increases with per capita GDP, and that one reason
for the paucity of restaurants(and food delivery) in India is its low GDP, less than a fifth of
per capital GDP in China and a fraction of per capital GDP in the US & EU.
2. Less digital reach: To use online restaurant services, you first need to be online, and digital
reach in India, in spite of advances in recent years, lags digital reach in China, and is about
half the reach in the US and the EU.
3. Eating habits: Looking across the regions, it seems clear that there is a third factor at play, a
pre-disposition on the part of the populace, to eat out. Looking at the number of restaurants
in China and the size of its food delivery market, it is quite clear that Chinese consumers are
far more willing to eat out (either in person at or with delivery from restaurants) than people
living in the US and EU, especially if you control for per capita income differences.

The Zomato story, or at least the upbeat version of it, is that the Indian food delivery/restaurant
market will grow, as Indians become more prosperous and have increased online access. A
simplistic way to illustrate the difference is to adjust the size of the market for per-capita income
and digital reach, and I attempt to do that, relative to the Chinese market, in the table below:

Used 2019 food delivery market number for India, and 2020 numbers for every thing else, in scaling up; COVID effect on 2020
Indian food delivery market very different from the rest of the world

Put simply, even if Indians had the same per-capita income and digital reach as Chinese
consumers, the food delivery market in India would be far smaller than the Chinese market,
perhaps because eating out is not as much as entrenched in Indian eating behavior. You can find
multiple flaws with these comparisons, but the core fundamentals that will determine the size of the
Indian food delivery market are clear. The size of the market in future years will be determined by
how robustly the Indian economy will grow in the next few years, how quickly digitization continues
its advance in the country and if and whether Indians become more open to eating out than they
have historically.

Zomato: Story and Valuation

With the lead in on Zomato's history and business model, I can start constructing a story and
valuation for the company, with the recognition that the biggest part of the story is in its macro
elements. It stands to reason that disagreements about the story will be largely on those macro
components, rather than in the company-specific components.

The Prospectus

To get the assessment of the company started, I began by looking at Zomato's prospectus and all
of the concerns I noted about excessive and distracting disclosure that I laid out in last week's post
on the topic, came rushing back to me. The Zomato IPO clocks in at 420 pages, much of it
designed to bore readers into submission. Let's start with the useless or close to useless parts:

1. Definitions and abbreviations: The prospectus starts, and I wonder whether this is by
design, with 17 pages of abbreviations of terms, some of which are obvious and need no
definition (board of directors, shareholders), some of which are meaningless even when
expanded (19 classes of preferred shares, all of which will be replaced with common shares
after the IPO) and some of which are just corporate names.
2. Risk Profile: If you did not believe my assertions about the pointlessness of risk sections in
IPOs, please do read all 30 pages of Zomato's risk profile (pages 39-68 of the prospectus).
The company lists 69 different risks investors may face from investing in the company, and
after you have read them all, I dare you to list three on that list that you would remember.
The risk profile starts with a statement that the company has a history of net losses and
anticipates increased expenses in the future and goes on to add invaluable nuggets such as
the "COVID-19 pandemic, or a similar public health hazard, has had an impact on the our
business".
3. Subsidiary/Holdings Mess: I find it mind boggling that a company that is only thirteen years
old has managed to accumulate as many subsidiaries, both in India and overseas, as
Zomato has done. Since Zomato owns 100% of most of these subsidiaries, there may be
legal or tax reasons for this structure, but there is no denying that it adds complexity (and
pages) to the prospectus, with no real information benefits.

If you do make your way through this mush, there is useful information in the prospectus about the
company's economics:

1. Growth & Profitability trends: The company provides three years of financial statements in
the prospectus (2018-19, 2019-20 and 2020-21) and you can get a sense of the company's
growth and profitability trends by looking at the annual numbers:

Zomato Prospectus

Since the numbers for 2020 are distorted by the COVID shutdown, the company provides
quarterly numbers for the most recent quarters to argue that the growth reversal in 2020 will
be quickly put in the rearview mirror:

Zomato prospectus, with 2020 Q1 & Q2 numbers estimated

Note the sharp and predictable drops in gross orders in the first two quarters of the 2021
fiscal year, but also the increase in gross orders in the last quarter of FY 2021 (the first
quarter of the 2021 calendar year), as the shut downs ease up.
2. Unit Economics: The company does provide a sprinkling of unit economics to suggest that
the underlying business is moving towards profitability. The lead in their argument is the
contribution margin, i.e., the slice of the a typical order that is left as profits, after covering
the costs of catering to that order:

Zomato Prospectus

While the graph shows improvement, it is worth noting that the improvement is based upon
a single year's (2021) numbers. There are, however, other facts about the unit economics
that lend to optimism on the story. In particular, there is some evidence in the cohort table,
where Zomato customers are broken down by how long they have been using the platform,
that usage increases for more long-standing customers:

Zomato Prospectus

The users who joined the Zomato platform in 2017 were not only ordering three times more
than they were initially by the time they had been on the platform four years, but were also
more likely to continue ordering at those levels in the 2021 fiscal year, when COVID put a
dent in the Indian food delivery business. This is good news, but to make full sense of it, it
would have been informative to see what percent of each year's users stayed active on the
platform in subsequent years, but I could not find that statistic in the prospectus.
3. Competitive Advantages: The competitive advantage section could have been cut and
pasted from a dozen Silicon Valley companies in the last decade, with the networking
benefit captured in a loop, where the more a platform gets used, the more benefits it
provides to those on it, thus creating more usage:

Zomato Prospectus and Uber Prospectus

Note the similarities between the picture to the left, from the Zomato prospectus, and the
picture to the right is from the Uber prospectus, from 2019. That said, there is an element of
truth in these pictures about how growth can lead to more growth, but neither picture
addresses the fundamental business question of how to monetize this growth, since neither
ride sharing nor food delivery has figured out how to be profitable.
4. Proceeds: The company's plans for what it intends to do with the proceeds are mixed. A
portion of the initial offering will represent the cashing out of Info Edge, one of the first
venture capital providers to Zomato, and that has no direct effect on the valuation. Another
portion, amounting to approximately 9 billion INR will remain in the firm, to cover future cash
needs.

It would be churlish on my part to take issue with the bloat and selective disclosure in Zomato's
prospectus, since they are following the script that other technology companies around the world
have written for going public, but it is frustrating to read through 420 pages, and still be left in the
dark on key numbers.

The Story & Valuation

The story that I will tell for Zomato has several moving parts to it, but it can be broken down into
the following components:

1. Total Market: This is the assumption that will make or break Zomato as a company, since so
much of the potential in the company is dependent on how the food delivery/restaurant
market in India evolves over the next decade. As I noted in an earlier section, even allowing
for robust growth in India and improved digital access, I find it hard to see the total market
exceeding $40 billion, with US $25 billion, in ten years, being a more likely outcome. (In
rupee terms, this will translate into a market that is roughly 1800-2000 billion INR.)
2. Market Share: The Indian food delivery market is dominated by two big players, Zomato and
Swiggy, with a third player, Amazon Foods, that is unlikely to fade away. In my story, I will
assume that the market will continue to be dominated by two or three large players, albeit
with lots of localized and niche competitors who will continue to command a significant slice
of the market. Expecting any company to have a market share that exceeds 40% of this
market is a reach, and I will assume that Zomato will be one of the winners/survivors. In
making this judgment, it is worth noting that the online food delivery markets in other parts
of the world (US, China) seem to be also approaching a steady state of a few large players.
3. Revenue Share: While the market share and total market yield the gross order value for
Zomato, the company posts only its share of these orders, as revenues. That number was
23.13% in FY 2020, but dropped to 21.03% in FY 2021, as shut downs put a crimp on
business. I will assume a partial bounce back to 22% of GOV, starting in 2022, but the
presence of Amazon Food will prevent a return to higher values in the future.
4. Profitability: The profitability of intermediary businesses (ride sharing, apartment renting,
food delivery) that use platforms to connect users to service or product providers is still
being worked out, but the contours of how this will play out are visible. The biggest
expenses at these companies are often on customer acquisition and marketing, and as
growth scales down, these expenses should decrease, as a percent of revenues, delivering
a profitability bonus. The biggest challenge that these businesses face are in the absence of
stickiness and exclusivity, since users can have multiple food delivery apps on their devices
and pick the cheapest one, and in balancing the competing needs of users and
service/product providers with very different needs. For a food delivery service, restaurants
and customers are integral to the business, and providing a better deal for one may come at
the expense of the other. Online food delivery businesses around the world, and Zomato is
no exception, are facing backlash from restaurants and delivery personnel, who believe that
they are getting the short end of the stick, as the company seeks to offer lower prices and
better delivery deals from customers. I will assume that pre-tax operating margins will trend
towards 30%, largely because I believe that the market will be dominated by a few big
players, but with the very real possibility that one rogue player that is unwilling to play the
game can upend profitability. The scariest part of the food delivery market for Zomato is the
identity of its new entrant (Amazon Food), since Amazon is the most fearsome competitor
on the planet, willing to out-wait any company, if its intent is to capture a market.
5. Reinvestment: One of the advantages of being an intermediary business is that you can
grow with relatively little capital investment, defined in conventional form (as plant,
equipment or manufacturing facilities). That said, reinvestment takes a different form for
companies like Zomato, with investments in technology and in acquisitions, driving future
growth. I highlighted the acquisitions that Zomato has made over its lifetime, with UberEats
India as its most recent and most expensive illustration, but also noted that the company
has burned through billions in cash to get to where it is today. I will assume that this need
will continue in the near future, with a lightening up in later years, as growth declines.
6. Risk: In terms of operating risk, the company, in spite of its global ambitions, is still primarily
an Indian company, dependent on Indian macroeconomic growth to succeed, and my rupee
cost of capital will incorporate the country risk. Zomato is a money losing company, but it is
not a start-up, facing imminent failure. On the plus side, its size and access to capital, as
well as its post-IPO augmented cash balance, push down the risk of failure. On the minus
side, this is a company that is still burning through cash and will need access to capital in
future years to continue to survive. Overall, I will attach a likelihood of failure of 10%,
reflecting this balance.

With the story in place, and the inputs that come out of it, the valuation, in a sense, does itself, and
you can see the summary of the numbers below:

Download spreadsheet

With my upbeat story of growth and profitability, the value that I derive for equity is close to 394
billion INR (about $5.25 billion), translating into a value per share of 41 INR. That may seem like a
lot to pay for a money-losing company with less than 20 billion INR in revenues in the most recent
year, but promise and potential have value, especially when you have a leader in a market of
immense size. That said, the stock's pricing (72-75 INR, per share) makes it too expensive,
notwithstanding my story.

Facing up to Uncertainty

If you who are wondering whether the assumptions that underlie my Zomato valuation could be
wrong, let me set your mind at rest by assuring you that they most certainly are, and it does not
bother me in the least. The reason that they are wrong is simple. I do not control the future, and no
matter how many tools and current information I bring to the process, there will be surprises down
the road. The reason it does not bother me is because, as I have said many times before, you don't
have to be right to make money, just less wrong than everyone else. I do think there is a benefit to
being open about uncertainty and facing up to it, rather than viewing it as something to be avoided
or acting as if it is not there. I will use one of my favorite tools, a Monte Carlo simulation, and
quantify the uncertainty I foresee in three of my most critical assumptions.

Total Market Size: A major driver of Zomato's value is the expected evolution of the
Indian food delivery market. While I projected the market to increase to about $25
billion in my base case, that is based upon assumptions about economic growth and
digital reach in India that could be wrong. In the simulation, I allow for a market size of
between $10 billion (about 750-800 billion rupees) to $40 billion (3000-3200 billion
INR).
Market Share: In the base case, I assume that Zomato's share of the market will
stabilize around 40% by year 5, premised on the belief that this will be a market with
two or three big players, a a multitude of niche businesses. Given the regional diversity
of the Indian market, it is possible that there may be more players in the market, in
steady state, resulting in a lower market share (as low as 20%) or that the niche
players will get pushed out, because of economies of scale, yielding a higher market
share (up to 50%).
Operating Margin: The operating margin of 30% that I predicted in my base case for
Zomato is built on the presumption that the status quo will prevail, and that the delivery
companies will be able to continue to see economies of scale, while holding their slice
of the order value stable. If one of the players decides to aggressively go for higher
market share (by offering discounts or bidding more for delivery personnel), operating
margins will tend lower (15% is my low end). If, on the other hand, Zomato is able to
keep its advertising business intact as it moves forward, it could delivery higher margin
(45% is my upper end).
Notice that there are two assumptions that analysts often lose sleep over that I am ignoring. The
first is the reinvestment each year, that I estimate using a sales to capital ratio that varies across
time. It affects my cash flows, but its effect on value is dwarfed by changes in assumptions about
market size and share. The second is the cost of capital, a number that most valuation classes and
books (including mine) belabor to the point of diminishing returns. Raising or lowering the cost of
capital has an effect on value, but changing my assumptions about risk premiums, betas or debt
ratios has a much smaller effect that changing assumptions that alter cash flows. The results of the
simulations that I ran with distributions replacing point estimates for market size, share and
operating margin are shown below:

Put simply, I think it is hubris to dismiss those who invested in Zomato at 72 INR per share or
higher, as speculators or ill-informed, since there are plausible stories that get you to values higher
than 100 INR per share. That said, given my story and valuation for the company, I think that at a
70-75 INR per share price, the stock looks over valued to me.

Add ons and Distractions

The most dangerous moments, when valuing a company, are after you think you are done, as
those who disagree with your valuation (on either side) come up with reasons for adding premiums
for positives about the company that you may have missed, if they want a higher value, or
discounts for negatives about the company that you should have incorporated, if they want a lower
value. In this section, I will start with the argument that a platform with millions of users offers
optionality, a reasonable basis for a premium, but one where it can be difficult to attach a number
to the value. Second, I will consider whether the fact that India is a big market makes Zomato
deserving of a premium, and make a case that it is not. Third, I will confront the oft used contention
that value is in the eye of the beholder, i.e., that Zomato is worth a lot because other investors
believe it to be worth a lot, and examine a pricing rationale for Zomato. Finally, dismissing Zomato
as an investment, just because it does not make money now, or fails to meet some conventional
value tests on pricing (PE, Price to Book), is investing malpractice.

1. Platform Optionality

As a company with millions of users on its platform, there is an added layer to value for Zomato
or any other platform-based company, that goes beyond the intrinsic valuation above. In effect, if
Zomato can deliver other products and services to the users of the platform, it can augment its
earnings and value. This is the "optionality" that some investors highlight in companies with large
user bases (Amazon Prime, Uber, Netflix), but while I see the basis for the argument, I would offer
some caveats.

First, not all platforms are created equal, in terms of being adding value, with platforms
with more intense users and proprietary data having more value than platforms where
users are transitory and there is little exclusive data being collected. One reason that I
bought Facebook shares in 2018, after the Cambridge Analytica scandal, was my belief
that its platform has immense value because of its reach (more than 2 billion users in
its ecosystem), their engagement (Facebook users stay in the ecosystem for long
periods) and the data that Facebook collects, through their engagement (posts,
comments etc.).
Second, even if you believe that there is optionality, attach a numerical value to that
option is one of the most difficult tasks in investment. While there are option pricing
models that can be adapted to do the valuation, getting the inputs for these models,
especially before the optionality takes form, is difficult to do. With Facebook, in 2018, I
arrived at an intrinsic value that was only modestly higher than the price (<10%), but
used the optionality as the argument for pulling the buy trigger.
Zomato's platform has the benefit of large numbers, but it falls short on both intensity and
proprietary data. Thus, Zomato app users are on the system only when they order food, and the
engagement is often restricted to food ordering and delivery. If Zomato plans to expand its offerings
to its platform-users, it is very likely that these add-on businesses will be food-related, perhaps
extending into grocery shopping, creating some option value.

2. A Big Market Premium?

Indian and Chinese companies, especially in young and nascent businesses, have an advantage
that they often play to, which is immense local markets. It is not surprising that companies play up
this advantage, when marketing themselves to investors, with some analysts attaching premiums
to value, just because of market size. I believe that this is a distraction, because that market size
should already by incorporated into the intrinsic value, through growth and margin expectations. In
my base case valuation of Zomato, I assume that revenues will increase almost ten-fold over the
next 10 years, because the Indian market is expected to grow so strongly. In fact, the danger to
investors, when faced with Indian and Chinese companies, is not that they will under value these
companies, but that they will over value them, precisely because the markets are so big. In a post
and companion paper, I describe this as the big market delusion, where investors do not factor in
the competition that will come from existing and new players, drawn into the business by the size
of the market, and the resulting drop in profitability.

3. A Pricing Rationale

When you value young companies with promise, the most common push back that you will get is
that value is whatever people perceive it to be, and young companies can therefore have any value
that investors will sustain. This is a distortion of the word value, but it is true that young companies
are more likely to be priced than valued, and the pricing will be based upon a simple pricing metric
(anything from PE to EV/Sales) and what investors perceive to be the peer group. With Zomato, for
instance, there are two ways in which investors may attach a pricing to the company.

1. VC Pricing: The first is to look at venture capitalists priced the company at, in their most
recent funding rounds, and extrapolating from that number. In its February 2021 VC round,
Zomato was priced at close to 400 billion INR ($5.4 billion) by a group of venture capitalists
(including Fidelity and Tiger Global), who invested almost 50 billion INR (about $660 million)
in the company.
2. Comparable companies: The only direct comparable that Zomato has in India is Swiggy,
which is still privately funded, At the risk of stretching the definition of "comparable firm", I
compare Zomato's pricing (using the projected 72-75 INR share price on the IPO) to the
pricing of Doordash, which went public in 2020:

One of the perils of pricing is that you can find almost always find a way to back up your
preconceptions, if you try hard enough. Thus, if you are a Zomato bull, you could point to
the EV/User and argue that it is cheap, relative to Doordash, whereas if you are a bear, you
can point to Current revenue and GOV multiples, to make the case that Doordash is
cheaper. To make the argument even messier, using forward multiples, where you scale the
current enterprise value to expected revenues or earnings in 2031, make the Zomato case
stronger, since it has higher expected growth than Doordash does.

The bottom line is that pricing is not a panacea for uncertainty or a cure for bias, since the
uncertainty is just pushed into the background and there is plenty of room for biases to play out, in
how you standardize price (which multiple you use) and and what your comparable are.

4. It is a money loser

There are good arguments to be made against investing in Zomato at is proposed offering price,
but one of the emptiest, and laziest, is that it is losing money right now. I know that for some value
investors, trained to believe that anything that trades at more than 10 or 15 times earnings or at
well above book value, this argument suffices, but given how badly this has served them over the
last two decades, they should revisit the argument. The biggest reason that Zomato is losing
money is because it is a young company that is trying to take advantage of a market with immense
growth potential, not because it cannot make money. In fact, if Zomato cut back on customer
acquisitions and platform investments, my guess is that it could show an accounting profit, but if it
did so, it would be worth a fraction of what it is today.

Conclusion

In investing and valuation, there is the presumption that rules and even the first principles of
investing change as you go from one market to another, and this is particularly true when
comparisons are made between developed and emerging markets. I believe that the first principles
of valuation are the same in all markets, and I hope that I have stayed true to that belief in this
post. I valued Zomato, using the same process that I used to value Doordash, with the country-
specific effects being incorporated into my growth and risk projections. While I did take issue with
some of the holes and over reach in Zomato's disclosures, I ran into the same challenges, when I
valued Doordash. Zomato is a money-losing, cash burning enterprise now, but it has immense
market potential and is on track to delivering on a viable business model. It will face plenty of
challenges on that path, both at the micro level (management, competition) and at the macro level
(economic and political developments in India). I believe that the company is currently over priced,
given its potential, but I would have no qualms about investing in the stock, if the price drops in the
near future, with the full understanding that this is a joint wager on a company, a sector and a
country.

YouTube Video

The Zomato IPO: A Bet on Big Markets …


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Data & Spreadsheets

1. Zomato Prospectus
2. Zomato Valuation Spreadsheet

Posts/Papers

1. The Big Market Delusion (Post and Paper)

Posted by Aswath Damodaran at 4:59 PM


Labels: IPO, Valuing Young companies

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