Is the Zomato IPO euphoria sustainable?

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There is a big buzz about the Zomato IPO. The online food delivery service has caught the investors’ eye and the Rs 9,375 crore offer has seen over-subscription 38.24 times.

There is a big buzz about the Zomato IPO. The online food delivery service has caught the investors’ eye and the Rs 9,375 crore offer has seen over-subscription 38.24 times. The big qualified institutional investors bid nearly 52 times; and even the smallest retail segment was over-subscribed 7.45 times. The share listed on Friday opening at Rs 116, a 53% premium over the issue price of Rs 76.

There is euphoria because of its sheer size – after all, Zomato is the second largest IPO after Coal India’s stake sale in October 2010. Does it now herald another ‘digital’ round as Paytm, Flipkart and Ola queue up to make their IPO debuts. The obvious ‘success’ trigger is the nature of the business — the immense possibilities of online food delivery at a time when consumer options have been frozen by the Covid-19 pandemic.

The Zomato IPO is all about a blind belief in the ‘digital’ future. The company has never hidden the fact it has never made a profit; in fact it has said in its offer document it will continue to invest, and so losses might continue to grow. Zomato’s pre-IPO financials are nothing to crow about. Revenue dropped 23% to Rs 1,994 crore for FY 2021 and it made a loss of Rs 812 crore.

Yet investors believe, with the scale it has achieved, Zomato has set itself on a course of success. It is present in 525 cities and 23 countries outside India; it has 1.7 lakh delivery partners, it has an active list of 1.5 lakh restaurants it delivers from, and its app is used by 41.5 million customers. And the big thing Zomato has running in its favour is its monopoly; or duopoly to be precise, with Swiggy.

But belief in the ‘digital’ future is not enough. The question is: are these business formats sustainable in the long term? There is little data supporting the current market optimism, except iffy predictions by investment bankers that food delivery could become a $8-billion business in 2-3 years. But what if the pandemic vanishes, and malls and eateries open up? Or if people get fed up of ordering in?

Sample the case of Policybazaar.com. Here’s a business model that seeks to make money from providing customers a hub of comparative insurance products. It claims to process 25% of all term policies on behalf of insurers; but break it down, and it is a fairly niche business. It has also made a loss of Rs 213 crore and Rs 218 crore, two years running. Yet Policybazaar is in the market with an IPO to raise Rs 6,500 crore; and it is seeking a valuation of $4-5 billion.

The game is in the offer for sale (OFS), wherein the company raises funds by allowing existing investors to exit. It sounds almost like a Ponzi scheme. One set of investors exit, to be replaced by another, and another at each round of funding. Each set makes money irrespective of whether the company is in the black or not. The hitch is: the last set of suckers could be left stranded.

International flops

As more tech start-ups line up to raise funds from the market, it appears investors have not learnt from some of the big over-valuation flops of the past. WeWork, an office rental start-up with an international footprint and a dynamic co-working business plan, fell quickly from grace as investors realised it was over-valued. From an initial valuation of $47 billion in August 2019, it halved its target and ultimately could not get support for its IPO even at $12 billion. Saddled with debt, the company removed its CEO Adam Neumann, and delayed its IPO indefinitely.

Uber’s IPO and listing in the US followed almost an identical path, except it did not collapse. The amazing business model of ride hailing, which does away with people having to own cars, was pitched by Morgan Stanley and Goldman Sachs to an astronomical valuation of $120 billion. It did not sustain. Nine months later by May 2019, when Uber finally listed, it had dropped to about half that figure, listing at $45, with a valuation of about $69 billion.

Today, Uber is hovering around $47, which means the big investors like SoftBank of Japan, which pushed Uber and other tech stocks, have had a hard landing.

Some tech companies learnt the hard way, and some came out winners. DoorDash, US’ version of Zomato, also got its timing right, listing last December when people were still staying indoors. Kicking off at an awesome valuation of $38 billion, in 6 months its valuation has appreciated 35% to $92 billion; but its stock has not performed too well, trailing its listing price of $189.

The takeaways are investment bankers are struggling to value loss-making technology start-ups, and the right valuation is often anybody’s guess. Growth at any cost, as we have also learnt, cannot be a sustainable model. For start-ups, a bright idea must not only be a workable business, but it should be a constantly adapting enterprise to meet competition and sustain growth. Many of the big ideas like Uber are currently struggling because of their inability to take on competition from newer players.

In India, it will be interesting to see the trajectory Zomato and the rest will take.

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