Last year, Aswath Damodaran valued Zomato ahead of its market debt.
A professor of corporate finance and valuation at the Stern School of Business at New York University, you can read the detailed analysis here.
His analysis revealed that the stock's pricing (Rs 72-75 per share) is too expensive. The value that I derive for equity is close to Rs 394 billion, translating into a value per share of Rs 41. That may seem like a lot to pay for a money-losing company with less than Rs 20 billion 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.
The story that Aswath Damodaran tells for Zomato has several moving parts to it, but it can be broken down into the following components.
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. 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 10 years, being a more likely outcome. (In rupee terms, this will translate into a market that is roughly Rs 1,800-2,000 billion.)
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. 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 (U.S., China) seem to be also approaching a steady state of a few large players.
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.
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.
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.
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.
Read the detailed analysis here
