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BENGALURU : We don’t know how many Indians signed up for fitness classes in 2021, a year when the pandemic’s second wave ravaged both life and livelihood. Sporting arenas such as gyms were shut and operated with restricted capacity in most cities for many months. And yet, the valuation of six-year-old Fitso, a fitness app, galloped over six times in less than a year.

Fitso offers people in Noida, Gurugram, Faridabad, Delhi, Hyderabad and Bengaluru access to physical sports arenas such as gyms, tennis courts and swimming pools.

In November last year, the audit committee of food delivery startup Zomato Ltd hired a Delhi-based independent valuation expert to determine the value of Jogo Technologies Pvt Ltd, Fitso’s parent. A month later, the expert pegged its worth at 61.5 crore. In January, Zomato agreed to buy a majority stake in the loss-making startup, valuing it at 73 crore. Eleven months later, in December, Zomato sold Fitso to Curefit Healthcare Ltd. But now, the startup was worth 380 crore, or $50 million. This transaction was done even as Zomato acquired a stake in Curefit.

Zomato’s appetite for such deals is raising eyebrows. Some of these transactions have made analysts question if Zomato is behaving like a fund and whether founder and chief executive Deepinder Goyal is trying to replicate the model honed by early Zomato investor Sanjeev Bikhchandani at Info Edge (India) Ltd. Worryingly, a few of the transactions also raises questions around corporate governance.

Last month, when Zomato disclosed its performance for the September quarter, Goyal, in an open letter, said that the company has signed an agreement to acquire an 8% stake in Shiprocket (Bigfoot Retail Solutions Pvt. Ltd) for $75 million; $50 million in Magicpin (Samast Technologies Pvt Ltd) for a 16% stake; and a $50 million investment in Curefit. It also agreed to sell Fitso to Curefit for $50 million (thus a $100 million investment in Curefit gives Zomato a 6% stake in the Bengaluru-based startup). In June, Zomato picked up 9.3% in Grofers (now called Blinkit) for $100 million.

Zomato’s investments in each of the four startups were done at double the valuations of the previous round, according to Mint’s calculations based on documents available with the Registrar of Companies. Curefit was valued at $1.51 billion in November, as against $0.82 billion in July; Shiprocket was worth $0.95 billion, as against $0.33 billion in July; Magicpin was valued at $0.3 billion as against $0.17 billion in March 2021; Grofers was valued at $1.1 billion against $625 million in February. But are these investments strategically important for Zomato’s core business?

“We don’t see any direct synergies between Zomato and its other investees," Ambit analysts Ashwin Mehta and Vamshi Krishna Utterker wrote in an 8 December note. “A longer-term objective could be to leverage them for non-food delivery/discovery, but that is a restricted use-case for Shiprocket/Magicpin. Magicpin considers Zomato to be a financial investor. Shiprocket might help Zomato foray into 3PL (third-party logistics) as an aggregator but has low overlap with Zomato’s current hyperlocal business. Curefit’s business has very different dynamics," they added.

Significantly, for now, most valuations across asset classes are at frothy valuations, and any correction in the future could lead to Zomato booking a higher mark to market loss. Alternately, a rise in the valuation of these startups will shore up the gains for Zomato.

“Deepinder’s approach appears to follow what Sanjeev did at Info Edge," said a Bengaluru-based investor who didn’t want to be identified. “For over a decade, Zomato has lived on money from PEs (private equities) and VCs (venture capitalists). Now, without getting too focused on if he can turn around and make the food delivery business profitable, Deepinder is exploring if he can build a business case by financial investments in startups."

Unanswered questions

These investments bring us to the second related point around Zomato’s acquisition strategy.

In the open letter of last month, Goyal articulated his thinking: “This strategy is inspired by the likes of Alibaba and Tencent, where they invested behind the ecosystem at large, created multiple M&A (mergers and acquisitions) options for themselves, and in the worst case of M&A not panning out, realized windfall financial gains from their investments in market leaders across different categories," he wrote. Goyal added that Zomato plans to “deploy $1 billion over the next 1-2 years" on acquisitions.

Zomato has already committed $275 million in the four acquisitions mentioned earlier. This implies that Zomato will spend $1.275 billion or 9,700 crore on acquisitions until the end of November 2023.

Zomato’s red herring prospectus before the company went public explained how it plans to spend the money it was seeking to raise: 40% will be invested towards funding organic growth initiatives. These include spending on advertising, promotions, marketing, building a strong delivery and tech infrastructure among others.

Zomato did not quantify how much it intends to spend on acquisitions. Since Zomato is a loss-making company, it can only spend from the money it raised from investors as part of the IPO. It raised 9,000 crore. Of this, 272 crore was spent on expenses related to the IPO process, leaving it with 8,728 crore. It spent 563.4 crore in the quarter ended 30 September. As of 1 October, Zomato had 8,164.6 crore.

The unanswered question: how does Zomato expect to keep up with its earlier promise of spending 40%—or 3,600 crore—on building the business organically and spend 9,700 crore on acquisitions when it has only 8,164.6 crore as of now?

It is not clear if this kind of discrepancy in communication forced the market regulator, the Securities and Exchange Board of India (Sebi), to come out with new norms. Last month, Sebi proposed to limit a maximum of 35% of proceeds for acquisitions and general corporate purposes.

Zomato does have the option to go for additional fund-raise, including a qualified institutional placement (QIP), or borrow to keep up with its commitment. But for analysts, this is a sore point.

“Give clarity on your acquisition strategy instead of putting it out in an open letter," said a Mumbai-based analyst with a foreign brokerage who didn’t want to be identified. “Investors should ask the company if they are investing in the core food delivery business or are they investing in Zomato as a vehicle to get shares in other startups?"

“The company believes it is trying to replicate Tencent or Alibaba… However, one key difference between them and Zomato is that they had cash cow businesses, which funded these investments, whereas Zomato is making losses in its core business and ~46% of its cap table is unlikely to provide additional capital (Infoedge, founder & employees, Ant Financials, Uber)," Ambit analysts wrote in the 8 December note. “We see a risk of further dilution at Zomato over the next 1-2 years".

A game of valuations

Let us go back to Fitso, the startup which saw a close to six times increase in valuation.

Fitso’s valuation was arrived at by Delhi-based chartered accountant Sudhir Chandi in December last year. Fitso, founded in 2015 by former Zomato employee Naman Sharma, along with two of his friends, ended with 7 crore in revenue and 4.2 crore in losses in the year ended March 2019. The valuation expert projected the firm’s revenues at 88 crore and profits at 15 crore by 2025.

When Zomato agreed to sell Fitso for $50 million to Curefit, the food delivery platform also promised to invest $50 million in the Bengaluru-based startup. In consideration of this $100 million investment, it got a 6.3% stake in Curefit. After Zomato’s investment, Curefit saw its valuation rise from $340 million in February 2019 to $1.5 billion.

“FOMO (fear of missing out) is making most funds and old business houses invest in new-age startups," said the head of a Bengaluru-based VC firm. Zomato’s transaction with Curefit—where Curefit buys Fitso at a high valuation, which in-turn gives a higher valuation to Curefit—is a move rife with conflicts of interest. “Continue driving valuations higher until the last investor arrives, and he is left holding the can is the mantra," the executive added.

A matter of governance

Another sticky issue in Zomato’s investment approach is the entanglements with Goyal’s own investments.

A month after Zomato had announced that it plans to invest in Shiprocket, on 10 December, Mohandas Pai, a former board member at Infosys Ltd and now the chairman of Manipal Global Education Services, questioned the transaction. “Shiprocket to raise $185 million in Series E round co-led by Zomato, Temasek. Is there a conflict of interest if a listed co. invests in a startup where the founder of listed co. had invested?" Pai tweeted. He also tagged Bikhchandani, asking “how will this be resolved!"

Bikchandani, who is a member of the audit committee member of Zomato, did not respond. Goyal swiftly did.

“There are strong governance principles and processes being followed for every investment, and Zomato will continue to synergistically invest wherever we believe we will create value for our shareholders," Goyal said. “In this particular case, however, there was no conflict of interest to begin with. Here’s what we did to ensure zero conflict of interest during Zomato’s investment in Shiprocket—I exited my personal investments ($100 k only) at zero profit/loss before Zomato stepped in for the investment".

Goyal further added: “Btw, this personal investment was one of the key reasons we got closer to Shiprocket (and its founders). That’s how we discovered that there’s a potential long-term strategic fit."

Pai declined to comment. Zomato did not share any more details on Goyal’s investment. Shiprocket’s filings with the Ministry of Corporate Affairs shows that on 12 July, Goyal paid 74 lakh to pick a small stake in Shiprocket.

Goyal invested in Grofers in 2015, and later in TechEagle, a drone delivery startup. Zomato bought TechEagle in December 2018 only to divest it again in June 2021. It is not clear if Zomato’s board was made aware of Goyal’s investment in Grofers when the company invested $100 million.

Why are the transactions a red flag? There are three unanswered questions.

First, was the board–especially the four-member audit committee of Zomato–made aware by Goyal of his personal investment before Zomato decided to make an investment in Shiprocket and Grofers? Second, does the board have a policy of asking senior management to disclose their investments in private startups so as to avoid any potential conflict of interest? Finally, why is Zomato allowing its CEO to make investments in start-ups as a kind of discovery process to identify potential companies to invest in when it can instead set up a corporate venture arm?

The audit committee chairperson Sutapa Banerjee declined to comment. Calls to two other members of the committee—Kaushik Dutta and Namita Gupta—went unanswered. Bikhchandani declined to speak. A detailed questionnaire sent to Zomato and Goyal went unanswered, too.

“Transformation from a private company to a public one is not easy," said V Balakrishnan, former CFO at Infosys Ltd, and founder of Exfinity Ventures, a venture capital fund. “Soon, they will realize that credibility, trust and governance play a larger component of the price-earnings ratio. Markets will buy stories in short-term but finally cash flows, profitability and returns matter. The current set of founders exhibit some kind of an invincibility but they should understand that the market is the greatest leveller," he added.

Putting in place a credible board, separation of powers, creating an organization-wide mindset of being ethical are a must, he said.

All stakeholders stand to gain if startups going public realize this.

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