Markets
How to make the most of an IPO? Zomato shows us how it is done
Summary
- Zomato has opted to shore up cash reserves, rather than hand out easy listing gains to investors
- Zomato’s cash reserves post-IPO will rise to the unusually high level of 25% of its m-cap
The term ‘successful IPO’ is typically used for an initial public offering (IPO) of equity shares that lists at a significant premium to its issue price. But if the main idea of the primary markets is to help companies raise money to finance growth, the success of an IPO would depend on whether the firm raised as much capital as it needed at the best possible price.
By this measure, the ₹9,375 crore IPO of Zomato Ltd appears to tick all the boxes of success. The anchor investors’ book, which amounts to 45% of the total issue size, was lapped up by foreign and domestic institutional shareholders, according to news reports. And Zomato is making the most of this high institutional demand by pricing its shares about 70% higher than the price at which it sold shares to private market investors less than a year ago.
What this means is that the possibility of a huge listing pop is nearly ruled out, thanks to which demand from non-institutional investors may be moderate. But Zomato’s priorities are clear. It would rather shore up its cash reserves, than hand out easy listing gains to IPO investors. “A large cash balance will work as a deterrent for any competitor from trying to run us out of cash," said Akshant Goyal, chief financial officer, Zomato, in an interview. The firm’s cash reserves post-IPO will rise to an unusually high level of ₹15,750 crore or nearly 25% of its fully diluted market capitalization. For comparison, global food delivery firms Delivery Hero and DoorDash have cash of about 8-10% of their market cap, while cab aggregator Uber’s cash levels are only about 6% of its market value.
“Using Zomato’s FY20 absolute cash burn run-rate, the cash balance would suffice for 6-7 years of cash burn and, building in a lower burn-rate, this implies as much as 10 years of cash burn," analysts at Jefferies India Pvt. Ltd said in a note to clients. In other words, the IPO will give the firm a long runway in terms of its capital needs. And given that capital is the biggest moat for internet firms that burn cash, Zomato is using the IPO well to build its defences.
Apart from the stiff pricing and the defensive hoarding of cash, there are other signs that the IPO is meant for long-term investors. Less than 5% of the IPO pertains to an offer for sale of shares by an existing investor. While the firm’s existing investors are already sitting on huge gains, they are clearly in for the long haul. As the chart alongside shows, Zomato’s revenues are a tiny fraction of those of its global peers. But investors don’t relate this with challenges of scaling up. One favourite refrain of dreamy-eyed investors and analysts is that the potential for Zomato is huge, going by the experience in China. “India lags China by 8-9 years; even if Zomato doesn’t fully replicate the success at Chinese food delivery firm Meituan, the opportunity lying ahead is massive," says an analyst at a domestic institutional brokerage, requesting anonymity. While this distant dream has caused Indian stocks across sectors to rally disproportionally, investors should note that the path to profitable growth may be a tough one in the domestic market.
Zomato’s financial results post-covid suggest there are challenges in pursuing both growth and profitability. Gross order value in Q4 this year was less than 20% higher than pre-covid levels. “Investors should note that when Zomato reduced promotions in fiscal 2021, its margins improved, but growth was hurt, with some users dropping out. The flip side is that its current take rates are nowhere near making it self-sustaining, which means it is yet to demonstrate that it can deliver growth both in revenues and profitability simultaneously; if they go for revenue growth, profitability suffers and vice a versa," says Bhavin Shah, a former technology analyst and founder of Sameeksha Capital.
CFO Goyal is quick to disagree, pointing out that the firm has had a positive contribution margin post-covid.
The fact remains, however, that the firm burnt cash of over ₹1,000 crore last fiscal, despite better per unit economics. The large cash levels on the firm’s books, meanwhile, do raise other concerns. “With so much cash on its books, there is the risk of the company making attempts to buy growth, which may or may not click," says Shah.
The firm’s $100 million investment in Grofers indicates that it may pivot to the grocery segment to drive growth. “To drive higher growth, entering new segments such as grocery would be needed. But that would also mean lower cash generation, if not higher cash burn," says another analyst at an institutional brokerage. Given these concerns, it is quite something that Zomato has managed to convince institutional investors to agree to a pricing of over 12 times estimated FY23 revenues, about double the average of global listed peers.
