Why go Public?
The Zomato IPO has taken the Internet by storm, and everyone wants a piece of this pie. Investors are often confused whether investing in an IPO is a good decision. For example, would you invest in a currently loss-generating company with immense potential for exponential growth in India in the upcoming years? Or would you rather listen to heavyweight investors like Rakesh Jhunjhunwala, who have characterized these IPOs as bubbles that are going to pop soon.
First of all, what is an IPO? Suppose you run a company and you plan on expanding your business. Initially, all your company shares are distributed amongst a few investors like the founders and venture capitalists. However, applying for an IPO means you intend to sell a part of your shares to public investors in exchange for money that will be used in expanding your business.
Now you may ask why you should apply for an IPO? There are several reasons – First reason is that you get to buy the shares of a reputed company at a much lower price. After listing, prices generally shoot up as other investors scramble to buy the share. Furthermore, a company with solid results and good future prospects will give multibagger returns in the following years. Second, when a company is listed on the stock market, it generally opens at a premium. For example, if a company issues shares at a price bracket of 300-305 Rs. and it lists the market at a 50% premium, the stock’s opening price shall be close to Rs 450. However, there are no thornless roses. Suppose the market feels that the stock’s underlying price is inflated and is not in line with the fundamental valuations of the Company. In that case, hefty corrections can happen that can trap investors at higher levels.
The Hype behind the IPO
Here’s where the Zomato IPO comes into the picture. Incorporated in 2010, Zomato is one of the leading food delivery platforms. Customers can discover restaurants, order food, book tables, and make payments for dining at restaurants. As of December 31, 2020, Zomato has a presence across 23 countries along with 1,31,233 restaurants and 1,61,637 active delivery partners and an average monthly food order of 10.7 million customers. Zomato applied for the IPO to raise approximately Rs. 9000 crore for its organic growth initiatives and to meet corporate requirements. The Company set the price band from Rs. 72-76 and quantity of shares from 1-13 lots where one lot consisted of 195 shares. The IPO opened for applications from July 14 till July 16, with the listing date on July 27.
The IPO had a 38.25x overall subscription, which means that there were 38.25 buyers for one share. This is the third-largest IPO listing in the stock market history after the Reliance Power and Coal India IPO. Moreover, it reportedly invited the second-highest number of applications after the Reliance Power IPO in 2008. So, you can see the interest among investors in buying Zomato’s shares. However, you start doubting yourself when you find that the Company has been making losses for the past few years. The Company posted a loss of Rs 816.42 crore in FY21 and a loss of Rs 2,386 crore in FY20.
There are always Pitfalls
One may ask whether it is viable to apply traditional valuation rules to new-age digital startups. One may argue that currently, Zomato is in a phase where it spends more money than it earns to expand its business all over India quickly. In India, around 8-9% of Food consumed is from restaurants which is significantly less than countries like the USA and China, where the number hovers around 45-50%. As a result, there is an immense potential to expand into India’s semi-urban belt. Moreover, rapid industrialization has caused workers to look out for fast food options , a demand that companies like Zomato can fulfill.
From a long-term perspective, the Company expects robust growth. However, as investors, we need to be aware of the market’s current situation. Currently, the stock market might be in a bubble similar to the Dot-Com bubble of the 2000s. As a result, investors are running after a company’s sales, not the Price to Earnings (PE) and other valuation metrics. Therefore, one should be careful while entering this euphoric bull market.