Zomato Share Prices Are Languishing. Is Company's Capital Allocation Decisions Hurting Investors?

Zomato’s shares are currently languishing at ₹80, after falling almost 50% from the lifetime high of ₹154. While the shares of listed technology start-ups have fallen across the globe, some analysts suggest that Zomato’s decline can, in part, be attributed to investor concerns about the company’s recent acquisition and investment spree. Despite being unprofitable and continually burning cash, the company is currently deploying its money into new investments and acquisitions.

The capital allocation decisions have raised questions among the investor and analyst community. Given that the company is yet to generate sustainable cash flows from its core business, Deepinder Goyal’s (Zomato’s CEO) idea of becoming a quasi-venture capital fund for smaller companies has not impressed investors. A technology company investing in small start-ups is not a new trend – but usually, companies that turned into a VC fund had a highly profitable core business that generated significant cash flows but did not require much reinvestment into the core business. One of Zomato’s early investors, Info Edge, followed a similar model, but only after establishing itself as a major player in the digital classifieds business.

In the first half of the financial year 2022, the company Zomato burnt through ₹ 270 crores of cash on a revenue base of ₹1868 crores. Given that the company had around $1.7 billion in cash at the end of December 2021, it appears that the company could comfortably survive for a few more years. However, with one of the company’s two major focus areas being quick commerce, it is possible that the company could burn through the cash faster than envisaged. Quick commerce has recently come into focus, with companies like Zepto and Blinkit promising 10-minute deliveries.

However, the quick commerce business model brings with it several concerns for investors. For one, the unit economics of delivering small quantities of low-value items with each order doesn’t make sense unless these players can charge high prices from customers. In case Zomato enters quick delivery itself, investors would have to remodel the company’s unit economics, and profitability could be far off. It would take time for users to develop a strong habit of using the service, in order for the service to be sustainable. Hence, these companies are currently subsidizing sales to drive user acquisition and encourage repeat orders. In addition, these quick delivery services are likely to be limited to urban areas, and the companies involved must build a network of dark stores in these areas to service demand. Quite clearly, subsidizing customers with cash comes at a large cost – and Grofers-turned-Blinkit appears to have burnt cash quite quickly since it pivoted into a quick commerce service.

Previously, experts had raised questions about the possible conflicts of interest in several deals - with Goyal having personal stakes in certain companies such as Blinkit and Shiprocket before Zomato bought a stake in the companies. In addition, Goyal is an investor and board advisor for Bace Capital, a venture capital fund that had a stake in Adnomo. Zomato later acquired a 19 per cent stake in Adnomo for ₹112 crores. Other possible conflicts of interest include Akriti Chopra, Zomato’s Chief Financial Officer and co-founder, being married to Albinder Dhindsa, the founder of Blinkit.

Related party deals are usually viewed with caution among investors, as in the past, promoters of Indian listed entities have enriched themselves at the cost of public shareholders. Nevertheless, Goyal said that he had exited Shiprocket to prevent any conflicts of interest before Zomato invested in the company. The statement also said that such transactions would continue to happen by design. In February 2022, he sold his entire stake in Blinkit, possibly to prevent any conflicts of interest in case a merger or acquisition is conducted between the two companies.

The range of scenarios of how the numbers could look for new-age start-ups is quite wide. As a result, it is difficult for investors to estimate cash flows and come up with a rough range for the company’s intrinsic value. Unless operations turn around, which could potentially be difficult after a merger with Blinkit, Zomato would probably have to raise money from investors again – diluting the stake of current investors. New cash investments would only quicken the path to dilution.