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Zomato is proof that the valuation of Indian startups may be a dangerous bubble

Reuters/Rafael Marchante
Time to pop?
By Madhura Karnik, Suneera Tandon
Published Last updated This article is more than 2 years old.

The most vexing question in India’s startup ecosystem has arrived at the table of Zomato.

In a report last month, analysts at HSBC valued the Indian food-delivery and discovery app at $500 million, about 50% lower than what it was valued in its latest funding round in Sept. 2015.

That’s set off a chain of events, with tough questions being asked of the startup, a spirited defence by Zomato’s leadership and some good ‘ol social media sparring.

The HSBC report that triggered the melee was actually about Info Edge—the Noida-headquartered company that owns job search website Naukri—which is one of the shareholders of Zomato.

Here’s what the report said, according the Mint newspaper:

We do a DCF (discounted cash flow) and value the business (Zomato) at about 50% lower to the $1 billion valuation. Zomato is present in 23 markets so early on and none is profitable, implies that to address both the investments in last mile delivery and losses in international operations fund raising will be a continuous phenomenon, suggesting current valuations don’t make much sense.

The HSBC report argues out that the existing revenue stream isn’t really working for Zomato. Only about 6-8% restaurants on the platform pay for advertising, while the relatively new food ordering business is in a nascent stage.

“In our view, for to emerge as a market leader in the restaurant search space, it needs to focus on online food ordering and build last-mile delivery capabilities,” the HSBC report said.

But that’s an attack that Zomato isn’t taking lying down.

In an emailed reply, a Zomato spokesperson told Quartz that HSBC’s analysis may well be misplaced because it doesn’t understand the company’s business too well:

We have not raised any round since the last round of funding to have a valuation reset. Our investors are as bullish about Zomato as they were before. We are growing fast and are on course to become profitable as a company very soon. Our ad business in various countries has up to 93% gross margin. And our sales team is one of the most productive sales teams in the world. We are profitable in 8 countries as of today.
HSBC has never spoken to us, and doesn’t obviously understand our business well. Beyond this, we do not want to comment on valuation markdown speculations of third parties.

Sanjeev Bikhchandani, founder of Info Edge, also dismissed the HSBC report’s argument.

“The company has plenty of cash and its unit economics are really good,” Bikhchandani said in an email. “Revenue has more than doubled in the last nine months and continues to head north at a good clip. Costs have been rationalised and burn is down by over 70% from the peak.”

Meanwhile, Deepinder Goyal, founder and chief executive officer at Gurgaon-based, Zomato wrote an elaborate response to HSBC’s analysis on Zomato’s blog:

…nobody who knows our business has marked down our valuations. In fact, our existing investors are bullish about us, and are willing to back us further, if needed. And they have categorically said that our valuations are justified. Especially because we are more than doubling year on year, and the next year looks even more exciting for us. But external perceptions of valuations are determined by the state of the market, and the availability of facts to the person who is analysing these numbers.

Enter the bubble

Nonetheless, the possibility of a valuation bubble in India’s booming startup ecosystem has just been reinforced.

Already in 2016, e-commerce giant Flipkart has been devalued twice. In March, Morgan Stanley cut the firm’s valuation by 11%, followed by T Rowe Price a month later, when it slashed the value of its investment in Flipkart by 15%.

The reason why analysts and investors have suddenly become wary of these sky-high valuations is that few of these businesses are making any money. Moreover, no one really knows how these firms got the huge valuations in the first place. “Of recent, the valuation game has turned into a ‘black magic art’ more than a science,” Ravi Gururaj, the then chairman of India’s National Association of Software and Services Companies (Nasscom) product council, told Quartz in March 2015.

“There is no doubt that we have been in a valuation bubble,” Mahesh Murthy, co-founder of investment firm Seedfund, told Quartz. “Specifically to Zomato, valuing it at even half-a-billion is ambitious. In the businesses that Zomato is in, the revenue comes from restaurants who advertise and the food delivery part. Both these are low-value and low-margin businesses. So it makes it difficult to believe that with Rs97 crore ($14 million) of revenues, the company is valued at $1 billion.”

But when Murthy shared his analysis on social media, Goyal didn’t wait to hit back.

Yet, it is difficult to deny that food tech startups in India have been facing headwinds for some time now. Most companies scaled too fast, offered minimal delivery charges in a business where logistics costs are significant. Unsurprisingly, by end of 2015, some startups had to bite the dust.

In October 2015, for instance, Bengaluru-based Dazo shut down operations due to lack of funding. A month later, Mumbai-based TinyOwl Technology Pvt Ltd, scaled down operations amid news reports of lay-offs. In December, Foodpanda, funded by the local unit of Rocket Internet, laid off some 300 employees and was reportedly looking for buyers.

“What has happened is investors were promised specific growth rates and profitability estimates which were used for forecasting valuations,” said Arvind Singhal, chairman and managing director of Technopak, a consulting firm. “But both have not been met. These companies are taking longer than what they promised.”

“Initially exuberance had overtaken pragmatism,” he added.

Time for a reality check.

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