Quick commerce has been a strategic priority for Zomato, and Blinkit, with its expertise in that space allows for faster and more efficient scaling up in this segment.

Blinkit has built up core competency in understanding product supply chains, movement of goods from warehouses to dark stores (distribution centres that cater exclusively to online shopping) and a tech stack to optimise operations in this business.

To this extent, the deal appears a strategic fit for Zomato, although it would have been better if diversification is done after reaching profitability in core food delivery business, which still appears to be years away.

With recession risks looming in few developed economies, which will have spill over effects in emerging economies like India, one has to get conscious of the fact that growth for these businesses too may taper than what is being forecast now. Along with this comes risks to valuation assigned for the acquisition (all though this being an all stock deal hedges it to some extent); besides, integration risk which is common to any M&A is also present.

For any doubts, one just has to look at Zomato’s own assessment of the value of Blinkit in the last one year.  

The deal involves buying out of Blinkit’s e-commerce marketplace (represents 98 per cent of deal value) and a part of the B2B business.

Based on Zomato’s earlier 9 per cent stake buy in the e-commerce marketplace in Q2 FY22 for ₹518 crore (total equity valuation of around ₹5,758 crore), there will be around a 15 per cent equity valuation mark down, in less than three quarters for the marketplace business alone (equity valuation of business now at around ₹4,885 crore).

While details are not available on the value of the entire B2B business (separate entity in which Zomato has a 8.4 per cent stake and only part of it being acquired in this deal) of Blinkit, the markdowns in valuation for the combined business appears to be even higher. It needs to be noted that this markdown is happening when revenue growth has been good. Any negative change in this trend can have an outsized impact to valuations.

Delays profitability timelines

While deal does offer synergies in terms of more optimised utilisation of Zomato’s delivery fleet, and cross selling to existing customers/ increasing stickiness for both platforms, it comes with higher cash burn and negative profitability margins.

In the current environment of rising interest rates, and tighter financial conditions, cashflows and profitability matter. Thus this deal will delay Zomato achieving breakeven at a consolidated level and this may be viewed negatively from a short- to medium-term perspective.

Also to be noted is that unlike food delivery, this space is more competitive with deep pocketed players like Tata, Reliance, Flipkart and Amazon also into grocery delivery. If they feel quick commerce is eating into their market share, they might start competing in that space aggressively

The fact that Zomato has a good balance sheet with cash of around ₹12,000 crore, will provide it some succour in dealing with few more years of cash burn and intense competition.

According to Zomato’s letter to shareholder explaining the deal contours, Blinkit business is currently around 20 per cent of Zomato in terms of gross order value (value of orders transacted on a platform).

It is growing much faster, while at the same time its cash burn rate/ EBITDA loss margins are worse off. Not unusual given higher growth for new age companies comes at a cost. The enterprise value assigned to Blinkit’s business (₹5,618.9 crore) based on the deal terms is around 10 per cent of Zomato’s current enterprise value.

Current Blinkit shareholders, on conclusion of this all stock deal (closure expected by August), will own 6.9 per cent of Zomato.

What should investors do?

Given the synergies and risks, whether the deal is good or not for shareholders will be known only few years down the line. However at present it really does not turn the tables much for Zomato.

At BL Portfolio, we had recently given a sell recommendation on the stock, and there is nothing from the deal to change this view. Investors must stay cautious when it comes to unprofitable new age companies in the current environment.

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