Will the Zomato-Blinkit deal work despite skepticism about valuation and cash burn?

Following news of Zomato’s merger with Blinkit for Rs 4,447 crores, several social media handles expressed surprise and skepticism over the deal. Although the Zomato-Blinkit deal has been in the works for some time, the official decision was made at a board meeting on Friday.

The acquisition would involve the issuance of new shares worth Rs 4,447 crores, creating a dilution of equity of 6.88%. Lead firm Blinkit Commerce Private Limited (BCPL) would be acquired for Rs 4,447.5 crores, halving its valuations. The warehousing and ancillary services business of Blinkist’s subsidiary Hands-on Trades Private Limited (HOTPL) would be acquired for an additional Rs 60.7 crore, to be paid in cash.

Zomato’s point of view

Zomato had invested in Grofers, the name under which Blinkit previously operated as a grocery delivery company. She owned 9% of Blinkit even before the acquisition thanks to her previous investments in fast-trading players.

According to Zomato, food delivery and fast-paced commerce are hyper-local businesses. Therefore, having the platforms operate under the same umbrella would help companies increase their share of the customer’s wallet. Additionally, he expects higher customer frequency and engagement after the acquisition.

Zomato’s post also contains data from Blinkit that signals a shift towards unplanned and spontaneous buying, indicating that fast trading is becoming increasingly preferable to next day delivery. For example, weekly user retention percentage jumped 1.6x between the first and fourth quarters of fiscal 2022 following Blinkit’s pivot to fast trading.

Additionally, Blinkit’s gross order value has already increased by 471% in the last 14 months. According to Zomato, the move towards fast trading is not driven by discounts that have recently dropped, but is an organic move.

Although the Blinkit brand and app will operate separately from Zomato, its CEO Deepinder Goyal suggested they would look at different ways to explore synergies between the platform.

But despite the positives of the acquisition highlighted by Zomato, why are skeptics still worried?

Cash consumption continues.

Both Zomato and Blinkit are loss-making companies and are still burning cash to run their operations. Zomato reported a cash burn of Rs 693 crores for FY22, which came down from a burn of Rs 1017.9 crores for FY21. While Zomato’s earnings before interest, tax, depreciation and amortization (EBITDA) margins fell from -153% in FY18 to -18% in FY22, the business still remains unprofitable.

Blinkit had reported revenue of Rs 2,700 crore and loss of Rs 6,127 crore for FY21. Additionally, Zomato is still unsure of Blinkit’s profitability timeline – with the team sharing an ‘educated guess’ but not an “orientation”.

Zomato says Blinkit could break even in terms of adjusted EBITDA in less than three years. But even then, there is no guarantee that the cash burn period will be over. If reports are to be believed, Blinkit has already faced a cash crunch, closed several shady stores and laid off employees. It is widely believed that Blinkit’s cash burn accelerated after its pivot to fast trading.

In order to prevent Blinkit from shutting down, Zomato previously granted a loan of Rs 1125 crores to Blinkit. Additionally, Zomato plans to potentially allocate an additional Rs 1,875 crore to the fast delivery business from its own cash balance. Indeed, the acquisition would cost almost Rs 7,400 (Rs 4,500 in stock plus the Rs 2,900 crores of additional investments), taking into account the additional investments planned by Zomato. Definitely, the investments are quite colossal for a company that has been struggling for a while.

Others have expressed concerns about the numbers provided by Zomato. For example, the total number of orders placed by Blinkit also includes canceled orders. Additionally, the numbers provided in the release are unaudited numbers that were received directly from Blinkit. It also appears that the number used for Blinkit’s GOV is based on the maximum retail price, rather than being adjusted for any discounts applied to the order.

“GOV is defined as the total monetary value of orders, including the maximum retail price (MRP) of the goods sold (except in cases where MRP is not applicable, such as fruits and vegetables, in which case the price of final sale is used in place of MRP) and customer delivery charges but excluding tipping,” Zomato’s statement said.

Internal issues aside, Blinkit continues to face competition from other fast-trading startups backed by deep-pocketed entities, making it harder for the company to become profitable.

Valuation and dilution of transactions Concerns remain

Given Blinkit’s lack of profitability, it becomes difficult for even the smartest analysts to value the company, as the profitable entity’s cost structure might be difficult to estimate. Given the wide range of scenarios for how the company’s revenue and cost structure might ultimately turn out, the valuations at which Blinkit was acquired remain concerning.

Blinkit’s all-stock deal would dilute equity by around 6.88%, which is quite significant, especially since the deal involves the acquisition of a company that is expected to burn cash over the coming years.

Zomato’s public investors have already struggled after the share price nearly halved since its IPO.

Zomato investors could face further dilution in the event that Zomato is unable to become profitable. In this case, Zomato would again have to raise funds from investors, again diluting the shareholding of public investors. Zomato has so far denied any plans to raise more capital to become profitable and believes no further equity dilution would be necessary.

Despite the negative aspects, the data provided by Zomato suggests that people have developed or are developing spontaneous grocery/essential shopping habits. In addition, its core business also showed several improvement measures. It remains to be seen whether these will translate into profits and a significant return on capital employed.

Sara R. Cicero