Recent IPO of Zomato has been the centre of attraction for many investors in India and globally. It marks the beginning of many tech IPOs lined up in the country. Given the huge liquidity surplus in the financial markets, it is indeed an opportune time for companies to get listed at great valuation and provide liquidity to existing investors as well as get a wider participation from retail investors.

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The thing though that has caught the attention of many analysts and investors alike is the right share price of Zomato. The opinion seems extremely divided and there are 4 broad possibilities that are currently out in the market:

1. Zomato true share price is Rs. 41 as per a post by valuation guru Aswath Damodaran

2. Zomato true share price is close to the upper range of its IPO price = Rs. 76

3. Zomato true share price is close to Rs. 140 i.e. current closing price on 2^nd August 2021.

4. Zomato true share price is Rs. 170 as per estimate of analysts most bullish on the stock.

The range is clearly very wide from Rs. 41 to Rs. 170 which is almost a gap of 4x between them. The question is whom should you believe?

To answer this question, we have created a fundamental discounted cash flows (DCF) model of Zomato to arrive at the company’s true share price. Based on this model, we have reversed calculated what you need to believe to justify each of the four potential price scenarios. Before we reveal those “what you need to believe” set of financials, it is important to go through the key assumptions we have built in our valuation spreadsheet.

Key assumptions:

Operating Profit Margins (EBIT %) over next 10 years

1. FY 2021 EBIT margins is -33%.
2. Going forward we assume EBIT margins to improve to 35% by FY 2026. After that, we expect the margins to around the same level.

After 10 years, we assume the revenue growth rate to be around 9% (close to nominal GDP growth rate) and the cost of capital (WACC) is around 12%.

With the above set of assumptions constant across all 4 potential scenarios, we reverse implied the revenue growth rate assumptions to justify the respective price:

1/ Zomato true share price is Rs. 41 as per a post by valuation guru Aswath Damodaran

For this to be true, our DCF model suggests that between FY 2022-FY 2031 i.e. next 10 years, the average revenue growth rate should be around 15%. This would mean that from current revenues in FY 2021 of Rs. 1994 crores, FY 2031 revenues would be close to Rs. 8000 crores.

2/ Zomato true share price is close to the upper range of its IPO price = Rs. 76

For this price to be justified, the revenue growth rate should be between 20-25% over the next 10 years leading to FY 2031 revenues to be close to Rs. 15,000 to Rs. 16,000 crore almost double of the first case scenario.

3/ Zomato true share price is close to Rs. 140 i.e. current closing price on 2^nd August 2021.

At revenue growth rate of 30-35% over the next 10 years, the model suggested price will be around Rs. 140. This means a significant bump in the FY 2031 Revenues of the company to Rs. 34,000 to Rs. 35,000 crores.

4/ Zomato true share price is Rs. 170 as per estimate of analysts most bullish on the stock.

This most bullish price scenario requires the next 10 years revenue growth rate to be around 35% to 37% which translates to a FY 2031 revenue of around Rs. 43,000 to 43,500 crores

So to summarize the different scenarios we can create a table like below:

Clearly, the future revenue growth rate is a very critical factor driving the true price of Zomato’s share. The growth expectation increases dramatically as we move from second to the third scenario. Clearly, there is a lot riding on the future revenue growth rate of Zomato that is driving the true share price of Zomato.