Summary
- Grubhub reported strong Q4 earnings, highlighting what has been a good year for the delivery business.
- The company agreed to sell for $7.5 billion ($75 per share) in June, which might have been too cheap considering its growth aspects.
- The market remains extremely saturated and investments can be highly risky, which is why an appropriate investment strategy is crucial.
Overview
Grubhub (NYSE:GRUB) experienced a strong year in 2020, as restaurants were ordered to close due to the pandemic. The broken business model had a chance to recover and rewarded investors with a 35% return throughout the year. While one of the most anticipated technology companies in 2018, harsh competition in the food delivery space caused its share price to slump by more than 80% from all-time highs, recovering slightly afterward, but still down by roughly 50%. Fast forward, in June 2020, Grubhub accepted an acquisition offer for $7.3 billion, or $75 per share.
The immense competition from companies such as Uber Eats (NYSE:UBER), Delivery Hero, Postmates, and DoorDash (NYSE:DASH) caused Grubhub’s market share to drop significantly within the last years, with gross margins declining accordingly. However, at the acquisition price, too much pessimism may be baked in Grubhub’s future in the delivery market, as revenue continues to grow at impressive rates. While the market may be extremely saturated, it is also a growing market fueling more growth. Moreover, profitability for Grubhub could return soon, as gross margins are somewhat stabilizing. As Grubhub has been acquired, investors might look for other companies to invest in to benefit from an ever-growing market. Thus, with extreme competition in the market, investors need to deploy an investment strategy to reduce individual risk.
Strong Growth
The food ordering marketplace announced impressive Q4 earnings. Revenue was up by 48% year-over-year to $504 million, with gross food sales growing 52% YOY to $2.4 billion, compared to $1.6 billion in 2019. Moreover, active diners came in at 31.4 million, an increase of 39% from last year, when the app counted just 22.6 million diners. Daily orders also increased by a solid 31% to 658 thousand. Overall net revenue for 2020 was $1.8 billion, which is roughly 39% higher than in 2019.
2020 was a transformative year for our marketplace. Strong new diner and restaurant additions across all of our markets coupled with increased order frequency from existing diners culminated in record gross food sales during the fourth quarter. Absent the ongoing support spend we are providing to our restaurant partners, drivers, and diners, the business could easily support long-term economics of more than $1.50 of adjusted EBITDA per order. – CFO Adam DeWitt
However, Net Income is declining, posting a $38 million loss, compared to a positive income of $73 million in 2019. Deteriorating margins make it increasingly difficult for Grubhub to grow profitably, as Net Income margins stood at roughly 15% in 2018.
Crowded Market
The food-on-demand delivery market is crowded, which is not surprising. The barrier of entry is extremely low with small capital requirements and little needed expertise. Essentially, all it takes is an app and an externally hired fleet of freelancers delivering for the company. Thus, it is challenging to build any brand loyalty or customer relationship as there are practically no differentiating factors between competition. What matters for the customer is that the food will be delivered on time from the desired restaurant; which food delivery service carries out the transaction doesn’t matter too much.
Simultaneously, the market size is desirable for new startups: The global online food delivery market size is expected to exceed $164.5 billion by 2025, growing at a CAGR of 14% annually. The pandemic has accelerated these trends further, as dining in restaurants was disrupted in many countries worldwide. Initially, margins were attractive too, exceeding software-like 50-60% through delivery fees, yet have been depressed ever since competition flooded the market.
Source: Forbes
The delivery war around the world is heating up: More and more delivery startups are entering the market to take market share from large established delivery companies such as Delivery Hero, DoorDash, Delieveroo, and Uber Eats. As a result, Grubhub’s gross margins have dramatically deteriorated.
Since being founded, gross margins dropped from an all-time high of 78% to just 29% in Q4. In accordance, profitability dropped and pushed net margins in negative territory. However, the chart points to a slow but steady stabilization in the margin decline, only dropping by about 1% from the prior quarter. This is unsurprising when considering how steeply margins fell in recent years. The industry’s overall gross margins are around 20%, meaning there’s only limited downside from current levels. However, even at 20%, companies can still operate at 5-10% net margins, which would convert to around $200 million in annual income for Grubhub. Thus, profitability trends could reverse again soon, especially when growth slows.
Losing Market Share – But Still a Household Name
Since 2015, Grubhub has steadily lost market share in the U.S food delivery market. Once controlling nearly 70% of the market share, it now sits at less than 20%, far behind competitors including DoorDash and Uber Eats, which collectively control more than 70% of the entire market today.
Source: Food on Demand
However, a 22% market share has been sufficient for Grubhub to grow its sales from just $500 million in 2016 to nearly $2 billion in 2020. Like most large food delivery apps, Grubhub has faced various controversies, including charging hefty fees for restaurants, abusing its initial monopoly in the market.
Cheap Compared to Competitors
Compared to other public delivery services, Grubhub has been trading at a significant discount. Here, most delivery companies, including Uber, Delivery Hero, and Just Eat, are all trading at around 10x EV to sales or higher than Grubhub’s P/S of just 3.5x. These companies are also growing at a similar pace and have comparable margins, operating in a low-margin industry. It’s also worth mentioning that the anticipated delivery company DoorDash is valued at a staggering 30x its current sales. Thus, Grubhub’s valuation at the acquisition may have been too low, even when considering stagnating margins and profitability. If Grubhub would have returned to profitability margins of 10%, the business could have been upwards of $10 billion, representing an upside of 33% from its acquisition price.
Alternatives for Investors?
Grubhub will continue to operate as a separate business, yet it may soon end its North American operations. The acquisition has been strategic for Just Eat to win the delivery war against Uber, as the service company tried to acquire the company in 2020 as well. So, investors of Grubhub are forced to find a new investment now. Despite the hefty competition in the space, the market continues to grow quickly and offers investors attractive investment opportunities. Therefore, alternative investments could include Uber (NYSE:UBER), Just Eat Takeaway (OTCPK:TKAYF), or DoorDash (NASDAQ:DASH). However, while DoorDash currently captures the largest market share, it is also pricey valued, and as mentioned before, the competitive pressure in the space could cause DoorDash’s margins to decline.
Thus, a possible opportunity to capture the market’s growth could be a strategy to equally distribute investments into the major leaders of the food delivery space or invest into an ETF to diversify risk. However, currently, no ETF concentrates solely on food-on-demand companies.
Takeaways
Grubhub has been a rollercoaster since its IPO, briefly surging to $146 in 2018, as the company reported robust market-share, growth, and profitability. However, the success didn’t last long as new competitors quickly took market share from Grubhub, resulting in deteriorating margins. The company eventually sold for a reasonable price of $75 per share, yet considering future growth aspects that might have been too cheap. Either way, investors need to search for alternatives, which is not easy in a highly competitive market. While DoorDash excites investors with ultra-growth and market share, it is priced for perfection and future success in the market is uncertain. Thus, investors looking to capitalize on the quickly growing industry could split an investment across different companies to diversify the risk.