Description

Demae-Can Write-Up for VIC

Executive summary

Demae-Can offers a highly asymmetric investment opportunity.  Comparable company valuations and recent M&A transactions suggest limited downside at the current share price versus +575% upside in bull case scenarios.  

Founded in 1999, Demae-Can is the Japanese incumbent online food delivery platform with widespread consumer recognition and one of the largest restaurant networks.  A transformational March 2020 equity placement led to 61% combined ownership between LINE/Naver and Z Holdings/Softbank and fundamentally rebooted strategy, management and resources.  LINE and Z Holdings (renamed from Yahoo! Japan) are Japanese Internet kingmakers that are integrating Demae-Can into their dominant messaging and payment ecosystems.  Following its $750 million equity raising in October 2021, Demae-Can is accelerating investment to capture leadership in the still nascent Japanese online food delivery market.  Demae-can estimates 17% of Japanese consumers actively order food online today versus 37-40% in the U.S., U.K., Singapore and the Netherlands.

Demae-Can should emerge as one of the winners due to several advantages:

Existing scale and accelerating growth:  Demae-Can and Uber Eats are already far and away the largest food delivery operators in Japan.  Growth massively accelerated post “takeover” by LINE and Z Holdings with active users growing 12% in the August 2019 quarter, 31% in the August 2020 quarter and 87% in the August 2021 quarter.  GMV consequently inflected from 24% growth to 31% then 58%, which was further outpaced by sales from 23% growth to 55% then 181% reflecting increasing proportion of higher take rate delivery transactions at the expense of marketplace transactions. 

Unparalleled advantages within the Japanese ecosystem:  Key shareholder LINE is the dominant messaging app in Japan with 89 million monthly active users and the closest thing to a Japanese “SuperApp”.  The LINE app provides Demae-Can a head start for user acquisition and engagement with access on its home and wallet tabs.  LINE also provided the new Chairman/CEO, CFO, and COO and accompanying engineering resources.  Key shareholder Z Holdings operates leading Japanese online properties for search (Yahoo! Japan), e-commerce (Yahoo! Japan Shopping/Auctions, Zozo, and Askul) and mobile payments (PayPay) with support from parent Softbank which operates one of the three incumbent telcos.  Z Holdings is working to improve the efficiency and density of Demae-Can’s logistics infrastructure by leveraging its last mile delivery for Z Holding’s e-commerce businesses.  International competitors bring know-how but limited synergies with global operations given the hyper-local nature of food delivery.

Aggressive management mindset and strong balance sheet:  Until March 2020, Demae-Can was capital-starved, particularly versus online food delivery competitors.  Average year-end net cash for the three years ending August 2019 was below ~$25 million.  LINE and Z Holdings subsequently helped Demae-Can raise ¥30 billion in March 2020 and another ¥83 billion In October 2021.  During the latter roadshow, Demae-Can management reiterated intentions to further accelerate investment to put pressure on publicly-listed competitors with profitability targets. 

Business model description

Most readers will be familiar with the online food delivery business model and the distinction between marketplace orders for which the restaurant provides the delivery; and delivery orders for which delivery is outsourced to the food delivery company and its partners.  Demae-Can operates a hybrid marketplace/delivery model and refers to the two different models as Ecommerce (marketplace model) and Shared Delivery.  The company has been rapidly scaling up its delivery model and adding new restaurants.  As a result, while marketplace orders accounted for 68% of full year GMV (August 2021 year-end), the company exited the year with delivery orders accounting for 60% of 4Q-Aug21 GMV. 

With 7.3m active users, delivery model household coverage of 56%, and 84k restaurants on its platform, Demae-Can has a long runway ahead of it.

Marketplace Model

Demae-Can started out with a marketplace model which enables users to order from restaurants with in-house delivery capabilities.  Merchants are charged an order commission as well as various systems and payment fees.  Over the past two years, the company has raised the order commission rate that it charges restaurants.  In the most recent fiscal year ending August 2021, between order commissions and other fees, Demae-Can realized revenue equivalent to approximately ~7.5% of GMV.  This monetization rate remains well below the low-to-mid-teens marketplace fees achieved in other markets.  Going forward the company expects the monetization rate to continue to rise as more merchants adopt a 10% pay-as-you-go service fee; in the future, Demae-Can also aims to introduce an advertising offering.  Demae-Can’s marketplace model is asset-light and was historically very profitable despite relatively low monetization rates:  for example, in FY-Aug12 and FY-Aug13, Demae-Can achieved +40% EBITDA margins despite monetization rates below 6% of GMV. 

Delivery Model

In recent years, Demae-Can has aggressively built out its Shared Delivery model to serve restaurants which lack in-house delivery capabilities.  The company reported that its delivery model currently covers 56% of households.  Demae-Can estimates Japan has 30k restaurants with in-house delivery and 600k restaurants in total, which implies 570k restaurants which lack in-house delivery (Oct. 2019 presentation).  Put another way, building out a delivery model arguably expands Demae-Can’s addressable restaurant market by 20x!

For delivery orders, Demae-Can experimented with both in-house staff and outsourced delivery.  Going forward, fulfillment will primarily be outsourced to third-party delivery staff.  The delivery model is compulsory to expand the restaurant base, offer consumers greater choice, and defend the profitable marketplace business. 

Demae-Can charges an incremental 25% delivery commission for delivery orders, a portion of which is borne by users.  At present these incremental revenues to Demae-Can are more than offset by the associated delivery costs.  The company intends to aggressively expand its delivery model and has guided that it will “increase the number of delivery staff 3.6x” in the coming fiscal year.  Management envisions an end state where the outsourced delivery service breaks even and the company can turn a profit on its order commissions which are applied to all orders and system fees which are applied to all restaurants. 

Future initiatives

Demae-Can is also looking to expand its delivery model to cover non-restaurant categories and has announced partnerships with Seven-Eleven Japan and Askul, a B2B office supply e-commerce company which is 45% owned by Z Holdings.  Expanding beyond the restaurant delivery segment would significantly increase Demae-Can’s “Total Addressable Market”.  Demae-Can estimates the Japanese supermarket, CVS, and drug store markets would more than double their existing TAM.

We don’t think Demae-Can is the next Grubhub or Just Eat Takeaway

While Grubhub and Just Eat remain led by founders who cut their teeth during the profitable marketplace-dominant era, the entire Demae-Can team including Chairman/CEO, CFO, and COO turned over to aggressive, mobile-oriented, app-native executives seconded from LINE, the dominant Japanese messaging app.

We think Demae-Can is better-positioned today in Japan than GRUB and Just Eat were in the U.S. and U.K., respectively.  Whereas GRUB and Just Eat were reluctant supporters of the delivery model, Demae-Can is all-in with respect to building out its delivery model.  Another important difference is the strong support Demae-Can receives from its major shareholders.  Demae-Can has access to the massive user traffic on the LINE and Yahoo! Japan ecosystem:  e.g., Demae-Can highlighted how, between September 2020 and June 2021, LINE/YAHOO contributed an incremental 166% growth in total traffic.   In addition, Demae-Can is receiving significant technical/development support from mobile Internet-native LINE.  Management has also been supplemented with executives from LINE.

Regarding Uber Eats, in Japan Uber does not have a ride-hailing business which limits Uber’s ability to leverage driver networks across both offerings and cross sell Rides and Eats.  That said, Uber Eats has executed well in Japan and represents Demae-Can’s strongest competitor.  Uber is also at a different stage in its lifecycle today.  As a private company under founder Travis Kalanick, Uber was an ultra-aggressive operator, profitability be damned.  In contrast, the Uber of today has promised public shareholders that it will soon reach profitability, perhaps reducing the competitive intensity for Demae-Can.

LINE and Z Holdings:  Shareholders With Benefits

We believe Demae-Can’s major shareholders can be difference makers in the battle for market share in the Japan online food delivery sector.  Beyond simply providing capital, LINE and Z Holdings are contributing management and development resources.  Furthermore, they are integrating Demae-Can into their existing ubiquitous internet services and seeking additional opportunities to work together.

LINE

LINE is the dominant messaging app with 89 million monthly active users in Japan.  Demae-Can and LINE first started working together in 2016 when LINE took a 20% stake in Demae-Can and the company became an equity method affiliate of LINE.  In 2020, the two companies announced a further capital and business alliance.  As part of this agreement, LINE and an affiliate of its parent company NAVER invested ¥30 billion, raising the combined LINE/NAVER stake in Demae-Can to ~61%.

From LINE’s perspective, food delivery is a high-frequency use case that can drive user engagement within the LINE ecosystem.  Since the initial tie-up, Demae-Can has been progressively integrated into the LINE app on multiple levels including:  Home Tab placement, Wallet Tab placement, LINE Search results, and a Demae-Can Official Account which pushes promotions to users.  On the back-end, the two companies’ User ID systems are also being integrated with each other.  With the help of LINE’s developers/engineers, Demae-Can has revamped its product functionality and UI/UX.  LINE has also reinforced Demae-Can’s organizational structure with personnel from LINE.  Today, most of Demae-Can’s senior executive team hails from LINE, including the current President/CEO/Chairman, Hideo Fujii; CFO, Satoshi Yano; and COO, Shouji Fujiwara. 

Z Holdings

In late 2019, Softbank Group and Naver Corporation effectively decided to merge Yahoo! Japan and LINE.  Following a series of transactions, Z Holdings became the holding company and operator of Yahoo! Japan and LINE.  In Japan, Yahoo! Japan’s ecosystem includes a collection of Japan’s most popular internet services, including Yahoo! Japan (with search powered by Google), e-commerce sites Yahoo! Japan Shopping/Auctions, Zozo, and Askul; and Japan’s leading mobile payments service, PayPay.  

Demae-Can stands to benefit from Yahoo! Japan’s substantial user traffic.  For example, Demae-Can enjoys a page link near the top of the Yahoo! Japan home page, the second most visited site in Japan after Google.  Interestingly, Z Holdings appears to be most interested in Demae-Can’s logistics capability.  In its company presentation, Z Holdings highlights its aim of “becoming no. 1 in distribution volume in the domestic food delivery market, while achieving further synergy in the last mile delivery domain, through investment in Demae-Can.”  Z Holdings is working with Demae-Can to strengthen the last mile delivery network and identify other “quick commerce” / “instant delivery” categories.  To that end, the two companies are trialing a service through which customers of Z Holdings’ Askul e-commerce subsidiary can have daily necessities delivered by Demae-Can.

Accelerating KPI trends

While food delivery has undoubtedly been one of the biggest beneficiaries of the pandemic, Demae-Can has managed to maintain high user and GMV growth even as the company laps strong comps. 

Pressing the Accelerator

Last October 2020, the company announced an aggressive three-year Medium-Term Management Plan in which it planned to more than triple GMV in the three years ending August 2023:

Demae-Can managed to meet the first year FY-Aug21 targets and subsequently revised up its FY-Aug22 GMV target from ¥250 billion to ¥330 billion, implying a doubling of GMV in the coming year.  However, this incremental growth will come at a high cost.  Whereas management had previously planned to reduce losses and approach break-even in FY-Aug22, the company now expects operating losses to balloon to -¥50-55 billion as it prioritizes growth.    

 We think some of the recent share price weakness may be due to investor apprehension around a growth-at-any-cost strategy.  That said, management sees an opportunity to press the accelerator with a newly-filled war chest and a competitor in Uber which has publicly committed to a path toward profitability.

Industry Landscape

The Japanese online food delivery sector is in its early innings.  We can look at the number of active paying users, # of restaurants, and food delivery GMV as measures of online food delivery penetration.

User #s

The exhibit below comes from a recent Demae-Can roadshow presentation (September 2021).  According to this data, 16.8% of Japan’s population are active paying users of online food delivery.  This compares to adoption rates ranging from 21.5% to 40% in other developed markets. 

Restaurant #s

Demae-Can had 84k restaurants on its platform as of August 2021.  Uber reached 100k restaurants in May 2021.  The Statistical Handbook of Japan 2021 states there were ~591k eating and drinking establishments in Japan as of 2016, in-line with Demae-Can’s 600k estimate.  Government statistics suggest roughly a third of establishments are bars and nightclubs that are unlikely to utilize food delivery platforms, leaving a target market of ~400k restaurants.  So back of the envelope, we estimate Demae-Can has only penetrated 20-25% of the addressable restaurant market.

In comparison, Doordash, the largest food delivery operator in the U.S., has penetrated ~42% of the restaurant market in the US and Canada.  Specifically, DoorDash exited 3Q21 with over ~460k restaurants (“well over 500k partner merchants” less “40k non-restaurant stores”).  The National Restaurant Association estimates there are 1 million restaurants in the US and Statistics Canada states ~there are more than 97k restaurants, bars, and caterers across the country.”

Online food delivery GMV

The exhibit below shows 2019 GMV and User penetration based on Euromonitor and UBS data, where:

• GMV Penetration = (online delivery sales through third party platforms) / (food service sales)

• User Penetration = (active users on platforms) / (population above +15 years old)

Note that this data set reflects 2019 data.  Online food delivery sales have increased significantly since the coronavirus outbreak.

Coronavirus Structural Uplift

The following Euromonitor exhibit highlights the remarkable growth of online food delivery in 2020.  Note that the penetration rates shown below are lower than the prior exhibit due to a different numerator.  Namely, the numerator in this exhibit includes all online delivery sales, inclusive of both third-party platforms and restaurants’ own online ordering platforms.

Competitive Landscape

Online food delivery is a competitive sector that is fought on a market-by-market basis given restaurant and delivery network effects tend to be local in nature.  Numerous domestic and international players are operating in Japan including Uber Eats, Doordash, Foodpanda (Delivery Hero), Wolt, etc.  The number of new international entrants arguably validates the early-stage, under-penetrated opportunity in Japan.  As mentioned earlier, we think international players will enjoy limited synergies with their existing operations outside of Japan.  By most metrics, Demae-Can and Uber Eats are far ahead of the pack. 

Demae-Can and Uber Eats are clear leaders in Japan

Data from various publicly available resources suggests the two companies attract similar levels of interest on Google, while Uber Eats appears to be leading in terms of app downloads (AppAnnie data) and GMV (Measurable AI data).  A few caveats:

• App downloads may flatter Uber Eats as many Demae-Can users still use the Demae-Can website.  In addition, the Demae-Can platform is accessible through the LINE app.  (We need to check with management on the current channel mix).  We tend to play down the app download rankings as LINE has 89 million monthly active users and every user can access Demae-Can through LINE.  Demae-Can’s main challenge is how to more effectively convert LINE users into Demae-Can users.

• We came across Measurable AI data which shows Uber Eats with a commanding 55-60% of online food delivery sales.  This compares to Demae-Can at 35-40% of GMV.  We have reached out to Measurable AI to better understand the e-receipts dataset that they rely on. 

 Google Trends shows similar levels of interest in Demae-Can and Uber Eats over the past 12 months; other players barely register.

AppAnnie data shows Uber Eats outperforming Demae-Can in terms of app downloads

Apple IOS store:  over the past 90 days, within the “Food and Drink” category, Uber Eats average download ranking was 2.34 ranking vs Demae-Can at 3.37.  (The McDonald’s app outperformed both.) 

Google Play store:  over the past 90 days, within the “Food and Drink” category, Uber Eats average download ranking was 2.43 vs Demae-Can at 3.62. 

 As referred to earlier, Demae-Can is already available to all LINE users.  As a result, we believe converting LINE users is a greater priority than accumulating Demae-Can app downloads.

We also came across the following market share data from alternative data provider Measureable AI which tracks e-receipts.

Source:  Measurable AI; https://blog.measurable.ai/2021/09/30/japans-untapped-food-delivery-market-is-already-crowded-whos-winning/

Over the past 20 months, Uber Eats averaged 64% market share (mean) vs. Demae-Can at 31% market share.  This implies all other players averaged ~5% market share (of the spend tracked by Measurable AI).  We have reached out to Measurable AI to better understand their methodology and to what extent it captures Demae-Can sales which go through the LINE app.

Social Media Following

Demae-Can and Uber Eats Japan have very different followings on social media depending on the platform.  Demae-Can has far more followers than Uber Eats Japan on platforms which are popular in Japan (LINE and Twitter), but has a limited presence on Facebook and Instagram.

Multi-bagger Upside

Hundreds of billions of market cap have been created by leading food delivery companies around the globe.  In a nutshell, we believe Demae-Can’s $1.1 billion market cap  (which gives no credit for Demae-can’s ~$800 million of net cash) is far too low for a top two player in the world’s third largest economy.  Below are two extremely crude measures of where things stand today in Japan and the tantalizing possibilities for Demae-Can: 

Exhibit assumptions and comments

• US:  I value UBER’s US food delivery at 25% of UBER’s EV (50% for food; of which 50% for US).

• Brazil:  Just Eat Takeaway (JET) has said they rejected a 2.3b EUR offer for JET’s 33% iFood stake.

• UK:  I value both players at ROO’s current EV, though both JET and ROO are in multiple markets.

• Germany and S. Korea:  I assume the top 2 players were similar in size at the time of consolidation.

• Japan:  I assume Demae-Can and Uber are similar in size; I value Demae-Can at mkt cap and ignore the +$800 million of net cash.

Even if one quibbles with some of these assumptions, it is clear that Demae-Can’s current enterprise is a small fraction of leading food delivery companies in other major markets.  Namely:

• EV/GDP:  the median combined EV/GDP of the top 2 players is 0.52% vs Japan at ~0.045%

• EV/Pop:  the median combined EV per pop of the top 2 players is ~$149 vs Japan at $17

o   The only country in the same ballpark is India where GDP per capita is ~1/20th of Japan

EV/GMV is a less crude and more commonly utilized valuation metric in the online food delivery sector.  Demae-Can still screens as the least expensive online food delivery company, though here the gap with peers is narrower, in part reflecting Demae-Can’s lower effective monetization rate.  Note that pinning down the Demae-Can’s enterprise value is tricky given the company plans to spend most of the recently raised cash over the next 2-3 years.  Below I show Demae-Can’s EV/GMV multiples with and without the cash (currently equivalent to +70% of its market cap).  Demae-Can valuation looks particularly compelling in light of its targeted growth rate which is the highest within the peer group.  (Demae-Can’s valuation would be further flattered if we adjust Demae-Can from an August to a calendar year end).

FY-Aug25 GMV and “Normalized” EBITDA Forecasts

Forecasting quarterly results is a challenge given the rapid growth and many moving parts on the cost side.  We have taken a higher-level approach to framing the longer-term earnings power and valuation.  We start with Demae-Can’s FY-Aug22 GMV guidance and assume growth decelerates thereafter.  In the exhibit below, we have GMV growing from ¥162 billion in FY-Aug21 to ¥660 billion in FY-Aug25.  This is equivalent to a 42% 4-year CAGR and a 26% CAGR for the three years after achieving management’s FY-Aug22 target.

Next we apply our EBITDA margin assumptions.  As context, below are some of the achieved and targeted EBITDA margins as a % of GMV by international food delivery companies.  Uber and Delivery Hero have presented long-term adjusted EBITDA targets, though note that Uber’s “adjusted EBITDA” excludes certain corporate expenses.  Similarly, the Just Eat Takeaway achieved country-level EBITDA margins are before certain head office costs.

Based on the range of EBITDA margins seen above, we’ve shown Demae-Can achieving normalized margins of 2.5% in FY-Aug22, rising to 5% in FY-Aug25.

The above GMV growth and EBITDA margin assumptions combine as follows.  Assuming a 15-25x P/EBITDA (equivalent to an EV/EBITDA multiple with zero net cash) suggests limited downside and potentially ~575% upside.

Below is a sensitivity table showing EBITDA as a function of GMV growth and EBITDA margin.  The second table shows the implied P/EBITDA at the current share price.

As suggested above, we believe Demae-Can can be a multi-bagger.  In terms of downside, while it is possible Demae-Can could be completely out-executed and/or out-spent by competitors, we think the company will still retain significant nuisance value as a sizeable #2 or #3 player.  It is worth flagging that Softback is a significant shareholder of Demae-Can (through Z Holdings), Uber, and both Doordash and Wolt. 

Below are some recent M&A transactions for non-market leading platforms.  Note that the Woowa acquisition took place prior to the coronavirus outbreak, while the GRUB and Postmates acquisitions took place in the earlier months of the pandemic. 

If we applied these transaction multiples to Demae-Can’s run-rate GMV, we’d get the following implied share prices (with run-rate GMV set to increase significantly as the company progresses against its guidance). 

Key risks

We view competition and equity dilution as the major risks and we think they are likely linked.  Almost certainly, Demae-Can will need to come back to the market to raise additional capital as the current cash will likely be consumed in the next 24 months.  If competition intensifies and Demae-Can loses more money and more market share than expected, new equity will likely be very expensive and dilutive to existing minority shareholders.  

For reference, here is Demae-Can’s current market capitalization and enterprise value: 

Catalyst

- Accelerating GMV growth as the company executes against its FY-August 2023 GMV target

- Coronavirus-related lock-downs and re-openings

- Industry consolidation