Description

Recommendation: Short Grubhub (GRUB US) as it will face growth headwinds as the company pushes out of its core New York market. Competitive pressures from other food delivery start-ups, implementation of a NY Attorney General ruling, and lapping the infamous Polar Vortex of Winter 2013/14 will put the company at risk of a top line miss in 2015. Our base case scenario assumes revenue growth of 20% in 2015 which argues for a re-rating of EV/Sales multiple to 3x from today’s 8.5x, yielding a valuation of $14/share (-60% from today’s equity value). Please see the comparables appendix for chart illustrating correlation between comp set revenue growth and EV/Sales multiples.

Business Description: GRUB is an online and mobile platform for restaurant delivery and pick-up orders. GRUB claims to operate in 600 US cities across all 50 states. The platform includes more than 30,000 restaurants and 4.6 mm ‘active users’ in 2014. GRUB is comprised of Grubhub and Seamless.com which merged in Q3 of 2013. Seamless mainly operates in New York City and Grubhub operates nationally. On average, restaurants pay ~15% on the ‘gross food value’ (F+B, tax, tip, delivery fee) to Grubhub for every order placed on the site.

Investment Overview:

·         Revenue concentration in New York City of >70% opens GRUB up to the following risks:

o    The market is not aware that the vast majority of combined Grubhub/Seamless revenues are in New York City. Through consumer credit card data data pools, we estimate that 70-80% of GRUB revenues originate in NYC[1]. The merger between Grubhub and Seamless allowed the company to cross-sell to its NYC restaurant and consumer base and enjoy one time synergies in 2014 such as migrating Seamless to a higher commission structure which contributed 10% to 2014 growth. Given the maturity of the NYC market (Seamless was founded in 1999) and lapping of merger benefits, NYC is unlikely to support the 30% revenue growth Consensus expects in 2015.

o    New Yorkers spend a lot more on delivery than people in the rest of the country. Seamless (primarily NYC) users spent 135% more per year than Grubhub users (primarily Chicago and other cities)[2]. As GRUB expands outside of NYC, average user spend will be diluted by non-NYC users.

o    The NY Attorney General’s office ruled in April 2014 that Grubhub has a 1 year deadline to exclude tips from its ‘gross food value’ base upon which it charges restaurants commission[3]. We called 30 restaurants and received majority confirmation that this change has not yet been implemented[4]. In 2015, this should be a significant headwind for GRUB in its key market as its total food value shrinks by 10-20%.

GRUB faces tough comps as Northeast markets lap the polar vortex. From Google Trends we can see Seamless and Grubhub interest spiking during the polar vortex, leading to strong yoy comparison in Winter 2013/14. From searcho    trends we can see that the delta between 2014 and 2013 compresses throughout the year as weather normalizes which point to GRUB facing difficult comps in Winter 2014/15.

·         The TAM that the company uses as a reference point is inflated by 9x.

o    GRUB and GRUB bulls maintain that the TAM of the US market is ~$9 bn in revenues = $67 bn is spent annually on delivery and takeout at independent restaurants in the US x average GRUB commission rate.

o    According to historical US restaurant data from Euromonitor (the same data source used by GRUB), delivery accounts for ~3% of US restaurant spending while takeout accounts for 19%. These ratios have been unchanged since 2008, indicating consistent consumer behavior.

o    A negligible amount of GRUB’s commissions come from takeout orders. On the whole, it seems that consumers do not currently use GRUB when ordering takeout, only delivery. Therefore, we would argue that the takeout market is not a part of GRUB’s TAM since only a small percentage of restaurants in the US offer delivery services and very few consumers use their service for takeout ordering.

o    According to Euromonitor data, US spending on delivery alone ~$16.7 bn in 2014. 47% of the restaurant spend in the US is spent at independent (non-chain) restaurants. Therefore, we estimate that only $7.8 bn is spent on independent restaurant delivery which equates to ~$1 bn TAM for GRUB.

o    We believe that GRUB understands this dynamic as reflected by the fact that the company is running pilot programs where they offer restaurants delivery services. The company is currently hiring delivery employees in Chicago, LA, and San Francisco[1]. If GRUB becomes a delivery services provider, we anticipate a major change in its margin profile.

·         GRUB’s incremental pricing power is structurally limited. GRUB benefited in 2014 from migrating Seamless to Grubhub’s tiered commission model (bid for higher placement on the site vs old Seamless flat fee). However, going forward, it will be difficult for GRUB to continue to increase price. On average, full service restaurants make ~35% margin after accounting for F+B and wage costs[2]. The GRUB commission represents 60-100% of that margin.

·         GRUB is facing intense competition from start-ups and established companies.

o    Traditional restaurant platform competitors include Eat24 and Delivery.com who recently partnered with Yelp to power food delivery.

o    New and expanding competitors include Foodler, Caviar (Square), Task Rabbit, PostMates, Munchery, etc.

o    Large players include Amazon (Seattle pilot) and Uber.

o    Cook at home genre: Blue Apron and similar models that deliver chef designed meal ingredients.

Risks:

·         Acquisition risk: A larger player (Amazon, Yelp, etc) may buy GRUB to acquire its restaurant listing network. The mitigant to this risk is that other platforms such as Eat24 have a comparable number of restaurants (~25,000 vs 30,000 for GRUB) on its platform and would likely be cheaper targets.

·         The company is cash rich with $277 mm to spend on sales and marketing. If the company spends to acquire customers through deals such as free delivery, recommend a friend and other programs, GRUB will be able to inflate user metrics as long as the company keeps spending. Since user metrics are measured on a 12 month basis (if you used the platform in the last 12 months you are listed as an active user), user attrition will be unclear for at least 4 quarters.

·         We may be overstating the effect of the tip reduction on NYC orders.

·         We may be overestimating how much the polar vortex helped comps in Winter 2013/14.

Catalyst

Top line miss or guide-down on 2Q15