Description

Introduction

GrubHub (GRUB) operates the websites www.grubhub.com and www.seamless.com, which enable consumers to order meals from third-party restaurants for delivery or takeout.  The company has a two-sided network; it has 35k+ restaurants and 6.4m active diners.  Over the past year, it has processed 79 million orders (“grubs”), or over 200k per day, for total gross food sales of $2.2b.  The company takes in over $4 in revenue per order ($26 average order @ 15.5% take rate) and its Adj EBITDAS margins are ~26%.  57% of orders are placed from mobile phones.  Pro forma revenue grew 42% from $254m in 2014 to guidance of $361m for 2015 and Adj EBITDAS grew from $79m to guidance of $102m.  The CEO is the original GrubHub founder.  The combined company had its IPO in April 2014 and first-day trading closed at $34.29/share. 

GRUB was previously written up on VIC by icarus76 on 2/02/15 as a long at $35.43/share and on wanna974 on 3/31/15 as a short at $45.39/share.

GRUB stock price is $24.17/share, 85.9m FDS, $2,075m Market Cap, $330m net cash (FYE), $1,745m EV.

Company Description

The company is based in Chicago and is the result of an August 2013 merger between GrubHub and Seamless.  Those two companies had very similar businesses but focused on different areas: GrubHub was strong in Chicago and had a larger national presence and Seamless was dominant in New York City.  The company currently is still very dependent on those two markets; it does not disclose the revenue or EBITDA share but it is likely very high, north of 80%.  The company uses the GrubHub brand in every market but New York, where it still uses Seamless because of that brand’s historical strength there.  

The company breaks its markets in Tier 1, Tier 2, and Tier 3 but does not disclose any data about them. There are 7 Tier 1 markets (NYC, Chicago, Boston, LA, Philadelphia, SF, and DC).  Tier 2 is mostly cities with professional sports teams and there is a longer tail for Tier 3 markets.

The service is generally free for consumers, though some restaurants add an upfront delivery fee.  Restaurants pay GRUB for order flow, which makes sense for them because additional orders have high contribution margins and they have significant fixed costs.  The GRUB take-rate (disclosed by the company, revenue / gross food sales) is ~15%.  GRUB has shifted to a model recently where restaurants bid for placement on the website.  This has driven up the take rate over the past few years by several hundred basis points.  The company says that in its most competitive markets (dense areas of Chicago with competing pizzerias), the take rate gets as high as 35%.

GRUB has a Corporate business which is ~10% of revenue and growing at ~10% annually.  In this business, companies allocate a certain amount of money per meal to employees.  For instance, UBS bankers might get $25 per night for dinner.  This business is highly lucrative for GRUB and has served as a base on which they built their consumer business.  It has lower commissions but also much lower associated costs.

Competition

Online food delivery is a business highly dependent on local scale.  It doesn’t display winner-take-all characteristics like some marketplaces, but the leader in a local market has meaningful advantages.  I think of GRUB’s model as more like Western Union than something like Facebook in terms of market structure, though GRUB is not susceptible to lower consumer price competition like the former.  It is vulnerable to losing share to either a competing market that is “good enough” and has a decent offering, or to getting cut out of the order entirely if the consumer develops a direct relationship with the restaurant (e.g. Domino’s Pizza app or calling the local Chinese restaurant directly).

Consumers tend to gravitate towards GRUB’s platform because a) it’s free to the consumer, b) it has the widest selection and highest throughput and is generally a smoother experience, c) once the consumer starts using any given platform because of a work account or otherwise, there is a lower chance they will switch due to lock-in (saved payment info, order history), and d) because it is the largest player, it benefits from the intangible and logistical advantages of being the leader in the space.  Once you start using the site as a consumer, there is no real reason to switch.  On the restaurant side, they will ultimately pay for order flow, and it is also easier to standardize on a platform.

GRUB is multiples the size of its nearest competitor, which is currently Eat24 (acquired by YELP in February 2015 for $134m).  This model exists in many countries around the world.  JUST Eat is the dominant player in Europe (publicly traded in UK) and earns 40%+ EBITDA margins in its mature markets.

GRUB’s growth has slowed significantly in the past few quarters.  Organic growth in Daily Avg. Grubs slowed from 29% in Q1 to 25% in Q2 to 22% in Q3.  The worry is that the increased competition is taking a toll and that growth will continue to slow going ahead.  Short interest has increased sharply since June and now is 25% of shares outstanding, I think largely due to these concerns.

The competition comes in a few types:

Straight up competitors like Eat24 or OrderUP: These are standalone businesses or part of a larger company and compete with the same model as GRUB.

Third-party delivery sites:  Postmates, Instacart, DoorDash: These are mostly venture-funded companies that serve as third-party delivery sites.  In many cases they are not deeply integrated into the store but effectively serve as outsourced delivery.  I believe that none of these sites are remotely close to profitability and many are in land-grab mode.  They tend to charge significant delivery fees or markup menu prices due to their lack of scale.

Giants entering business as adjacency:  Amazon (Prime Now Restaurant Delivery) and Uber (UberEats)

In addition, there are a number of smaller players.  According to one sell-side report, VC’s have invested $1.5b on food delivery startups in the past two years.

Competition has certainly impacted GRUB’s sales and will continue to do so going ahead, though it may recede a bit if these companies never establish profitability and end up folding.  Even if they do stick around, GRUB has significant advantages.  They are focused solely on sub-hour food delivery, they have the biggest network, and they are most tightly integrated into the restaurant’s systems.  Having high volume makes everything work more smoothly.

Due to the increasing competition, GRUB made the decision in early 2015 to acquire two food delivery companies, Diningin.com and Restaurants on the Run for $72m.  It announced a third acquisition, Delivered Dish, the other day (terms undisclosed).  Management believes that it is important at this point to maintain its scale lead and sees these acquisitions as a part of that.  Roughly, orders that are GRUB delivered have similar absolute unit profitability but higher revenue and lower margins, as there is basically a $3 pass through expense.  GRUB is losing ~$13m in 2015 and $15-20m in 2016 in delivery costs as it builds out supply ahead of demand.  This supply is variable (basically just hourly drivers) and could be shut off fairly easily, but GRUB feels the investment is worth the long term scale benefit.

Of competitors, the one that I am most worried about is AMZN, as they are patient, willing to sustain multi-year losses, and have started rolling out their restaurant delivery as part of Prime Now more aggressively in the past few months.   A few counter-arguments to that are that AMZN’s offering is not at all established yet, they are focusing on much higher-end restaurants, the service is only eligible to Prime members, and it is not their sole focus.  It is easy to pitch AMZN as the bogeyman that is going to overwhelm every market that it enters, but in a very localized business like this it will not be easy for AMZN to gain huge share.  This is not shipping food out of warehouses; it is physically touching 35k restaurants around the country and constantly updating menus.  It’s a slog.  All the while, GRUB will be focused solely on the business and growing off a $2b+ base of gross food sales.

Valuation

I think about GRUB’s valuation in two ways: off its future earning power and as a possible acquisition target by a player looking to dominate in the space.

GRUB is attractive because it is the biggest player by far in a business where scale matters and which has a long growth runway.  Ordering food online is a better mousetrap than ordering by menu, and there are advantages to the consumer to using a platform that incorporates many different restaurants.  Market penetration is still very low and the business could grow at significant rates for many years.  From a financial standpoint, it is a terrific business and requires no capital.

If it doesn’t succeed as a standalone player, I think it is likely to get bought by a third party like Amazon, Uber, or JUST EAT.  GRUB only has one share class and it does not have any controlling shareholders.  It would be very straightforward to acquire and it has a fairly decent size ownership concentration among hedge funds that I imagine would support a sale.  I note that JUST EAT is a similar size and has a relative valuation over 2.4x that of GRUB.  JUST EAT also paid $687m in May 2015 for the Australia/New Zealand leader in the space, or 33x revenues.  In addition to getting the leader in a scale business, a strategic acquirer would likely have meaningful synergies in G&A and tech spending.

On earnings power, in 2015, GRUB should do ~$360m revenue and $102m Adj EBITDAS (28% margins).  SBC is about $13m and Depreciation & Amortized Software is about $9m, so Adj EBIT is about $76m.  Going ahead, contribution per order is in the range of $3 (75% on platform orders where restaurant delivers and 38% on GRUB deliveries).  GRUB will lose about $13m in delivery in 2015 and a bit more in 2016.

Big picture, I think a few years out that GRUB is doing $600m+ revenues and at maturity EBIT margins are north of 30%.  At a 15x EBIT multiple plus cash, I get a share price in the high $30’s in 2018.

An important thing to consider is that headline earnings of GRUB are meaningfully below what the business would show at maturity, and as such, the headline multiple is greatly overstated.  GRUB gets most of its orders (90%+) from its existing customers, and it spends roughly 25% of revenues on sales & marketing (18% advertising, 7% marketing), mostly to get new customers at the margin.  Like many recurring-revenue-heavy businesses, it spends a lot upfront on customers have a high lifetime customer value.  This penalizes current year earnings but is intelligent for the long-term.  If you add back a chunk of the marketing spend and look at the business on a steady-state basis, then the multiple comes way down from the headline number and I believe that you account for most of the existing valuation.  Implicit in this approach is that GRUB’s customer base has relatively low churn, which for reasons I have explained above I believe is a reasonable assumption.  The company confirms this by saying that cohort-level data is extremely solid and that customer lifetime value is significant.

Looking at this from another angle, while the company does not break out profitability by market, I believe that the NYC & Chicago markets make a ton of money and that the newer markets are losing money, mostly due to marketing spend.  I think that the “mature markets” plus the cash get you most of the way to the current valuation, and you get upside on the other markets.  These mature markets are greatly aided by the Corporate business, which would be hard for a competitor to duplicate.

Catalyst

Continued growth.

Acquisition..