Description

Business Overview

GrubHub is an online platform for restaurant delivery orders, connecting ~75k restaurants in ~1,300 cities across the U.S. through a two-sided network of restaurants and consumers. GrubHub’s legacy model was to act as an asset-light intermediary to generate orders for restaurants through online/mobile -- under this model, GrubHub would charge a ~15% commission on the total order price, while the restaurant’s own delivery drivers would fulfill orders. Under GrubHub’s new model, fulfillment is now handled by GrubHub’s owned proprietary delivery driver network. Under this model, Grub takes a ~30 – 40% take rate to help compensate for the cost to deliver. However, this is a less profitable business model with incremental profit margins much lower at ~35% (vs. 75% without owned delivery).

GrubHub has recently gained momentum with several growth initiatives: (i) expanding into Tier 2/3 markets through owned delivery, (ii) acquiring competitors, and (iii) signing high profile partnerships, most recently with Yelp and Yum Brands, all of which have caused GrubHub’s equity to more than quintuple over the last three years from $20/share in 2016 to $70/share today. We believe GrubHub is a grossly over-hyped growth stock with a quickly narrowing competitive moat, deteriorating business fundamentals, and whose growth prospects are misunderstood by the market.

Short Thesis

Highly competitive market with no identifiable competitive moat – Food delivery apps are proliferating and we cannot, contrary to what Bulls believe, discern any strong first mover advantages or network effects as the industry is structured today. Switching costs are zero for both users and restaurants, and most restaurants are incentivized to sign up to multiple delivery platforms because there are no upfront costs in signing up. GrubHub faces significant competition from well capitalized players who have powerful distribution networks and user bases that are orders of magnitude larger (Amazon, Uber) as well as other delivery startups (Caviar, Postmates, Doordash, etc.).

On the topic of Amazon and Uber, Founder and CEO Matthew Maloney commented during a recent earnings call that "Uber and Amazon are the new boogiemen in the market. We also believe that having the lowest fees is critical…" It is important to reiterate that GrubHub in fact does not have the lowest fees. Take rates for competitors are much lower, with Amazon at 20% and Uber at 25% for both order and delivery services (vs. closer to 30% for GrubHub). Both Uber and Amazon’s history of price action in their main businesses (retail, cloud computing, ride sharing) leaves little doubt that take-rate compression is a matter of when and not if. UberEats is on target to take $3bn in gross food sales according to recent press reports and has 3x the monthly active users on its app compared to GrubHub.

 Furthermore, on March 1^st, Doordash raised $535M from a group of high profile investors including SoftBank, Sequoia Capital and GIC. The capital raise provides Doordash with significant resources to finance new growth opportunities, including tripling the company’s geographic footprint from 600 cities to 1,600 cities over the course of 2018. We view Doordash’s capital raise as an incremental negative for GrubHub as it bolsters yet another well capitalized competitor (in addition to UberEats and Amazon).

 Business model shift to owned last-mile delivery is a transparently defensive move to forestall competitive pressures and comes with a much lower margin profile – GrubHub has historically operated an asset-light intermediary (relying on existing individual restaurant delivery personnel for fulfillment) and has only recently begun adding delivery capabilities of its own. In contrast, Amazon and Uber are first and foremost full-fledged and massively scaled delivery/fulfillment operations. Investing in last-mile delivery has allowed Grub to reach new markets and smaller cities where restaurant delivery is not as prevalent and consumer dining habits are different, but this business comes at a much lower margin. Owned delivery has fundamentally worse unit economics with run-rate profit margins of ~35% with delivery vs. ~75% without delivery.

 What’s more, even founder and CEO Matt Maloney has gone on record to state that owned-delivery is a poor, labor-intensive business model:

 "I'm running my delivery-based business with the explicit goal to break even," Maloney says. "That's not fun for me, and normally I'd say that's the dumbest business you could ever be in. Why run a break-even business? That's a pain in the butt." (Matt Maloney, 2016 Forbes interview)

 Deteriorating business fundamentals – A detailed look at various cuts of GrubHub’s performance indicators suggests weakening business fundamentals. Most strikingly, both average order count per diner as well as gross food sales per diner have been in decline over the last few years -- we believe these trends are a leading indicator of GrubHub’s inability to stave off competitive pressures. Concurrently, customer acquisition costs have nearly doubled since 2014. GrubHub’s unit metrics disclosure is poor (no churn numbers and poor customer definitions), but these indicators widely suggest a falling LTV/CAC. For a company expected to grow revenue over 25% while still growing margins, we anticipate one of those two variables to miss in coming years.

 M&A runway is contracting – A large portion of GrubHub’s growth has come from acquisitions, with GrubHub spending ~$450M to acquire five online restaurant delivery platforms over the last two years: Eat24, Restaurant on the Run, Delivered Dish, DiningIn, and LABite. These acquisitions were positively received by the market, and we do agree that there is value to reducing competition in the market. However, the M&A landscape is now fully exhausted with no remaining acquisition targets of scale. Matt Maloney said it best during the company’s latest earnings call:

“Over 1.5 years ago, we acquired the 5 leading RDS companies in the U.S. I don't think there's a lot left out there… There's no one else out there who's going to meaningfully augment our network through acquisition in the restaurant delivery space at least.” (Matthew Maloney, Founder and CEO, Q3’17 earnings call)

Inflated TAM with high value cities already fully penetrated / low quality regions remaining – GrubHub and GrubHub Bulls maintain that ~$70bn is spent annually on delivery and takeout at independent restaurants in the U.S. A negligible amount of GrubHub’s commissions come from takeout orders and, on the whole, consumers do not currently use GrubHub when ordering takeout. Therefore, one could argue that GrubHub’s TAM should not be inclusive of the takeout market. Euromonitor data (the same data source used by GrubHub) suggests U.S. spending on delivery alone was ~$17bn in 2017, what we view as a better proxy for GrubHub’s total addressable market.

 Furthermore, traffic in Grub’s core NYC market is fully saturated, and the consumer proposition in less populated cities is less powerful given differences in consumer dining habits and delivery restaurant density. We believe the ~$70bn TAM figure is overly optimistic and the real TAM is far less. Grub is not scalable to all U.S. regions and works best in large or highly dense areas.

 Insider selling – Insider selling patterns also do not invoke confidence with $75M in insider sales since January 2017.

Key Risks

Strategic takeout / acquisition by a competitor or new entrant

Mitigant: If one were to agree that there are no significant network effects to GrubHub’s business, then the only reason to acquire Grub would be to purchase the users themselves. However, at an EV of ~$650/active diner today, the price to acquire GrubHub’s users is extremely pricey.  Uber and Amazon are not the acquiring types and we do not see the logic in paying a premium for aggressive user expansion when competitors can build the exact network cheaply and organically.

Weakening competition – Weakening competition, primarily with regional players and VC-funded startups, could positively impact near-term Grub results. Postmates recently struggled to raise money at discounted valuations and the inflow of VC money into the food delivery sector has meaningfully decelerated.

New partnership announcements with fast food chains / other strategic partners – Recent Yelp and Yum partnerships were positively received by the market, and the size of the total addressable market could grow materially if GrubHub expands beyond independent restaurant delivery into fast food chain delivery (fast food chain delivery estimated TAM of ~$170bn incremental to ~$70bn TAM for independent restaurant delivery).

Secular tailwinds in online penetration for food delivery

Online penetration for food delivery is still very low at ~5% penetration today. This compares to ~10% online penetration for the eCommerce sector and ~40% online penetration for the travel sector. Secular industry tailwinds could support ongoing consumer conversion to online food delivery, from which Grub would benefit.

Capital allocation – Management recently authorized a $100M share repurchase program which could provide a positive uplift to shares in the near-term.

Catalyst

Catalysts

·         Announcement of competitive rollouts and new fundraising rounds for private competitors

·         Acquisition integration missteps (e.g., Eat24 integration in 2018)

·         Declining web traffic, daily average users, take rates, and orders per active user

·         Top-line / margin miss or guide down on earnings