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Summary

  • Merger between GrubHub and Seamless results in scale and execution risks.
  • Headline sales results are "inflated" as a result of the merger.
  • Yet, the future opportunity is enormous for this market leader.

GrubHub (NYSE:GRUB) made its public debut at the start of April. Shares of the online and mobile platform for restaurant pick-up and delivery orders have seen their fair share of volatility ever since, but are generally trading up following their debut.

The company is a market leader through an engineered merger last year, standing to benefit from a huge market opportunity in the coming years. Yet, the current valuation leaves quite some execution risks, and I do not believe that the current levels leave a great entry opportunity for investors, despite aggressive growth and the fact that the company is already profitable.

The Public Offering

GrubHub processes takeouts, connecting local restaurants in over 600 US cities with consumers in order to transform the takeout experience. The company focuses on a strong platform, creating a "direct" line with the kitchen in order to avoid confusion, inefficiency and inaccuracies, thereby allowing independent restaurants to boost their sales.

GrubHub sold 7.4 million shares for $26 a piece, thereby raising $192.5 million in gross proceeds. Note that some 4 million shares are sold by the company itself, raising $104 million in gross proceeds for the business, while the remainder of the shares are offered by selling shareholders.

Initially, bankers and the firm set an initial price range of $20-$22 per share, which later got revised upwards toward $23-$25 per share. Strong demand pushed the final offering price another dollar higher than the high end of the already raised range.

Some 9% of the total shares outstanding were offered in the public offering. At Monday's closing price of $35.16 per share, the firm is valued at $2.7 billion.

The major banks that brought the company public were Citigroup, Morgan Stanley, Allen & Company, BMO Capital Markets, Canaccord Genuity, Raymond James and William Blair.

Valuation

GrubHub is all about making live easier for both consumers as well as restaurants. Customers can try new restaurants with easy and online ordering, while restaurants can boost sales without adding waiting staff or tables. According to a report prepared by Euromonitor, US consumers spent about $204 billion across 350,000 restaurants back in 2012. GrubHub itself reckons about a third of this amount is spent on takeout.

The new GrubHub is the product of a merger which took place in August of last year, when Seamless and GrubHub turned into one company, putting 28,800 restaurants on their combined platform. In total, there are about 3.4 million users making active use of the service, taking out an average of 135,000 Grubs a day in 2013.

For the year of 2013, GrubHub generated revenues of $137.1 million, up 66.6% on the year before. Impressively, GrubHub reported earnings of $6.7 million, which was down in the year before on the back of very steep tax provisions. Operating earnings did, however, show a healthy rise.

Note that growth was inflated by the merger, of course, and the "inflation" of top line revenue growth is discussed in this well-written Forbes article. Note that GrubHub takes an impressive cut. The reported revenues of $137.1 million for last year were achieved on $1.05 billion in actual food sales, implying an average commission rate of 13% by the intermediary.

The company operates with $86.5 million in cash on a pre-IPO basis, and the offering will allow it to roughly double its cash balances. GrubHub has no debt outstanding. The current $2.7 billion valuation values operating assets just north of $2.5 billion. This implies a valuation of roughly 18 times annual revenues and a non-meaningful profit multiple.

Investment Thesis

As noted above, the offering of GrubHub has been a great success. The company priced the offering at $26 per share, some 23.8% above the midpoint of the preliminary offering range. The solid opening day returns of 30.8% have left shares trading some 59.8% above the midpoint of the preliminary offering range.

It should be noted that GrubHub is already profitable at the moment, unlike many IPOs these days. Operating at the intersection of technology and food, it has much growth potential ahead, while the merger of the two prominent takeout companies is boosting its competitive position. This is important given the importance of scalability and network effects, which results in a winner-takes-it-all outcome. As a matter of fact, mobile is no issue as well, with 43% of orders in the final quarter of 2013 being placed from a mobile device.

Of course, the current valuation is ridiculous based on the current metrics, even as the current run rate of revenues is approaching $200 million per annum and margins are fat. Yet, the valuation is based on the premise of future growth, taking a bigger share of the estimated $70 billion takeout market.

If GrubHub could take a nice market share of, let's say 30%, it would see $20 billion of food being processed through its network, resulting in $2.5-$3.0 billion in revenues per annum. On these revenues, very higher margins could be achieved. Yet, this requires years of growth and fencing off competition from yet unknown competitors, as well as guys like OpenTable (OPEN).

As such, GrubHub has a lot to prove, and most important will be to continue to show healthy revenue growth, although headline numbers will undoubtedly decline from the reported rates in 2013. As discussed before, these were inflated because of the merger.

Obviously, this could go both ways, but for now, I believe the current valuation is high enough to restrain me from jumping onto the bandwagon.

Source: GrubHub - Huge Opportunity Ahead, Yet Valuation Has Pushed Up Expectations