GrubHub: A History Of Smart Acquisitions And No Debt Make This IPO A Rare Opportunity

| About: GrubHub Inc. (GRUB)
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Summary

GRUB is a rare chance to own a market leader at IPO.

GRUB will look to quickly expand its revenues and footprint with acquisitions in the short term.

GRUB has found a recipe for monetizing recent societal and behavioral changes.

Who is GrubHub?

GrubHub Inc. (NYSE:GRUB) is the leading online and mobile platform for restaurant pick-up and delivery orders. They processed more than 135,000 combined Daily Average Grubs in 2013 and had approximately $1.3 billion of combined Gross Food Sales on their platforms in 2013. They connect local restaurants with hungry diners in more than 600 cities across the United States and are focused on transforming the takeout experience. They operate a software platform that has several variations available for tailoring to local restaurants and large corporations needs.

GrubHub Inc. is participating in an IPO on Friday, April 4th, 2014. They are expected to offer 7.03 million shares at between $23-$25 per share. Citi and Morgan Stanley are the main underwriters handling the offering.

What do they do and how do they expect to maintain a competitive advantage going forward?

GRUB operates a multi strategy software platform that connects hungry diners with local restaurants. They also operate a corporate program that helps businesses address inefficiencies in food ordering and associated billing. Their target market is primarily independent restaurants broken down to local markets.

These independent restaurants, which account for 61% of all U.S. restaurants (according to a 2013 industry report prepared by Euromonitor International), remain local, highly fragmented and are mostly owner-operated businesses. According to Euromonitor, Americans spent $204 billion at these approximately 350,000 independent restaurants in 2012. GRUB believes that Americans spent approximately $67 billion on takeout at these independent restaurants, which sums up their interest in essentially running a social network/dating site/toll road that connects people to food and vice versa. GRUB noticed a need, a developing transition to all things mobile, a behavioral change in society, a hugely fragmented market, and an obvious way to become a value add to both parties involved and they have become the market leader in the services they provide.

Normally, a description of the target market, the total, and then potentially capturable market is needed to better explain how the company going public expects to remain in business but I think in this case the above are self explanatory. We've all ordered take out, we've all eaten at establishments where we've paid for food, and I don't think the size of the restaurant industry or how the process of ordering food takes place is in question. GRUB hopes to capture a large portion of the local restaurant market in the US and then internationally, which is a simple explanation but I hope is understandable. It's also their simple business model and the obviousness of their necessity as a partner for local restaurants that helps make them a stock with a very bright future but more on that later.

GRUB's platform consists of several different products, all that work together to create a well oiled machine. The GrubHub product, the marquee product in the umbrella, consists of a web and mobile based platform that acts as a search engine for local restaurants that diners can use to place online orders instead of calling in directly to the restaurant. The other products in the umbrella are as follows (from the S-1 filing):

Seamless Corporate Program

On the Seamless Platform, we provide a corporate program that helps businesses address inefficiencies in food ordering and associated billing. Our corporate program offers employees a wide variety of food and ordering options, including options for individual meals, group ordering and catering, as well as proprietary tools that consolidate all food ordering into a single online account that enables companies to proactively manage food spend by automating the enforcement of budgets and rules. Our corporate tools provide consolidated ordering and invoicing, eliminating the need for employee expense reports and therefore significantly reducing administrative overhead relating to office food ordering.

Allmenus and MenuPages

Allmenus.com and MenuPages, both of which were acquired in September 2011 by GrubHub Holdings and Seamless North America, LLC, respectively, provide an aggregated database of approximately 275,000 menus from restaurants across all 50 states. The websites are searchable by cuisine type, restaurant name, menu items and other criteria. For those restaurants whose menus are posted on allmenus.com or MenuPages and who are also part of our restaurant network, we provide a link from their menus to our websites, through which diners can then place their orders, providing us with an efficient customer acquisition channel.

OrderHub and Boost

Restaurants have historically received orders from GrubHub through a facsimile or email and are required to confirm the order over the phone. Though most of our restaurants still use this traditional method, several thousand restaurants use our tablet solutions, OrderHub and Boost. These tools can electronically receive and display orders at the restaurant, providing operators with the capability to acknowledge receipt of the order and update the estimated completion time and status with an easy-to-use application. OrderHub and Boost allow us to monitor orders through the takeout process (receipt, ready for pickup, on the way, etc.). In turn, we can make that information available to hungry diners who are waiting for their orders, thus providing greater transparency, reducing their frustration and making the takeout experience more enjoyable.

As shown, GRUB's products work to position them as the one stop shop of takeout ordering. They have managed by organic innovation or by strategic acquisition to create an incredibly efficient and fluid company that allows any single product under the umbrella to depend on the other products to address any needs or shortfalls. They have also set up a business model that makes their services accessible, capital light, and a low risk for their customers. All which has lead to amazing numbers that we'll discuss in detail.

As for the actual restaurants, why exactly would they want to utilize the GRUB platform? First things first, orders. One of the biggest reasons that GRUB has experienced the massive growth and use of services that they have is their huge network. Currently, there are just under 30,000 restaurants that participate in the GRUB platform and 3.4 million active diners that participate as customers. That network effect has driven orders, which has driven restaurant participation, which has driven orders, which has driven...you get the point. GRUB's constant, targeted, and maintained growth of their network has accumulated so much momentum that the network effect they are having is the primary catalyst in all things for the company. It's driven a significant drop in cost per customer, increases in revenue, increases in operating margins, increases in overall commission paid by the restaurants participating (without the prompting of GRUB), and it's helped them grow from the inside out (organically, without investing further into the existing network). So the primary reason restaurants want to do business with GRUB is that it's good for business. Again, simple. Second reason, a targeted reach and marketing effort. For most of the restaurants that GRUB partners with, their ideal market is the folks living within a 15-20 minute drive of their location. GRUB's platform isn't designed to market these local restaurants nationally, they market them to the exact diners they would prefer to have, helping deepen diner loyalty and build long term customers for the restaurant. All huge value adds for both parties. Third, service and efficiency. One of the big problems encountered by smaller scale restaurants, and customers, is the problems that arise when trying to place a take out order. We'll all personally encountered these so I'll keep the explanation short but first there's finding an actual menu whether that be in a drawer or online, long hold times calling, a distracted order taker, difficulty actually communicating the order, difficulty specializing the order, inaccuracies in the actual pricing, and so on and so on. It really can be a nightmare. GRUB's platform helps with all of the above. Customer experience matters to a mom and pop shop that may only have one chance to win your business from a large corporation that you "know" will have uniform service at each location. This matters. Finally, maybe just as important as the orders themselves, the low risk high reward potential of using GRUB as a partner. GRUB's platform charges no upfront fees, doesn't force the restaurant to dig into their margins with markdowns on food, and can even allow them to increase margins by leveraging their fixed costs. GRUB charges a toll fee to the diner that at least to this point, the diner is happy to pay. The actual restaurants can contact GRUB and proactively pay an upfront fee and give some of the embedded margin spread back to GRUB for priority listing by GRUB's search algorithm if they would like, but it's not required. This is happening by the way. It's happening a lot.

What does the diner get? Well, all of the above also are beneficial to the diner. The diner does want an expansive list of options, the diner does want convenience, they do want a more enjoyable experience, and they still want all this at a good value, which they obviously feel they are getting. Outside of those, the diner also benefits from the ability to discover new options in their immediate environment that they often times didn't know existed. Again, all of this feeds into that powerful networking effect that is driving the profit train at GRUB. Both parties wanting the same thing and knowing they can get it.

GRUB's competitive advantage lies in their size, network effect, their metrics confirming that an already huge and growing base of recurring users is forming, their product innovation (both organic and through strategic innovation), and in their monetization of mobile devices and behavioral changes. GRUB's analytics have shown that they are increasingly becoming a mobile company, falling in trend with society and recent behavioral changes, and that they have and will continue to effectively monetize the mobile opportunity.

GRUB also has several products in their pilot stages, but finished with CAPEX requirements, that they project (I would agree) will help materially contribute to future revenue. As of 12/31/2013, almost all of GRUB's revenue was derived from their GrubHub product. Their other products listed above have not yet started to materially contribute to their earnings, but the company (and I would agree with them) projects that they soon will. I'm particularly interested in the potential of their Allmenu's product, not necessarily what it is but what it can provide the company. What they have done is use the collection of menu's to act as a very cheap lead generator and prospect identifier for business opportunity. They can see what menu's, even out of network menu's, that their markets are searching for and then proactively deploy sales and marketing to that restaurant to capture the business not currently in hand. It's a very innovative and I don't believe priced in potential opportunity that the company will continue to develop. The other product that I think will contribute to the balance sheet on a more short term basis is the OrderHub and Boost products. These could act as a way for competing in-network restaurants to differentiate themselves without making concessions to margins or commissions and also would help improve the customer experience. For GRUB, if they actively promote this strategy line to existing customers (which they have expressed they will do), this will deepen relationships, increase product saturation, improve retention, and create more revenue. All good things to improve the already defensible leadership position they have.

Where's the trade?

In the last few days GRUB has increased the offering price of their IPO and I think this is because the market is better understanding the opportunity. On the surface, GRUB's business appears to be one with low barrier to entry and one that will eventually devolve into a commodity based business with lower margins and concessions needing to be made. I think all are valid arguments if GRUB was still in the development stage. I don't think of GRUB in those terms as they are already Adjusted EBITDA positive and have shown positive net income the last 3 years. That's not mentioning their huge cash position and the fact that they are the rare IPO that has the current capability to strategically acquire competitors and/or make concessions, if forced, to squeeze their competition to the point of losing a market. The little guys often can't afford to have a "loss leader" on the books just to make sure that competition can't penetrate a market, GRUB has the capability. I'm not saying that's part of the "growth" strategy going forward, I'm saying it's possible and that's HUGE from a company developing a new industry. Defensible leadership is hard to value but there is obvious value in it that is visible by all. These guys have it.

GRUB's balance sheet looks amazing as well. Everything across the board:

(in thousands)

2011

2012

2013(1)

Statement of Operations Data:

Revenues

$

60,611

$

82,299

$

137,143

Costs and expenses:

Sales and marketing

17,198

26,892

37,347

Operations and support

13,961

18,165

34,173

Technology (exclusive of amortization)

5,651

10,172

15,357

General and administrative

9,777

12,249

21,907

Depreciation and amortization

4,033

6,089

13,470

Total costs and expenses

50,620

73,567

122,254

Income before provision for income taxes

9,991

8,732

14,889

Provision (benefit) for income taxes

(5,220

)

813

8,142

Net income

$

15,211

$

7,919

$

6,747

Other Financial Information:

Adjusted EBITDA(2)

$

14,827

$

17,185

$

38,134

As of December 31, 2013

Actual(1)

Pro Forma(2)

Pro Forma As
Adjusted(3)(4)

(unaudited)

(in thousands)

Balance Sheet Data:

Cash and cash equivalents

$

86,542

$

86,542

$

173,804

Working capital

29,568

29,568

116,830

Total assets

762,812

762,812

850,074

Convertible Preferred Stock

2

-

-

Total stockholders' equity

557,375

575,790

663,052

Year Ended December 31,

2011

2012

2013

(unaudited)

Active Diners(1)

689,000

986,000

3,421,000

Daily Average Grubs(2)

45,700

62,000

107,900

Gross Food Sales (in millions)(3)

$

412.2

$

568.8

$

1,014.9

Pretty amazing. Especially if you look at GRUB's cash, revenue, and Adjusted EBITDA growth compared to total expenses growth. These guys have so much opportunity for growth with declining expenses going forward that I expect all figures to increase in material amounts, sequentially, for the balance of 2014 and probably much further. I really like the idea that management will make developing existing markets the priority for 2014, unless something strategic opens up that absolutely forces their hand, and that the 2014 growth strategy should significantly lower expenses. I think the focus on product saturation (read: no further capex) and the organic growth coming from their existing network can propel this stock much higher in the coming months. I see a huge IPO for these guys and huge run into the balance of the year. The company has zero debt and the shares have a 180 day lockup, which means the buyer of the IPO can afford to let the shares run into what should be a great quarterly announcement. I really like these guys from a standpoint that they are the big player and have competitive balance sheet advantages that others don't. I also like, and this is complete speculation, that if management wants to acquire a sizeable company that they can take on debt to do the acquisition and not have to resort to dilutive measures. These guys have a great track record of making the right buys, at the right time, in the right ways. Management is always something that gets overlooked until you realize the guys running the show shouldn't be. That's not the case here. I like GRUB at IPO and further into the next 12 months for somebody looking for a mid to long term hold. I think if they get a great day one tomorrow that it could eliminate the buying opportunity for short term buyers but that mid and long term buyers can look forward to big things from GrubHub during the balance of 2014. Good luck to all.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.