- Grubhub needs to complete a merger with a large competitor to combat poor market dynamics and financial results.
- The food delivery industry is ripe for a price war, and Grubhub is especially exposed.
- Rapidly declining margin per order means Grubhub needs to aggressively cut overhead to restore profitability.
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Grubhub (GRUB) desperately needs to complete a merger to ensure its long-term viability. Luckily, Uber (UBER) has reportedly been in merger discussions with Grubhub, but a deal is far from done. Grubhub’s CEO has said that Uber’s offer price is too low, and there is speculation that a merger between these two food delivery giants could spur significant regulatory scrutiny. That being said, Grubhub’s longevity as a key player in the growing $94B food delivery market is hinged on its ability to consolidate with a competitor, such as Uber Eats, in order to survive the industry’s fierce competitive dynamics and the poor scalability of its business model. Investors would be wise to keep an eye on the merger’s developments, and if a deal can’t be reached, they should sell the stock as quickly as they can.
Since March 21, Grubhub’s stock price has soared over 75%, primarily based on the news of a potential merger with Uber. Uber’s most current offer values Grubhub at approximately $65 per share. For a stock that was trading near $30 per share as of the end of March, Grubhub investors should be cheering at this offer price. However, Grubhub’s CEO has balked at the offer and is greedily asking for more during a time when Grubhub’s fundamentals are faltering.
Source: Yahoo! Finance stock charts
The food delivery business is becoming increasingly unattractive as aggressive competition builds in an industry that requires billions of dollars of marketing spend per year to stay top of mind with consumers. It is no secret that consumers have several delivery options at their fingertips, all with non-existent switching costs. This has created brand-agnostic consumers who only care about paying the lowest delivery fee for the commoditized service. Brands have struggled to differentiate themselves in the eyes of consumers and, in turn, their restaurant partners. On top of this, Google recently announced that its popular Google Maps app will soon have a feature that allows restaurants to highlight their preferred delivery platform, which will only intensify competition. These industry features are classic warning signs that an inevitable price war may be afoot: high upfront capital costs with little promise to recoup this capital if the business fails, brand-agnostic customers with low switching costs, and a commoditized service.
Source: Google Maps’ current options for mobile order food delivery
A closer look at Grubhub’s revenue per order trends over time gives investors a clue that a price war could emerge in the food delivery industry. Grubhub’s daily average orders, a key metric utilized by management to gauge the health of the business, had grown ~14% on average over the last three years. However, an analysis of Grubhub’s most recent 10-Q will leave a sour taste in investors’ mouths – daily average orders actually fell ~1% in Q1 2020 as compared to last year. While average revenue per order grew by a reasonable clip, if daily average orders continue to fall, then management will have few options other than decreasing price to sustain the revenue growth that investors expect.
As if a potential price war wasn’t scary enough, the food delivery business model isn’t meaningfully scalable. Food delivery companies must rely on humans (at least for now) who can only deliver a maximum of two to three orders per hour, at best, due to travel times and to prevent food from going cold. These delivery lag times force companies to hire more and more delivery personnel to satisfactorily fulfill a growing number of orders. Because food delivery consumers are so fickle, one bad experience with a long delivery time or cold food from their favorite restaurant could cause consumers to quickly blacklist the company.
As a result, Grubhub has experienced rapidly increasing direct costs associated with providing its independent delivery network. By analyzing these costs on a per order basis, investors can see just how bloated Grubhub has become. Direct costs per order have increased by ~31% on average over the last four years, and they have more than doubled since 2017. This explosion in direct costs has led to a 21 percentage point decline in margin per order over the last four years. Even more alarming, this margin deterioration has been getting worse over time.
Okay… so what?
Grubhub will continue to experience slowing revenue growth unless the company burns more cash on sales and marketing to stay top of mind with consumers and drive order volume growth. Further, these orders will continue to have lower and lower margins unless management can avoid a price war and reduce costs.
These disturbing trends should trouble investors and they necessitate a big change in order to buoy Grubhub’s stock price – Grubhub must merge with a competitor to relieve potential future downward pricing pressure and to cut redundant overhead to improve operating margins. If a deal can be made and regulators eventually approve the potential transaction, analysts have estimated that a merger between Grubhub and Uber could generate $300 million in cost savings for the two companies. Additionally, the transaction would give the merged companies an estimated 55% market share in the third-party food delivery industry and allow them to ensure short- to medium-term price stability.
Key Investor Takeaway
If Grubhub approves a deal to merge with Uber, there will undoubtedly be significant regulatory scrutiny given the deal's potential for “pandemic profiteering” that has been widely criticized by public officials recently. Additionally, a merged company with 55% market share will almost certainly raise antitrust issues due to the potential for increased prices for consumers. The food delivery business has already recently come under fire regarding its pricing policies.
Investors will be wise to keep an eye on the merger talks and any regulatory roadblocks; it is my opinion that while Grubhub needs a large-scale merger to thrive in the crowded food delivery space, regulators will likely prevent the transaction from completing for the aforementioned reasons. This thwarted merger attempt will cause Grubhub’s stock price to crater as its delivery margins will continue to plummet over time. The long-term outlook of the industry is not favorable for a company that has been struggling to meaningfully differentiate itself. This stock is a sell, and I recommend investors underweight Grubhub.
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