Deliveroo Didn't Deliver

Summary

• Deliveroo public debut was a flop.
• A high valuation combined with losses and ESG concerns to crash its shares.
• The company's stock price could be further depressed in the short term.

Photo by Hollie Adams/Getty Images News via Getty Images

Deliveroo's (OTCPK:DROOF) public debut was a disaster with lows of 271p, below its initial offer price of 390p. Deliveroo has supposedly oversubscribed which begs the question "Why didn't demand show up?" Perhaps, it was because everyone sensed a tech-driven bubble brewing. This can be seen in the sudden highs followed by long lows seen in similar competitors such as DoorDash and Just Eat when they floated. In the IPO, Deliveroo originally looked to sell shares between 460p and 390p. This would place the loss-making business between £8.8 billion and 7.6 billion.

Business Model

The company is growing in the UK with over 20,000 new restaurants partnering with Deliveroo and 36 new grocery partnerships over the last year. Although, it is important to note this may be due to the Pandemic. It also a very crowded market (food delivery) with multiple players and tight margins. A race to the bottom is an applicable descriptor of the market.

At the end of 2020, Deliveroo is geographically dispersed with a presence in over 12 countries, but there has been a recent retrenchment in the German market (2019) and the Taiwan market (2020). The firm's business model can be split between two models. Firstly, 10% of deliveries made are from takeaways. Consumers order their food online and Deliveroo collects both a delivery fee and a commission fee from the restaurant. The fee is dependent on the service offered. The other side of the business concerns the delivery of on-demand groceries from convenience retailers. This side of the business has been moderately successful with partnerships with well-known firms like Waitrose, Aldi and Co-op in the UK and Carrefour in France.

ESG Concerns And Dual-class structure

Many Institutional Investors took a stance against the IPO, mainly due to the S and G in ESG. Institutional Investors including Legal & General Investment Management, Aberdeen Standard Investments, and M&G Investments. The S related to the growing need for fairer treatment of employees. The G related to dual-share structure, which left a disproportionate amount of power in the hands of the founder. An alien concept for UK investors. The shift in perspective is exemplified in a statement by EdenTree Sustainable and Responsible UK Equity Fund manager Ketan Patel: "The rise of the S in ESG during the pandemic has highlighted social inequity and injustice within society."

Furthermore, "The Deliveroo business model is best characterised as a race to the bottom with employees in the main treated as disposable assets which is the very antithesis of a sustainable business model." The shift of a sometimes-overlooked aspect is significant and in-trend with recent stories regarding worker treatment in the UK, such as Boohoo and Uber.

This agreement meant that the founder's William Shu's shares had 20x the voting power of other investors. This translated to roughly 58% voting share while only owning 6.3% of the company. Normal in the US seen with companies like Facebook (FB) and Alphabet (GOOG) (GOOGL). There are many pros and cons related to this but quite separately it is not the cultural norm in the UK and so investors here may have made their disproval clear. Although, the UK Investing community can't have their cake and eat it. Concerning losing listings to New York but being resistant to creating the reformist change to encourage more listing in the UK.

Fundamentals

Investors' appetite for loss-making enterprises is waning. A low end estimated value of £7.6bn against last year's revenue gave it a higher multiple than competitors such as Just Eat and that just ain't right. As can be seen in Figure 1. Revenue increased by 62% in 2019 but losses also increased after significant investment. In 2020, during the pandemic, revenue increased to 1.2bn but there was still a loss made of £226m. One can imagine a collapse of the company if they were made to give a fair wage to the gig workers. Arguably the losses would be unsustainable at that point.

Figure 1: Deliveroo Financials (Source)

Deliveroo has been reinvesting into improving the profitability with gross margin increasing between 2018 and 2019. This could be attributed to investment into technology to improve efficiency such as in delivery route allocation. Although arguable all this does is exacerbate reported cyclicality in the quarterly EBITDA of Deliveroo. The Pandemic has shown potential for operating leverage to be reduced within the firm as the £419m increase in revenues was offset by a £98.8m reduction in operating loss for 2020. Also, the fixed costs are simply too high and will continue to eat away profitability.

Finally, let us suggest a thought experiment if the rough £300m loss was flipped to become £300 in profit between 3 and 5 years. Furthermore, at an FTSE 100, Shiller P/E ratio of 13.66 gives you a value of 5bn in 5 years. Discounted to present value shows a very overvalued stock. Even using the 5-year estimate still shows a very overvalued stock.

An IPO That Did Not Deliver

Deliveroo is not worth it and could be a potential short opportunity. Estimates suggest that even from multiple branches of arguments. Deliveroo is best delivering returns via a short position. One should spare a thought to the biggest potential loser of the fallout - the retail investors invited to take part in the Deliveroo stock market listing.

Analyst’s Disclosure: I/we 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.