Uber Eats + Grubhub is equivalent to 1+1 = 3

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From WSJ earlier this week 

Uber Technologies Inc. is seeking to acquire Grubhub Inc. in a deal that would unite two of the biggest players in the cutthroat meal-delivery business at a time when the coronavirus pandemic has sparked a surge in demand for their services. Uber, which in addition to its flagship ride business operates a big meal-delivery unit known as Uber Eats, in February approached Grubhub with an all-stock takeover offer and the companies have been in talks since then, people familiar with the matter said.

From Verge earlier this week [A pizzeria owner made money buying his own $24 pizzas from DoorDash for $16]

Apparently, this is one way that DoorDash does customer acquisition — by bullying restaurants. But what’s funnier about Roy’s friend’s problem (and it was a real problem because of Yelp reviews and angry customers) is that DoorDash priced the pizzas incorrectly. “A pizza that he charged $24 for was listed as $16 by Doordash,” emphasis Roy’s. And then: “My third thought: Cue the Wall Street trader in me…..ARBITRAGE!!!!” 

USA food delivery market can finally become rational with the merger of Uber Eats (UBER) and Grubhub (GRUB). This merger makes more sense now vs 1-2 years ago as private market funding is drying up (implications for DoorDash) and public market investors focus shifts from market share grab to profitable growth. 

A quick discussion around food delivery network:

There are three key players involved – restaurants, diners, and drivers (logistic/delivery). Since it is a hyperlocal city based three sided network, it is more powerful than typical two sided network (like driver, passenger model of Uber ride) but less powerful than typical global networks like AirBnB (building supply for global travelers as one unified network). 

In a typical food delivery transaction, platform takes a take rate (typically between 10%-20%) and after that order is fulfilled by restaurant or delivery partners / drivers. If platform is providing delivery service also, it will result in a delivery fee indicating higher take rate. Grubhub provided an illustrative example on Q1-19 earnings call (April 25th 2019)

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Now we know the basic of this market, let’s have a look at Grubhub’s historical KPIs and marketcap. 

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A few observations from this data over 2013 – 2019 period

  • From 2013 to 2019, Grubhub active diners and total orders have grown 6.6x and 3.6x. This means that orders / diner / year have steadily declined to approximately ½ of what they used to be in 2013. There can be many reasons for this (lack of innovation, best diners are early adopters, competitions etc.) but one of the biggest reason is high competition starting in late 2016 / early 2017 with privately funded companies like Uber, DoorDash etc.
  • Gross food sales (GFS) have grown 4.6x but GFS/diner has shown similar trend as order frequency per diner – declining to 0.7x of original GFS/diner. Even though, GFS/order has gone up starting in 2017, it is more of a function of added delivery fees rather than diner order basket increasing. 
  • Revenue (including inorganic / M&A) is up 7.7x and revenue/diner and revenue/order show healthy growth without any deterioration. 
  • Despite all the great KPI’s shown above, Grubhub’s market cap has not shown 5x – 7x increase as you would expect. This can be explained by EBITDA margin and EBITDA/diner contracting due to competitive pressure (market share loss) and investment in logistic / driver network (discussed below). 
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Uber and Doordash spend a lot of money (probably with negative unit economics) in 2017 – 2019 period to build out diner base and market share (see chart). Grubhub couldn’t invest in delivery and unprofitable diners as a public company. This unique public / private arbitrage resulted in Grubhub losing market share. Based on 2019 data, DoorDash was leading in market share (with Caviar M&A) owning approximately mid 30% of market. 

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This share shift has intensified during COVID crisis as Uber being a public player can’t spend on Uber Eats share gain like 2017/2018 but DoorDash can. Same can be said for Grubhub. As of April 2020, DoorDash has solidified market share to 45% level and Grub and UberEats are distinct number 2-3 players. 

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This brings me to the main point – consolidation and a rational outcome for all the players.

Industry consolidation among Uber Eats and Grubhub will create a solid duopoly in this market. This will allow Grub and Uber to solidify network density and diner base among key cities. This means diners have fewer platforms to toggle between and hence probably lower marketing as a % of revenue for all the players – resulting in overall better margin structure for the industry. Also, Grubhub brings complementary strength in 2-sided marketplace while Uber brings logistic strength. This creates structurally a better combined company rather than two standalone public companies. 

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This will also be good for DoorDash as it can sell a very solid story to public investors through IPO – discussing how deferred profits for last few years will start to flow through the income statement in coming years. 

This M&A will be good for Softbank which is common investor in Uber and DoorDash. Softbank’s invested entities (Uber, DoorDash) will own close to 80-90% of food delivery market in USA. 

It can also increase customer loyalty as discounts will be less and fewer resulting in almost no switching incentive for diners. 

Any M&A among big 3 will be a bad outcome for Postmates as it will be left as a niche / subscale business for which cost of capital will be very high. In my view, Lyft should look at Postmate if it becomes a distressed asset.  

There are global precedents in food delivery M&A for rational competition and market cap creation across geographies including China (early M&A of Meituan and Dianping – now called Meituan-Dianping), Germany (Delivery Hero and Takeaway.com merging German assets), S Korea (delivery Hero buying Woowa), UK (Just Eat buying hungryhouse, JustEat bidding war between Prosus and takeaway.com) etc. Prosus (Nasper’s investment portfolio) has consolidated it’s lead in food delivery market across globe ex USA. At some point, I am expecting Indian food delivery market to rationalize between Zomato and Swiggy. 

I think it is about time for USA food delivery market to get rational and create 1+1=3.

Disclaimer / Disclosure –

These are my personal views. It is not an investment advise. I am not responsible for any investment decisions made after reading this article. I own Uber shares.

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