Mario Cibelli Marathon GrubHub Uber DoorDash Postmates Jim Chanos Kynikos Just Eat Naspers

Rumble in the Jungle

When there's a fire, the value investor's instinct is often to walk toward it rather than away and maybe sift through the smoldering ashes. Is that a reasonable idea when it comes to the shares of food-delivery company Grubhub?

Kudos to famed short-seller Jim Chanos of Kynikos Associates for his bearish call last month on food-ordering company Grubhub. In an interview with CNBC, he argued that the company’s already thin margins were severely threatened by potentially rising labor costs and intensifying challenges from the hyper-aggressive Uber Eats and DoorDash, competition which he likened to being “locked in a cage with a psychopath with an ax.” At around $64 prior to the CNBC segment on September 19th, Grubhub shares have taken it on the chin – especially after a disastrous earnings release earlier this week – and now trade at $34. Just over a year ago they were near $150.


You could certainly forgive even the boldest value investor from sitting this one out, but Mario Cibelli of Marathon Partners Equity Management thinks the Grubhub drubbing may have gone too far. He argues that the relative industry greybeard – it went public in April 2014 – has a superior, proven business model in a market for online food ordering and delivery that has a long growth runway ahead. He also believes the “psychopathic” competition, ruinous as it is in the near term, won’t continue in the long term simply because it can’t. “I would argue the better analogy is that Grubhub is in a boxing ring with a bigger, harder-hitting opponent, but that opponent is swinging wildly and starting to tire,” he says. “Grubhub can simply outlast him.”


The company’s core business is providing an online "marketplace" platform for customers to order food for delivery from a wide range of restaurants. For roughly 70% of the orders, Grubhub earns a minimum 15% or so commission on the sale from the restaurant and the restaurant handles the delivery. For a higher commission, Grubhub will also handle the delivery as well. It’s a strong network-effect business: more diners using the platform attracts more restaurants in search of business, which attracts ever more diners to the platform. Prior to the wave of new competition, the company had a nicely profitable business. In calendar 2018, a year in which revenues topped $1 billion and grew nearly 50% from 2017, the company earned nearly $180 million in EBITDA and approximately $150 million in free cash flow.


Those solid economics have been significantly pressured by the market-share grab over the past year from deep-pocketed rivals such as Uber, DoorDash and Postmates. Grubhub’s operating income through the first nine months of 2019 fell 80%, as the growth in expenses for “operations and support” and “sales and marketing” significantly outpaced a 35% increase in revenue. The company’s revenue and profit guidance for the current quarter called for more of the same as it vowed to continue to go toe to toe with its competitors.


Cibelli’s case that the company can weather the competitive storm rests in part on its strong balance sheet – it has modest net debt – and the fact that its core marketplace model produces sufficient free cash flow for the company to internally fund its operations, including the more aggressive promotional spending promised by management on the recent earnings call. 


He also believes that the growth-at-any-cost strategies of Grubhub’s competitors will prove to be short-lived. In the aftermath of WeWork’s IPO debacle, he thinks market-share grabs are less likely to earn ardent private or public capital-market support. He estimates that DoorDash, Uber Eats and Postmates produce negative EBITDA at roughly a $1 billion annual rate. If that isn't already an unattractive proposition, he believes it will be soon, causing a significant retrenchment in competitive intensity and mounting pressure for the industry to consolidate.


After WeWork's IPO debacle, mindless market-share grabs are less likely to earn capitalmarket support.


If he’s right and Grubhub once again operates in a more rational market environment with fewer participants, he expects there to be plenty of business to go around. Restaurants may complain about the commissions to pay, but just as hotels – especially the vast number that are smaller and independent – have found online travel agents to be a critical demand generator, independent restaurants are increasingly likely to do so as well. At the same time, Grubhub’s marketplace provides a valuable service to diners, who may order directly from a few of their favorite haunts but also find utility in the ease of use and broad selection of options its platform offers. “The convenience of digital ordering drives both first-time and repeat usage, which we believe will drive significant growth in the total addressable market for a long time,” Cibelli says. “It’s not a coincidence that so much VC money has flowed into this space.”


Are Grubhub's shares cheap enough to warrant taking the plunge? Cibelli believes its core markets – Boston, Chicago, New York, Philadelphia and Washington D.C. – could produce approximately $400 million in annual EBITDA right now if the business were run to maximize profitability. At that normalized level, the company’s shares currently trade at an EV/EBITDA multiple of just under 8x, which he considers very low for the highest-quality industry player with commanding shares in key markets. At the same multiple of revenue offered in a hostile bid for British peer Just Eat [London: JE] by Prosus – the Dutch affiliate of South African tech titan Naspers – Grubhub’s shares would go for around $80. 


“It's entirely possible the pain for the company is not over,” says Cibelli. “But the share valuation is far too low, especially in an industry poised for consolidation. We think shareholders who can stomach the volatility will be rewarded.”