Dig into Grubhub

Posted On August 15, 2017 1:27 pm

Grubhub (GRUB) had already been the dominant platform for online and mobile platform for restaurant pick-up and delivery orders. Last week’s deal to purchase EAT24 delivery division from Yelp cements Grub’s position as industry leading with now more than 50% of the food delivery market; UberEats and Amazon trail with 20% and 11% respective market share.

The deal in also allows Grub to appear on Yelp’s reviews platform in exchange for fee from orders it originates. The scale of this one-stop point of service and sale creates a nearly impenetrable competitive moat other delivery services will find it nearly impossible to breach.

To my mind, GRUB and YELP just formed the a duopoly of “casual dining” similar to “Wintel” Microsoft (MSFT) and Intel (INTC) that controlled the PC market throughout the 1980s.

The EAT24 acquisition along with better than expected earnings on August 4th propelled shares up some 20% to $56 over the next two sessions. The stock is now bit extended and I want to be patient. I’m looking for a pullback towards the $50 level to establish a bullish position.

Meet the New Landlord

The right location is said to be crucial for the success of a restaurant. This is especially true of independent and mid-priced casual which might not have large marketing budgets and are not deemed “destination” spots foodies are willing to travel and discover.

Locations on busy street or well trafficked area usually command higher rents for a good reason; they drive business. Likewise, as consumers are increasingly ordering food online (or with mobile app) for delivery it becomes crucial for restaurants to locate or set up shop where they are most likely to be found and provides an easy transaction experience.

Grubhub is that location. All your choices are in one location (no more riffing through menus in your kitchen draw) with all your account information and a reliable delivery system in place.

The company connects more than 40,000 local restaurants with diners in more than 1,000 cities across the United States. The company’s target market is consists primarily of independent restaurants and it has recently pushed into “virtual’ restaurants; that is businesses that operate on a delivery only format.

As the largest ‘landlord’ in delivery Grub has leveraged it’s network or auction effect in which more buyers brings in more sellers to a virtuous growth path. And it allows Grub to charge more for appearing on its prime ‘Main Street’ location. Its margins approach 30%.

And restaurants which install apps find that over 57% of their patrons use it at least once a month and can increase sales by as much as 25% within the first year. As overall restaurant revenues have stalled the past few years cannot afford to not provide delivery.

Big Picture Growth

One of GRUB’s biggest differentiators is that the company got into the food delivery industry early and it has been very focused on developing its platform, such as on the front of API and technology integration. This is lacking and cannot be easily built by its competitors. Over time, we have seen such investments paying off. Platform improvements around search, page load times, and onboarding continue to positively impact conversions and order frequency. 30-day orders per ending active diner declined less than 1% year over year, the smallest year over year decline since GRUB went public.

The company also made a lot of improvements to the product in Q2, including improved layout of mobile web restaurant landing pages, personal recommendations, simplified search, and funnel improvements. Additionally, GRUB is aggressively adding ratings and reviews, generating 70K consumer data points daily. 

This has all led to strong revenue and margin growth. In Q2, performance from GRUB’s own delivery network proved to critics that it is the right investment to boost company’s growth. Delivery accounted for 12% of gross food sales in the quarter compared to 9% in 1Q. The company will continue ~$4 million investments per quarter. This points to more room for revenue to grow. Currently delivery is only available in 50+ market but the goal is to expand to 70 markets by the end of the year.

Furthermore, GRUB’s own delivery network is effectively improving demand. It allowed for addition of restaurants that were not able to participate in GRUB due to lack of delivery offers. These restaurants tend to skew to the mid to upper end which provide much higher margins.

Based on feedback of restaurants that joined the GRUB delivery network, they saw 10% more orders per restaurants and 60% more new diners per restaurant than other restaurants on the platform. This amount of high traffic also locks in loyalty on the supplier side. They are willing to pay for the higher commission rate charged by GRUB. Average take rate or fee reaches a new high of 16.5% per ticket.

Loyalty Tipping Point. In the latest quarter 90%+ of sales on GRUB is from repeat sales. From surveys, restaurants also said that they are reluctant. Perhaps the more astonishing fact from Q2 is that despite persistent growth in active diners, sales and marketing expenses have been falling as a percent of revenue. New diner acquisition costs has also fallen down to historical average.

Grub has also started a corporate program that helps businesses address problems in food ordering and associated billing. In certain markets, the company also provides delivery services to restaurants on its platform that do not have their own delivery operations. It essentially can act like as a platform for catering or outsourcing corporate cafeteria needs which creates a steady revenue stream

Going Virtual: The company has taken this concept a step further and has recently teamed with some high profile chefs in New York and San Francisco to act as the delivery service for their new “delivery only” business models.   This is where chefs such as David Change can house two or three concepts out of one kitchen is a smaller space in a lower cost neighborhood.

“Brick-and-mortar is a hard scene,” says Stan Chia, senior vice president of operations at Grubhub/Seamless, which has been supporting a few delivery-only concepts. “We were actively looking for how to solve this problem.” Restaurants have to pay a commission on every transaction, whereas rent is a fixed cost.

Seamless is still the biggest name on the market. It’s still the website where most people decide what to order for delivery, even with Amazon (AMZN), Uber, PostMates, and other start-ups getting their hands in the game. For better or for worse, Seamless is Main Street for people looking for delivery, and having your own app and website is kind of like setting up shop on a side street.  Some of the delivery only restaurants pay as much as 30% of all sales to the platform, a rate that means delivery-only restaurants are essentially swapping rent for GRUB’s fee.  In this sense Grub is becoming a virtual landlord for the restaurant industry.

Last quarter’s earning shed a lot of light on the latest operational improvements within GRUB. As Yelps decision to exit the delivery business and sell EAT24 to Grub competitors cannot keep competing on their loss-making platforms and will eventually be squeezed out of the market

The fact the company was able to capture such high growth in the short time these new improvements were rolled out point to the strength of the company. The re-acceleration of the business has only just started.

I’m looking to start building a long term position in coming weeks.

About author

Steve Smith

Steve Smith have been involved in all facets of the investment industry in a variety of roles ranging from speculator, educator, manager and advisor. This has taken him from the trading floors of Chicago to hedge funds on Wall Street to the world online. From 1987 to 1996, he served as a market maker at the Chicago Board of Options Exchange (CBOE) and Chicago Board of Trade (CBOT). From 1997 to 2007, he was a Senior Columnist and Managing Editor for TheStreet.com, handling their Option Alert and Short Report newsletters. The Option Alert was awarded the MIN “best business newsletter” in 2006. From 2009 to 2013, Smith was a Senior Columnist and Managing Editor for Minyanville’s OptionSmith newsletter, as well as a Risk Manager Consultant for New Vernon Capital LLC. Smith acted as an advisor to build models and option strategies to reduce portfolio exposure and enhance returns for the four main funds. Since 2015, he has worked for Adam Mesh Trading Group. There, he has managed Options360 and Earning 360, been co-leader of Option Academy, and contributed to The Option Specialist website.