GrubHub Has A Growth Problem

By Fabian Knigge :

After a successful IPO last year, GrubHub ( GRUB ) recently had to cope with disappointing earnings and the CEO cashing in his shares, which sent the stock lower. Yet, insider trades and sluggish earnings should not be the No. 1 concern for people looking at GrubHub.

What investors should look at and what many probably miss is a German internet company that just IPO'ed overseas last year called Rocket Internet. You probably have never heard of it so far, but it is the biggest global internet platform outside the US and China. If you want to know more about the company, you should read my instablog post .

Rocket owns stakes in several online food delivery companies which together make up the world's largest player in this field. Rocket's "Global Online Takeaway Group" (GOTG) comprises its stakes in Delivery Hero (40% owned by Rocket), Foodpanda (52%), Pizzabo.it (100%) and LaNeveraRoja (100%). Together, these companies are the biggest online takeaway group in the world, far larger than GrubHub or Just Eat ( JSTLF ). GOTG operates in 71 countries and is the No. 1 player in 59. The countries of operation as well as the market position in each country are shown in the picture below.

(click to enlarge)

(Source: Rocket Internet 2014 Results Presentation)

Note here that Rocket contributed its stakes in e-Food, Yemeksepeti and Talabat.com to increase its stake in Delivery Hero from 30% to 40%. They are all now 100% owned by Delivery Hero.

GrubHub Has A Growth Problem

The strengths of Rocket's GOTG highlight where GrubHub's weaknesses are. GOTG easily overtakes GrubHub and Just Eat in terms of orders and the number of takeaway restaurants. It also operates in more favorable markets. GOTG is big in fast-growing emerging markets such as China, Indonesia, India, Mexico, Turkey, Nigeria, etc. These countries are characterized by a large and young population but low Internet penetration. Its geographical exposure to emerging markets gives GOTG attractive long-term growth prospects.

(click to enlarge)

(Source: Rocket Internet 2014 Results Presentation)

You might not be aware of it yet, but GrubHub's problem is growth. It operates only in the US and London, UK, where the market is already dominated by Just Eat (No. 1) and Delivery Hero (No. 2). GrubHub is currently trading at a 10x sales multiple and a 96x PE multiple, which implies investors are discounting earnings at only a bit more than 1%. To justify such high multiples, GrubHub has to grow fast. The problem is where this growth will come from.

Growth can come from the following sources:

• GDP growth of countries of operation
• Higher market penetration
• Higher margins
• Acquisitions

GrubHub's growth right now comes mainly from higher market penetration. GrubHub estimates that online takeaway orders just represent 5% of the total delivery market. We can now do a quick back-of-the-envelope calculation to see when the market will be saturated. First of all, a certain percentage of that market will always remain offline because of convenience, sub-100% internet penetration and low penetration of rural areas. Let us assume 20% of the food delivery market will remain offline and inaccessible for GrubHub. GrubHub is currently growing at a 50% rate and as the No. 1 player in the US, we can assume that market penetration of online takeaway orders grows at the same pace. If growth continues at the same pace, GrubHub's market will be saturated just within seven years.

(Source: GrubHub June 2014 Investor Presentation)

Once its home market is saturated, GrubHub has to grow through margin expansion or acquisitions. Given it operates only in the US and the UK, GDP growth will not be a big growth driver. Its move to London also was not the best idea. Just Eat is the No. 1 player in the UK and Delivery Hero is No. 2. Once the market saturates and consolidates, most markets will likely be dominated by either 1 or 2 big players, leaving GrubHub only with the US as a profitable market.

On the contrary, Rocket's GOTG is well-positioned in emerging markets. The growth opportunities just from higher market penetration are huge. Given the low internet penetration and high population in the countries it operates in, a 1% increase in Internet penetration means 54m additional potential customers. It will probably take decades until GOTG's market is saturated while GrubHub's market could be saturated within seven years already.

This leaves GrubHub with the option to grow through acquisitions, and the company is already pursuing this opportunity. The problem is that GOTG already is the No. 1 player in the most attractive markets. So the possibilities to grow by geographical diversification are very limited.

GOTG Ready To IPO

GrubHub and Just Eat both went public last year and the CEO of Delivery Hero, the largest company within Rocket's GOTG, has already stated that they are also eyeing an IPO even though he said it will not happen this year. In case of an IPO, I believe that Rocket will contribute its stakes in Foodpanda, LaNeveraRoja and Pizzabo.it in exchange for a higher share in Delivery Hero as they did before with Yemeksepeti and Talabat.com. This would create the biggest player in the online food delivery market. I believe that an IPO will get a lot of attention because of the size of the company as well its superior long-term growth prospects.

I'm especially worried by the lack of growth opportunities for GrubHub in the long term. Of course, seven years of 50% growth would be very impressive, but even at this level, GrubHub seems decently valued. Taking last year's EPS of $0.3 and assuming EPS growth of 50% for the next seven years would yield EPS of $5.13 by the end of 2021. If we discount this number at a reasonable 10% per year gives us a present value of $2.63. At the current stock price of $35, this eventually leads to an implied P/E multiple of 13.3x, which is not cheap at all.

Of course, it could very well be the case that GrubHub grows faster or slower over the next years. Seven years is a very long time horizon to consider for such a young company and is connected with a lot of uncertainty. The calculations presented are just made for seven years, but I see a lot of risk in the years beyond. If you want to justify GrubHub's high trading multiples, you have to look at a very long time horizon that expands beyond 2021. I think that most investors are not aware of the lack of long-term growth opportunities because they are not aware of Rocket Internet's strong position in the online delivery market.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.