By David Trainer, Kyle Guske II, and Matt Shuler
The food delivery market is filled with competitors offering the same service: cheap food delivery. They deliver at about the same speed. Without any other differentiating factors, switching costs are very low. Figure 2 demonstrates that consumers are increasingly exploiting the low switching costs.
You don’t have to be a business expert to understand that businesses without differentiated offerings struggle to charge prices above the cost of the service. In other words, they never turn a profit.
The only competitive disadvantage that may be worse for DoorDash than low switching costs is competing with your suppliers. Before the standalone food delivery services entered the market, YUM! Brands, Domino’s and Papa John’s delivered food to customers for free. Now, most of the time, they charge for delivery albeit at prices usually far below the pure-play food delivery firms.
The point is that these restaurants can offer delivery for a much lower price or even free because they have core businesses that generate profits.
When we use our reverse discounted cash flow (DCF) model to analyze the expectations implied by the midpoint of the IPO price range, DASH appears significantly overvalued with expectations for huge improvement in both market share and profit margins, two metrics that rarely improve simultaneously in competitive markets.
To justify a $25 billion valuation, DoorDash must:
1.Immediately improve its net operating profit after-tax (NOPAT) margin to 8% compared to -67% in 2019 and an estimated -12% over the trailing 12 months (8% NOPAT margin is equal to UPS’s 2019 and TTM NOPAT margin
2.Grow revenue by 35% compounded annually for the next 11 years.
In this scenario, DoorDash would earn nearly $24 billion in revenue in 2030. At its TTM take rate, this scenario equates to about $204 billion in marketplace gross order volume for DoorDash in 2030. Take rate measures the percentage of marketplace gross order volume (GOV) DoorDash captures as revenue.
For reference, UBS estimates the global food delivery market will be worth $365 billion in 2030, and the average NOPAT margin of peers in Figure 1 is -5%.
In other words, to justify the midpoint of its IPO price range, DoorDash must capture over 56% of the projected 2030 global food delivery spend, compared to around 16% TTM.
Importantly and even more challenging, DoorDash must capture this market share while also improving margins from -12% to 8%, well above peers’ average.
To illustrate the difficulty in maintaining market share and high margins in an industry competing on price, look no further than GrubHub /zigman2/quotes/210404212/composite GRUB +1.64% . In 2017, GrubHub held around 55% of the U.S. food delivery app market (excludes restaurants that deliver their own food) and earned a NOPAT margin of 10%. As competition flooded the market, GrubHub’s market share fell to 18% in October 2020, and its TTM NOPAT margin is -5%.
Given the high level of competition in the food delivery app market, we think it is highly unlikely, if not impossible, for DoorDash to achieve anything close to the market share growth and NOPAT margin improvements baked into its projected IPO valuation. Hence, we’re calling this IPO the “most ridiculous of 2020”.
DoorDash and its bankers want to get this deal done as soon as possible – before the COVID-19-driven tailwinds subside. Demand for food delivery soared earlier this year, as in-restaurant dining was shut down across the country. As the largest food delivery service in the United States, DoorDash greatly benefited from this increased demand.
The firm’s revenue grew 172%, 214%, and 268% year over year in the first, second and third quarters of 2020, respectively. What better time to IPO than when revenue is tripling year over year? However, such rapid revenue growth is expected to decline by the company’s own admission. Plus, the emergence of multiple highly-effective COVID-19 vaccines will likely bring food delivery back to levels where no one would consider trying to IPO a food-delivery company.
David Trainer is the CEO of New Constructs, an independent equity research firm that uses machine learning and natural language processing to parse corporate filings and model economic earnings. Kyle Guske II and Matt Shuler are investment analysts at New Constructs. They receive no compensation to write about any specific stock, style or theme. New Constructs doesn’t perform any investment-banking functions and doesn’t operate a trading desk. This is an abridged version of their report “DoorDash: The Most Ridiculous IPO of 2020 ”. Follow them on Twitter @NewConstructs.