Deliveroo part 7 - Valuation

I am writing a long post because I don’t have time to write a short post.*

*Wrote this before the valuation range came out. I mean, £8bn at the mid-point… that’s pretty high. That prices the company on a much higher valuation than $DASH on a comparable accounting perspective. Also, existing investors which include Will Shu will be selling OVER £600mn shares...interesting

What should Deliveroo be worth, even in the bull case

DROO is probably close to worthless. The fact is DROO is a sub-scale player competing against a well capitalised, aggressive, and larger competitor with a structural cost advantage, in an industry that benefits from network effect. 

Regardless, let’s play devil’s advocate and assume the bull case for DROO is the $DASH of Europe. Fine… what valuation should DROO deserve then? Well, a lot lower than market expectation, even if we apply a $DASH valuation. The reason is simple — the market fails to identify the accounting differences between $DASH and DROO, which overstates the profitability and size of DROO.

There are two mistakes that undiscerning investors are making:

1. DASH’s GOV does not include white-label delivery which is a sizable part of its business

2. DROO’s gross profit is overstated relative to $DASH’s. DROO does not account for courier/restaurant/customer management cost in COGS while DASH does

Bull case — EV/GMV

Bulls are attaching $DASH’s EV/GOV to DROO without realising that $DASH’s GOV doesn’t include white label. Using sell-side estimates, white label is probably 20% of $DASH’s orders in 2021, and is growing twice as fast as the marketplace business. Hence, the relative valuation isn’t like-for-like. It would not be fair as white label represents a sizable part of DASH’s business, and is growing faster. 

If we include the GOV from white label, $DASH is actually guiding to ~$40bn of GOV for FY2021, or a 1x EV/GOV.

Applying this multiple to the midpoint of DROO GTV guidance suggest DROO should be valued at £5.5bn.

Bull case — EV/GP

Aside from EV/GMV, bulls also use EV/GP to account for the difference in monetisation between the two assets. They do it by simply attaching $DASH’s 20x NTM GP multiple to $DROO’s guided GP, bridging to more than £8bn valuation. 

Here is the problem. There is a big difference between IFRS and GAAP accounting standards for gross profit. DROO’s gross profit could be 30-40% lower if we use $DASH’s definition of gross profit.

DROO follows the IFRS reporting standard, where COGS only includes the cost of paying couriers and supporting revenue such as payment processing. Staff costs in managing couriers and restaurants are parked inside “admin” cost, under operational expenses. On the flipside, $DASH follows GAAP, where staff costs are included in COGS (h/t to my CFO).

This is extremely important. The staff costs allocated to manage couriers and restaurants are variable costs that increase as DROO expands. As per the prospectus, DROO has more than 1,800 ops and admin staff that are in day to day operation roles, which don't enjoy the same benefits of scale (DROO has to hire more of them to keep up with operations efficiency). Therefore, these costs must be considered when deriving DROO’s gross profit and unit economics, similar to $DASH. 

Applying $DASH’s 20x EV/GP on DROO’s guided gross profit (adjusted for reallocation of cost to COGS to make it comparable to $DASH) gets us to a £5.7bn valuation. (My estimates suggest DROO’s FY21 adjusted gross profit to be ~£289m, 40% lower than mid point of guidance)

Note that the bull case valuation would be a lot lower by s=imply making adjustments for accounting standards. 

Adjusting for growth, legal overhang, and competitive position

There are a few key differences between DROO and $DASH that are worth highlighting, which suggest a much lower valuation.

1. DROO’s growth is simply lower than DASH

Consensus expects 27% gross profit growth for DASH, while DROO is guiding towards 20% gross profit growth. Nobody knows how much this discount deserves, but say 10%?

2. DROO has much higher legal risk than DASH

Let’s go back in history. I’m sure many of you remember what happened to $LYFT in 2020, where investors were so afraid of the AB5 ruling, which caused the stock to tank. But the moment Prop 22 passes, $LYFT share price jumped from $23 to $30 almost instantly.

That tells us that a LYFT with high legal risk around its labour model is worth 25% less than a LYFT with low legal risk.

To put things into perspective, $DASH is like $LYFT with low legal risk and DROO is like $LYFT with high legal risk, and hence, DROO should trade at a 25% discount purely on the fact that it’s business model is more at risk. In fact, it might actually be worse than 25% since the market must have been pricing a sizable probability that Prop 22 will pass, and still priced $LYFT at a 25% discount on the likelihood that it doesn’t. 

Also, a change in the labour model has more pronounced implications on the food delivery model industry (profit pool is already limited and European consumers are price sensitive), which again, supports a lower multiple.

I mean, we know that this legal risk is happening for DROO in many countries right now. And so... perhaps an even bigger discount is warranted?

3. DROO is competitively weaker than $DASH

$DASH is the #1 player both in the US suburbs and US overall, while DROO is often either #2 or #3 in its markets. It’s very clear that market leaders trade at a valuation premium while smaller competitors trade at a discount. $GRUB traded at 7-8x gross profit before getting acquired (60% discount), and $WTRH is currently trading at 4x GP (80% discount to $DASH). 

Again, nobody can pinpoint the exact discount, but we know DROO deserves to trade at discount for its inferior competitive position. Let’s just use 20%. 

Combining these three elements together tells me that DROO should trade at a 45% discount to DASH, or a £3.2bn valuation (at 11x EV/ adjusted GP). Further downwards adjustments might be necessary.

Section 3 - DCF using the company’s own assumptions

A DCF valuation using DROO’s own assumptions doesn’t support a large valuation as well. 

DROO expects to grow 20-25% in the medium term, which I am taking as the next 5 years. I then taper the growth further to 2030, and exit at 20x profit after tax on a mature earnings profile. Lastly, I discount the cash flow back at a 11% cost of equity (+1% for dilution). Doing so implies a valuation of around £4bn. I think the biggest difference between my valuation and a certain sell-side firm (rhymes with referee) is that I properly account for staff costs as a variable item that broadly scales with orders, while they melt it flat as if it’s a fixed cost. It costs money to manage a 100k+ courier fleet and turnover twice a year and service 6 million customers buddy.

Interestingly, DROO is effectively projecting a massive gross profit deceleration in 2H21. This supports my thesis that gross profit will decline by a ton after covid (especially after accounting for the staff cost to make it comparable to $DASH). Growth and margin in the first half of the year would continue to benefit from Covid which tells us that the 2H is going to be a disaster (easily declining 40%+ before any reduction in delivery fee or increase in courier costs) using the guide. Investors should probably look at 2H21 gross profit number instead of the full year as that gives them a better indication of business quality. 

Section 4 - Takeaway

Let’s not forget $TKWY is coming for blood and none of the valuation above accounts for that. Another thing to note is DROO’s makes £1 in adjusted gross profit per order and delivery fee is easily £2 per order. 

If DROO were to compete with $TKWY, by matching and offering fee delivery, it means DROO will not be profitable on both a gross profit and adjusted gross profit basis.

Section 5 - Why would you buy Deliveroo if you can buy $TKWY?

$TKWY is valued at €17bn or €14.5bn excluding iFood. 

I don’t think anyone would say it’s controversial if we value Germany and Netherlands at 2.5x GMV (monopoly that is still growing rapidly able to achieve 8 to 10% EBITDA to GMV margin in the future), which implies €12.5bn. 

This suggests the rest of the world, which includes the UK, US, Canada, Australia, Spain, Italy, Poland, Belgium, Austria, Israel, and so on and so forth, are implicitly collectively valued at €2bn. 

I mean, if we were to put things into perspective...you can buy the #1 player in 

1. Rest of Europe (except France) 

2. Australia 

3. Canada 

and a strong US player in certain stronghold cities with a ton of marketplace FCF, for €2bn. Or you can spend multiple of that for DROO which is the #2 or #3 player in all of its market (and losing market share as well) with a ton of legal risks. To make the comparison even more laughable, $TKWY marketplace FCF from these countries is easily over €500mn - €600mn per year (and growing), implying an absurd value (negative) for a logistic business which is bigger and growing faster than DROO.

Look, we are valuing this part of $TKWY business at 0.1x EV/GMV that 

1. is expecting 2021 GMV to be over €20bn, 

2. has an embedded delivery business that is larger and growing faster than DROO

3. is profitable/self-financing

4. does not have any legal risk. 

I won’t bother attaching that multiple to DROO as I think you get the idea by now. 

On a side note, $TKWY reminds me of $SE when it traded down from $15 to $10 back in late 2018. The market was pricing in negative value from the ecommerce business (Shopee), and that turned out to be wrong. SE has 20x since. I would like to think that $TKWY will 20x in 2-3 years but it probably won’t. That said, I have more conviction in the strategy and competitive positioning of $TKWY relative to Shopee back in the day (could have easily been worth negative), which makes $TKWY a far superior risk reward choice of investment.

Funny enough, this news appeared when I was writing this post: https://www.thisismoney.co.uk/money/markets/article-9383753/Deliveroos-blockbuster-share-offering-faces-rough-ride.html

I’ll leave it to you guys to read it, but here’s a quote from it:

“Both fund managers suggested the flotation, which will initially raise £1billion of new funds, might not succeed unless the value was cut to encourage investors back to the deal. The valuation is indicative and a final price has yet to be set.”

I wish good luck (not really, you brought this on yourself) to any investor that decides to participate in DROO’s IPO. Investors will be paying a massive multiple for a food delivery business that 

1. has to choose between burning over £500mn a year to defend sub-scale market share (and probably still lose market share) or lose market share 

2. does not have a credible path to push out its antagonists. 

3. Is facing massive legal liabilities and potential business disruptions that are happening...right now. 

Also, the decision to sell £50mn of shares to retail is very interesting. That probably limits DROO ability to over-price the IPO and risks negative PR.

It is interesting that existing investors are also trying to sell. That sure tells us something :)  

Anyway, I’m glad there are actually people reading my stuff (honestly thought nobody cared), and have received interesting inputs. Also, thanks to those that sympathize with my student loans situation. I’m adding a donation button below. If you find value in my work, help out by buying me shares in $TKWY (or wine as I write these posts at night with several glasses of wine).

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Links to other related parts:

• Deliveroo part 9 - 1Q21 update

• Deliveroo part 8 - The aftermath

• Deliveroo part 6.b - Reply to comment

• Deliveroo part 6.a - Reply to comment

• Deliveroo part 6 - White label killed the delivery star

• Deliveroo part 5 - Top 10 red flags

• Deliveroo part 4 - Hell is coming. Gross profit might decline by more than 50%

• Deliveroo part 3 - How did Deliveroo managed growth in the past

• Deliveroo part 2 - So what about groceries delivery?

• Deliveroo part 1 - $7bn valuation...Really?

Links to other related companies:

• Just eat Takeaway

• Uber Eats