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Morningstar | Grubhub Easily Beats 2Q Expectations and Announces Acquisition of LevelUp; Raising FVE to $81

Grubhub posted very strong revenue growth accompanied by slight margin expansion, surpassing our internal projections and consensus for the seasonally weaker second quarter. The firm once again benefited from the Eat24 acquisition as it pushed the number of diners, daily orders, and gross food sales a bit higher than expected year over year. Excluding Eat24 figures, growth in those numbers more closely resembled increase seen prior to the acquisition, which in our view supports our doubts regarding the firm's ability to maintain a network effect moat source. Plus, some statistics show that Grubhub is losing market share to other service providers including Uber Eats in the United States. However, the LevelUp acquisition, which likely will close in fourth quarter, may help Grubhub more easily attract restaurants and retain them at a higher rate. Given management's higher full-year revenue and adjusted EBITDA guidance, along with our own estimate of revenue from LevelUp, we upped our projections, which led to a fair value estimate of $81 per share, much higher than our prior $61. While the stock has reacted very well to second-quarter results and higher guidance, we continue to view this no-moat name as overvalued with shares trading at 12 and 46 times our 2018 sales and adjusted EBITDA estimates. For 2019, those multiples are 9 and 31.

Grubhub's total revenue grew 51% year over year to $240 million, driven by higher active diners and gross food sales, which increased 70% and 39% from last year, respectively. Excluding the acquisition of Eat24, those figures grew 26% and 22%, respectively, comparable to levels prior to the deal (24% and 20%). Average number of daily orders increased 19% organically, up from 16% in 2017. Total gross food sales per order growth decelerated for the second consecutive quarter as it increased only marginally, or around 3% year over year.

We were impressed with continuing acceleration in Grubhub's average commission rate, which we estimate stood at 20% during the quarter, up around 200 basis points from last year and 100 basis points from first quarter. This may be due to the addition of what we think are higher-paying Eat24 diners. We have modeled in higher commission rates but increasing an average of only 100 basis points per year.

Operating margin came in at 14.3%, up only 40 basis points year over year, mainly due to slightly lower-than-expected spending on sales and marketing, partially offset by higher operations and support, and technology expenses as the integration of Eat24 continues. Given our assumption of the lack of a network effect moat source, we expect Grubhub to increase its sales and marketing spending going forward. We have assumed a 15% 10-year CAGR in spending on sales and marketing, compared with total revenue CAGR of 17%.

Grubhub also announced it is acquiring LevelUp, a restaurant digital ordering, payments, and customer relationship management platform provider, for $390 million. We think by integrating LevelUp with its platform, Grubhub just may be able to create some stickiness and exclusivity when it comes to restaurants. With more restaurants on the Grubhub platform, the firm may be able to more easily attract more diners. However, we note that firms such as Uber, Amazon, and Alphabet’s Google, are capable of quickly matching LevelUp offerings. In addition, in our view, Grubhub may have paid a hefty price for LevelUp as we think the $390 million represents nearly 10 times revenue for LevelUp, which may be too high for a company that has yet to generate EBITDA. We do expect LevelUp revenue to grow at a 27% nine-year CAGR through 2027 and have included it in our model, beginning in 2019.

Per management's higher guidance and the strong second-quarter results, we increased our projections significantly, leading to a fair value estimate of $81 per share, up from $61. We have modeled total revenue growth of 45% for 2018, amounting to around $992 million. We expect nearly 34% to follow such growth in 2019 as Grubhub continues to attract diners and restaurants. In addition, we have included our $60 million estimate of revenue generated from LevelUp. We expect operating leverage beginning in 2019 as the firm is likely to have completed the Eat24 integration. With that, operating margin is projected to expand to 24% by 2027, up from 13% in 2017 and 14% in 2018.