Deliveroo
Deliveroo promises rapid delivery of restaurant meals. IPO investors will have to wait a while for a return,
The company’s recent IPO was a flop for investors but founder Will Shu has £1bn extra to play with. The question is, can food delivery on bikes ever turn a profit?
There’s a dearth of detail and an abundance of hype in the listing document for Deliveroo, which went public on the London Stock Exchange at the end of March. One of the best bits was regarding what the company intends to do with the IPO proceeds. The company stated: ‘The way we think about it is simple. There are 21 meal occasions in a week – breakfast, lunch, and dinner – seven days a week. Right now, less than one of those 21 transactions takes place online. We are working to change that.’
Founder Will Shu (41) has been talking a good game since establishing the venture in February 2013. So much so that investors backed Deliveroo with £1,310m in equity investment over the years. The company required all that funding because it burned through £1,140m since Shu first got on his bike to deliver a restaurant meal eight years ago.
The operating loss in 2020, a boom year for meal deliveries, was £220m, though the ‘adjusted Ebitda’ outcome was less alarming, at minus £12m. That adjustment was arrived at by excluding ongoing operating costs such as legal costs and regulatory settlements (£80m), share options and related social insurance payments (£75m) and exceptional costs (£23m).
Some serious investors weren’t too bothered. Deliveroo priced its IPO at 390p a share, valuing the enterprise at £7.6bn. A number of UK institutional investors shunned the share sale, on the basis that the pricing was unrealistic and because Shu’s special shares leaves him in control after the issue of the new equity. In the event, the IPO proceeded as planned, albeit with some initial propping up of the share price by underwriters.
In the share offer, Deliveroo sold 256 million new shares to raise gross proceeds of c.£1 billion. Existing shareholders sold 128 million shares for c.£500m, including the founder, who grossed c.£26m. After the listing, the share price collapsed from 390p to 280p recently, at which level the market values Deliveroo at £5 billion.
In a matter of days, Deliveroo’s IPO investors were nursing losses of £400m. On the basis that they take the long view, what’s the underlying attraction in Deliveroo for some fund managers? The growth story is spectacular, with the company doubling revenue between 2018 and 2020. However, investors are taking a lot on faith, as the IPO prospectus is opaque about business model details.
Gross Transaction Value
The starting point with Deliveroo is Gross Transaction Value (GTV). This figure, which doesn’t make it into the accounts, is the total value paid by consumers for their food basket, including VAT and other sales taxes.
In lockdown 2020, the company grew GTV by two-thirds to £4.1bn.
Revenue
Company revenue or turnover is Deliveroo’s share of the GTV, which in 2020 was £1.2bn. That suggests that for meal orders from a restaurant made through the Deliveroo app, the company’s take is 30%. That margin won’t apply to every order. Some restaurants handle delivery themselves, and in the UK the Deliveroo service also extends to supermarkets and convenience stores, for whom a 30% commission would be untenable. The revenue line also includes sign-up fees, and the fees consumers pay for delivery. No clarity on the various revenue streams was provided in the prospectus.
Cost of Sales
Cost of sales accounts for 70% of revenue, so in the prospectus you might expect some explanation as to what costs are included in this line item. All that’s revealed is that the largest element of cost of sales is the cost of delivery from restaurants to customers. This refers to Deliveroo riders, a cohort of freelancers who typify the gig economy. As of December 2020, Deliveroo provided work for over 100,000 riders across its 12 markets, which is twice the number of riders in the previous year.
Even if all the cost of sales goes to riders (and it doesn’t), £835m divided by 100,000 equals an average of £8,350 per rider p.a. Rider exploitation was another factor cited by ESG-conscious fund managers who gave the IPO a miss. Churn is a big issue for Deliveroo – the average rider delivers for 10 months. The company says 16,000 people in the UK applied to ride with Deliveroo every week in Q4 2020, and technology investment shortens the ride time. Still, driving down this expense line as a proportion of revenue will be challenging.
Gross Profit
Deliveroo’s gross profit margin as per the accounts is 30% but the company prefers to focus on the gross profit margin as a percentage of GTV. This increased from 5.8% in 2018 to 8.8% in 2020, primarily, the company says, by improving the efficiency of rider trips.
The company expects that its GTV will grow 30% to 40% in 2021 and will continue to grow 20% to 25% per annum. There is a limit to rider efficiencies, with gross profit margin guided as 7.5% to 8.0% in 2021 and improving to c.8.5% in the medium term. Taking a five-year view, all going well the company’s gross profit could increase from £360m last year to £900m in 2025. If overheads were maintained at the 2020 level, that would leave a surplus of £330m, reducing the five-year forward p/e to x15 times.
Administrative Expenses
Administrative expenses account for 48% of revenue. That figure plus the 70% for cost of sales explains why Deliveroo is loss-making. There is more clarity about this line item in the prospectus. Of the £580m total last year, staff costs were £205m and sales and marketing costs were £135m. Depreciation and amortisation was £35m, the R&D overhead was £16m and provisions were £80m, relating to abundant legal and regulatory issues. Covid and pre-IPO costs added up to another £20m. That still leaves c.£80m in admin costs not specified.
Cashflow
An accounting loss is one thing and cashflow is another. Cash generated from operations in 2020 was £7m, a big swing from the £200 cash outflow the previous year. Large investors who participated in the IPO will have number-crunched projected cashflow based on GTV growth, though sceptics wonder if GTV will increase at the projected rate once societies re-open.
Outlook
Will Shu has brought Deliveroo a long way in a short time. The company operates in 800 locations across 12 countries. Half the business is generated in the UK and Ireland and the balance in Australia, Belgium, France, Hong Kong, Italy, Kuwait, Netherlands, Singapore, Spain and the United Arab Emirates. International expansion can be tricky: Deliveroo has retreated from Germany and Taiwan, and authorities in Italy are demanding that the company start paying social insurance for riders. With the IPO proceeds, Shu can extend geographic reach in its home market and elsewhere.
In the markets where it operates, Deliveroo estimates that online home delivery accounts for c.4% of total restaurant sales. That proportion is smaller for grocery sales, a segment the company has been tapping into since 2018. As its heft increases, Deliveroo is also looking to expand exclusive restaurant and grocery partnerships, with the company leaning on partners to only offer certain menu items on its platform.