Description

Note: I can't find TKWY NA ticker on VIC nor JET LN, so I had to use the old GRUB which is today not active anymore.

It’s almost becoming an annual VIC tradition to pitch TKWY long and I didn’t want to miss the opportunity to be the first one in 2022. I strongly recommend the excellent, albeit ill-timed write ups from Coyote (June 2020 – stock down over 50% since then) and tyro (March 2021 – stock down over 40%), where Takeaway.com history and business model is well articulated. I’ll give a brief overview of the group for background purposes; I encourage readers to read those 2 write-ups as highly informative.

Summary investment thesis

Most readers will know the bear case on TKWY – the company is slowly but surely losing market share in its key markets (Germany, UK, US) and the transition to a delivery model from a marketplace one is going to erode margins seemingly in perpetuity. Plainly put, we are in full agreement with the bear case but believe it to portray the history. It’s not even a bear case anymore – TKWY is losing market share, its margins are declining and yet we see the potential for the stock to double over the next 18-24 months. Buffett’s dictum that “in the short term the stock market is a voting machine” is very applicable to TKWY – the market has voted, and it voted out while valuation arguments (the “weighing machine”) are temporarily irrelevant. Inconsistent message from management to the market, ill-timed and expensive acquisitions, new ventures in adjacent unproven verticals and mounting operating losses have proven too much for even the most resilient long-term investor. That’s precisely why today we see a compelling opportunity. We expect near term disappointments on order volume trends and mounting losses to finally put pressure on management to do right strategic decision and exit the US market. Our bull thesis is not necessarily relying on Jitse deciding to sell the US business after less than a year from closing the Grubhub acquisition, but it certainly represents a nice incremental upside to the shares.

Background

JustEatTakeaway.com (TKWY) is a high-growth business which has massively derated due to several moving parts clouding the equity story. We believe that the market does not understand the evolution of TKWY from a pure marketplace business to a hybrid marketplace-logistics business and therefore does not understand the long-term profitability of this “hybrid” business model. Management has certainly been unhelpful in first decrying the validity of the 3rd party logistics model, then reluctantly accepting it and finally fully embracing it. The recent announcement of TKWY’s partnership with Asda and One Stop in the UK for grocery delivery partnership is proof that over the last 2 years, management’s strategic thinking has completely shifted in favor of 3rd party delivery models. “If you can’t beat ‘em, join ‘em” seems to have become Jitse’s new motto as it’s clear to everybody that 3rd party delivery models are here to stay as they are a better consumer proposition. Furthermore, while we believe the pandemic significantly accelerated the demand for restaurant deliveries and TKWY is ideally positioned to benefit from this secular trend, the pandemic has also introduced a significant amount of volatility and difficult comps for the market to digest. The pandemic has also, in our view, significantly reduced management visibility. For example, management’s latest guidance was for 2021, which was given to the market less than 2 months ago, is probably going to disappoint. TKWY guided for at least 45% order growth in 2021, which would imply c. 240m orders in Q4 (excluding Grubhub):

We think that the trading update next week will disappoint the market. Channel checks point to some 200-210m in orders in Q4, or only mid-teens order growth over Q4-20, which is significantly below guidance that implies c. 33-35% order growth in Q4-21:

As per chart above, UK and Germany are by far the biggest value driver being the two largest markets and the most profitable ones, but their margins have come under pressure in recent years:

Stay-at-home has been a huge factor in driving demand but has also made it very hard to predict quarterly figures. A top line order miss would then be interpreted as a confirmation of the structural pressures the business is exposed to. It all makes for a nice bearish narrative.

Because of this narrative, TKWY’s valuation multiples (based on EV to forward sales) dramatically shrank in the last 3 years from as high as 11x to below 2x today:

 We highlight below 5-6 important events (orange bars in the chart above) that in our view help to understand the derating process of the stock. These events corroborate the bearish narrative of a once-great-stock that lost its core values to empire building motivations on the part of the CEO, just as the company struggled under the pressure of mounting competition from logistic players (e.g. Deliveroo and Uber Eats). The events that appear above are:

·         TKWY merger with TKWY, creating a leading European player in the food delivery market

·         TKWY merger with Grubhub, creating a global leader in the food delivery market

·         DoorDash IPO, which highlighted mounting competition from logistic players in the US

·         Deliveroo IPO, which highlighted mounting competition from logistic players in Europe

·         Grocery delivery launches in both Germany and the UK, suggesting a clear strategy shift

We don’t necessarily disagree with this narrative, yet believe that the stock offers the opportunity of generating 20-30% IRR for the next 3-4 years in a base case scenario, with further upside in a bull case scenario.

Original business was a winner-takes-all proposition

The original Just Eat / Takeaway.com / Grubhub businesses were simple online marketplaces connecting consumers that wanted a take-away order to restaurants. The actual delivery of the order was then left either to the restaurants themselves or to customers (pick-up). The marketplace solution had 2 advantages to restaurants:

·         Offer a simple and easy online platform for little restaurants that weren’t tech savvy

·         Offer restaurants a demand generation tool. Small independent restaurants don’t have the budget to spend on advertising. Online aggregators can do this more efficiently

As other online marketplaces, online food aggregators benefit from strong network effects that fuel long term growth and create winner-takes-all situations, where the winner enjoys durable superior economics. As the customer base grows and customers get used to order food online and find new choices of restaurants, they will order increasingly more. As the marketplace grows and more orders are generated from the aggregator, more restaurants will join the platform. This will in turn increase the customer choice which will attract new restaurants…These network effects proved very powerful for Takeaway.com, the pioneer of online food marketplace business in Europe. Over the period 2016-19 (we’ve excluded 2020 because of distortions due to TKWY acquisition and COVID-19), such powerful network effect led to nearly 50% CAGR in orders:

As a first mover, Takeaway.com was able to gain a dominating position in virtually each market it operated. The business was launched by Jitse Groen in 2000 in the Netherlands, the company’s most mature market. Jitse Groen is still the CEO 21 years later and has replicated the successful Dutch playbook to most European markets.

Because of the network effects described above, the first mover typically has a massive advantage and creates nearly unsurmountable moats. There are various reasons for this. First of all, the marketplace business attracts small independent restaurants that don’t have online capabilities but do offer delivery services. These restaurants typically don’t want to deal with different marketplaces because it adds a degree of complexity. It’s much easier to manage 1 source of online orders rather than several. Restaurant loyalty is therefore an element that prevents new entrants to steal market share. Furthermore, happy customers are unlikely to leave the platform for an inferior one with a smaller choice of restaurants. Finally, the larger player enjoys economies of scale in marketing which can’t be easily replicated by a new entrant.

Such dominance naturally leads to superior economics. In 2016, the Netherlands, the company’s most mature market, reported an EBITDA margin of 63% The economics are very simple. Revenue is generated by charging restaurants a fee based on the order value, typically around 12-15% of the gross order value. There are some costs associated with processing (primarily credit card fees and some platform costs) but the variable costs are very low. Gross margins can be as high as 90%. What ultimately drives the margin is the amount of marketing the company is willing to spend to fuel growth. In the Netherlands where penetration is the highest, marketing is relatively low and EBITDA margins are therefore very high:

Vice versa, in markets where the company sees significant growth ahead, like in Germany, the company will not shy away from investing aggressively to reach a dominant market position like they achieved in the Netherlands. Over 2017-2019, the company spent cumulatively 65% of sales in marketing expenses alone, which is nearly 4x more than the level of marketing spent in the mature Netherlands. As a result, EBITDA margin was as low as -81% in 2017 in Germany, but this was a very deliberate strategic move that would ultimately fuel growth.

The results are there for all to see: in 2020 revenues jumped over 80% and EBITDA margins reached 33%, from 2% in 2019 and -43% in 2018.

The reason for these superior economics is customer loyalty. Once a customer is acquired, it tends to stick with the platform and orders increasingly more. Once market dominance is achieved and marketing spend normalizes, superior marginality emerges. The chart below shows that once acquired, new cohorts of customers generate revenues in a very predictable way:

The current fear is that TKWY’s cake will be eaten in its key markets by the likes of Uber Eats or Doordash. For example, in November Doordash acquired Wolt, which operates in Germany, signaling competition ahead in Germany. We are actually not too worried about this. TKWY seems to maintain its dominant position there and even Delivery Hero had to backtrack and announce the exit from Germany a few months after launching it. TKWY’s leadership in its key European markets is safer than people think.

Furthermore, notwithstanding the relatively maturity of this business in many countries, the room for growth remains enormous. Penetration in most of Europe remains very small and the there is still a huge number of restaurants that deliver but don’t have online capabilities.

The above-described desirable business attributes (barriers to entry, high margins, high growth) led TKWY to attract high valuation multiples. In Summer 2019, the stock traded on over 10x forward sales and if offered a clean equity story to investors.

3rd party logistics + M&A ruin the party

In August 2019, the company announced the intention to merge with Just Eat. Just Eat has a very similar business model to Takeaway.com being primarily an online marketplace for food delivery where restaurants fulfill themselves the delivery. Just Eat key market is the UK which represented the majority of sales and nearly the entire profitability of the group. EBITDA margins in the UK were close to 50%, so a level close to the mature Netherlands market.

While the deal did make sense strategically as it creates the European leading marketplace, it did create a complication to the equity story. First and foremost, Just Eat owned international businesses outside Europe, especially in Canada and Brazil, that didn’t really fit with Takeaway.com business model. Canada in particular was something tricky to understand. The Canadian business, called SkipTheDishes, is not the typical marketplace business; rather, it’s a logistic provider where the platform offers restaurants a delivery service. This was a major shift for Takeaway.com as it put itself in direct competition with other logistic providers such as Deliveroo, Uber Eats and DoorDash (more on this below). TKWY consolidated revenues jumped nearly 10-fold between 2018 and 2020 with gross margins going from 81% to 56%. The biggest problem though was the fact that it immediately put TKWY in direct competition with Deliveroo, which was just about to do an IPO and was aggressively expanding its London network. For the first time in its own history, TKWY had to tackle face-on a competing, yet different business model. It’s clear that Just Eat management at first underestimated the impact of new entrant logistic players and favored short term margins over long term market share. The move allowed Deliveroo to quickly gain market share. To put things in perspective, in 2019 Deliveroo grew its orders over 60% Vs. only 8% for TKWY.

The single biggest mistake that Just Eat, and TKWY, management did, was to assume that the logistic food delivery business model had very little overlap with the classic marketplaces. Restaurants would either opt for one or another, depending on their preference. Small moms and pops restaurants with a very low average value per order, would opt for a cheaper marketplace model and take care of deliveries themselves. Larger, more sophisticated, and higher ASP restaurants could afford to pay the hefty (c. 30%) charges that the likes of Deliveroo and Uber Eats would take.

The reality turned out to be quite different. While to a certain extent the churn is low and there are not too many restaurants that move from one model to the other one, for consumers, a fully integrated logistic provider offers a better proposition. As customers shifted to delivery models, some restaurants did too, eroding TKWY’s competitive advantage. Jitse Groen then compounded Just Eat management mistakes by going after the US market. In June 2020, TKWY announced the intention to merge with GrubHub, the leading US food delivery marketplace.

This move is a lot more controversial than the Just Eat acquisition because the US market is very different from the European market. In Europe, as we shall see below, logistic players like Deliveroo are growing rapidly but it’s a profit-less growth and marketplace businesses are still larger in size. The US market is much more competitive and delivery models like DoorDash are significantly affecting the incumber marketplaces. In October 2019, GrubHub share price collapsed 43% in 1 day as the company warned of weaker margins ahead due to a maturing market and intensifying competition. For reasons we shall describe below, the US market is one where delivery models can thrive and affect incumbent marketplaces. The choice of TKWY to merge with GrubHub turned out to be disastrous and led to a further derating of the stock. Furthermore, food delivery is a local business. There are going to be very little synergies in having a strong European business and a US one. The move was very much viewed as simple empire-building without a strategic rationale, with the simple aim of creating the world’s largest food delivery company, as per #1 goal stated by the company.

As a result of the transaction, TKWY will be the absolute world largest marketplace business, dominating in Europe and North America. There is no debate on the fact that TKWY is the ultimate marketplace winner now comprising the 3 original pioneers in the space, but the debate is now shifting to Marketplace Vs. Logistics and to the future viability of the marketplace business as logistic players are significantly outgrowing incumbent marketplace players:

Marketplace aggregators are losing share to 3rd party delivery companies like DoorDash and Deliveroo. The GRUB transaction highlighted this issue as the US market is the one that saw the fastest growth of Logistic players compared to aggregators. It also raised questions about the Just Eat transactions as the UK is another market where 3rd party logistic players gained significant share from aggregators:

As one can see from the chart below, in little over 2 years GrubHub market share in the US went from 39% to 16%. GRUB problems are now TKWY problems, and the market is scratching its head as to why Jitse Groen went ahead with this acquisition. There is a narrative about Jitse state of denial in terms of the new reality of the market. Bears argue that marketplace models are in structural decline as logistic solutions emerge. As per chart below, this is no longer a bear argument, it’s a reality:

GRUB problems are very evident. As per chart below, while the company was able to maintain a very healthy top line growth (+47% in 2020 and consistently above 30%), its EBITDA margin went from 30% in 2014 to 6% in 2020:

These dynamics clearly worried TKWY investors and finally made an impression on CEO Jitse Groen that seemed to get the point. As per slide below from most recent capital markets day, TKWY now sees delivery as a natural extension of its marketplace business, rather than a simple defensive move: