Uber (NYSE:UBER) sent shockwaves through the market last week when it announced its intention to acquire rival food delivery service Grubhub (NYSE:GRUB). Although Uber stock is still struggling with the implication of the novel coronavirus, it’s a temporary struggle.
If this comes to fruition, it should make Uber the clear leader in food delivery. And while both Grubhub and Uber have struggled with profitability, the combined firm could shed a lot of costs. Meanwhile, it could obtain higher profit margins as it would have more bargaining power with restaurants.
All along, the question has been which ride service company will be able to grab the pole position in the mobility race. Already, this crisis has been favorable for Uber in relation to Lyft (NASDAQ:LYFT) because Uber can strengthen its Eats concept, while Lyft is stuck in idle right now. The Grubhub deal could accelerate Uber’s advantage even further.
Uber Stock and Grubhub
Last week, the Wall Street Journal reported that Uber had approached Grubhub with a detailed offer to acquire that firm. Uber intends to issue about 1.9 shares of UBER stock as compensation for each share of Grubhub.
Based on Uber’s current valuation, that would work out to a valuation of $62 per share of Grubhub stock. Grubhub reportedly feels that this is insufficient. They are asking for 2.15 shares of Uber, which would work out to a valuation of $69 per share for Grubhub. Overall, a deal would come with a roughly $6 billion price tag.
Regardless of whether the final price tag comes in closer to $60 or $70 per Grubhub share, it looks like a reasonable price for Uber. Grubhub traded for as much as $80 last summer, and it reached a peak of $140 back in 2018. So Uber is definitely swooping in and making a deal at a discounted price.
Using all Uber shares to pay for the deal comes with pluses and minuses. On the downside, it means dilution. On the other hand, it keeps Uber from having to outlay any cash. Given the economic crisis and the fact that Uber is generating operating losses, it’s better to avoid heavy cash spending on acquisitions right now.
Also, it’s worth noting that Uber’s shares fell to as low as $13 each during the recent crash. Now, they’re back up over $30. So this is a nice time to go shopping with Uber’s stock as its currency; they will only suffer half as much dilution issuing stock at $30 as they would have at market prices near the March lows.
Regulatory Opposition
Now, to be clear, there’s a decent chance that the deal doesn’t go through. Not only are there the usual financial concerns, but there’s also antitrust risk. Regulators have seen how big tech has consolidated down to a few gigantic firms. They may seek to stop Uber before it can devour many of its key rivals.
Politicians may try to scuttle the merger as well. Prominent Democratic Senator Elizabeth Warren took to Twitter to voice her opposition to the proposed merger.
Warren criticized Uber and Grubhub, saying that, “Two giant companies with a history of crushing smaller businesses & exploiting workers want to use this crisis to get even bigger.”
She is asking for Congress to pass legislation that would heavily regulate mergers for the duration of the current financial downturn.
How have those concerns weighed on the deal’s outlook? Grubhub stock jumped from $45 to $60 per share on the news of the potential Uber acquisition. As of this writing, shares have settled around $57, indicating a good chance that Uber will be successful in making a purchase, but that it’s not a sure thing at this point.
UBER Stock Verdict
There’s been mixed reaction to the news. Some suggest that Uber needs to improve its own profitability before taking on another challenge, and there’s some merit in that concern. However, I side with those in support of a potential deal, though. In fact, I think this is a brilliant move on Uber’s part if they manage to pull it off.
Ultimately, these sorts of businesses tend to be winner-take-all or at least winner-take-the-majority markets. If you have five ride-sharing apps or food delivery services, there will be too much competition and they’ll all lose money. Narrow it down to one or two services, though, and you can find a price that ensures profitability.
Uber still has a lot to prove, both with food delivery and more broadly within its core ride-sharing business. The company is far from profitability, and sooner or later, it will need to generate strong cash flows to start delivering value for shareholders.
For the time being, however, Uber is still in the early innings of its growth story. I expect that investors will be patient as long as management continues to show a cohesive vision. Snapping up Grubhub on the cheap certainly fits with the broader overall strategy.
Winnow the playing field, and stand out as the biggest survivor. When the economy turns up and both ride-sharing and food delivery volumes grow, Uber could surprise its skeptics. That doesn’t necessarily mean Uber shares will soar immediately, but this could be a great entry point for a long-term investment.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek. At the time of this writing, he held no positions in any of the aforementioned securities.
