Food delivery company DoorDash’s (NYSE:DASH) Wednesday IPO saw immediate gains. Shares popped up 7% in auction as investors rushed to snap up DoorDash stock. More short-term gains look likely; speculators might want to buy the stock first and ask questions later, while the market digests the company’s unusual IPO.
The food delivery business was once quite profitable — rival Grubhub (NYSE:GRUB) consistently earned over 15% operating margins, similar to buyout target Corelogic (NYSE:CLGX). Anyone buying shares in 2016 would have seen a stonking 650% return through 2018 — and probably earned enough for a lifetime supply of pizza delivery. But since then, competition has left the industry ragged and profitless. GRUB stock collapsed from $146 to $31 by March 2020. Since then, shares have only recovered to $72.
That means investors buying DoorDash stock will need to balance the good (the company’s strong momentum) with the bad (a worsening competitive landscape). And above all, when the ugly rears its head, make sure you’re ready on the trigger to sell out fast. Here’s why.
DoorDash Stock IPO: The Good – Strong Momentum
First, there’s a good reason to buy DoorDash for 2021: the company is riding a tidal wave of growth. Revenues tripled in 2019 and skyrocketed another 226% in the first nine months of 2020 as the coronavirus pandemic forced many to stay at home. Its growth will likely continue through early 2021, even as Covid-19 vaccines start making their rounds.
Even without reading DASH’s financials, any couch potato would know of the company’s massive success. That’s because ordering food online has changed from a luxury to a necessity.
Let’s rewind the clock a decade. Ten years ago, getting one of Chipotle’s (NYSE:CMG) burritos delivered would have been a rather cruel task reserved for the office intern. Few people outside investment bankers and consultants with expense accounts would have consistently ordered Seamless every night.
Then, of course, came the novel coronavirus. Fast forward to today, and it has become almost polite to buy your food via delivery service. And not just that. With California’s Proposition 22, a ballot measure passed in November, gig-economy drivers can soon apply for healthcare and insurance from their contracted employers.
DASH’s investment bankers have clearly gotten the memo (with a side of waffle fries). Last Friday, they upped their IPO price range from $75-85 to $90-95, valuing the company at $32 billion. Investors have since bid prices up even further to $102 in its initial auction.
And in cases like this, 1960s singer Linda Scott had it almost right: “don’t bet [against] money, honey.” Studies have shown that fast-appreciating stocks tend to continue outperforming, and DoorDash stock fits neatly into this category of hot issues. The company has aggressively gained market share, and its private market value has almost doubled from $15 billion since July.
The Bad – Industry Competition
Hold the phone. There’s something wrong with our order. Even though DASH stock could reward investors in the short run, the company has seen its industry go from “five stars” to “hmm… let’s just do leftovers tonight.”
When food delivery companies first gained traction in the mid-2000s, they offered a highly profitable business model. When delivery apps like Seamless and Grubhub first started, they left it to the restaurants to fulfill orders. That meant customer money got divided just two ways: 1) to the restaurant and 2) to the delivery app. These companies went on to print money for investors. When Grubhub and Seamless merged in 2013, the combined entity earned a record-breaking 350% return on capital (ROC) just two years later.
That began to change in 2015 when Instacart, DoorDash and other “gig-economy” firms started entering. That year, Grubhub began to offer their own delivery service for restaurants with delivery drivers to compete. DoorDash and Uber Eats follow a similar model using outsourced contractors.
Even if diners didn’t notice, the results were financially disastrous for the firms. With revenues now split three ways (to the restaurant, driver and app), profits plummeted. Grubhub now earns negative 6.3% ROC. And in the past nine months, DASH made money on an adjusted basis. But it took a pandemic to make it happen.
That means DASH needs structural industry changes. Delivery-by-drone, consolidation or a reversion to the old business model could all push DoorDash stock higher.
The Ugly – Valuation
On Bad News: SELL
Then there’s the ugly. Or rather, a “cosmetically challenged” topic. That is, the issue of price.
Unlike recent IPO Airbnb (NYSE:ABNB), DoorDash’s bookrunners have pumped up the DASH IPO price as far as markets can bear. At $32 billion, that makes the company wildly more expensive than rival Grubhub’s $6.2 billion valuation, even when adjusting for market share. (I consider market share instead of sales because Grubhub’s higher-revenue, higher-cost business model makes it incomparable by revenue).
Considering market share, DoorDash should be worth just $17.6 billion compared to Grubhub, or only $46 per share. That means DoorDash MUST keep growth high to maintain its premium valuation over Grubhub or risk having Wall Street re-rate its shares.
Should You Buy the DoorDash Stock IPO?
Squint hard enough, and DASH stock looks like a tempting buy. Its price-to-sales ratio of around 12x looks like a bargain compared to other work-from-home companies like Zoom Video (NASDAQ:ZM) at 62x or Shopify (NYSE:SHOP) at 51x. And in the short-term, investors should expect DASH shares to climb as Covid-19 vaccine delays stretch immunizations into Q3 next year. (You can’t order a vaccine by delivery app yet, last I checked).
But the market is a fickle thing. Stock fads can disappear just as quickly as they appear. And even though DoorDash holds a 51% U.S. market share, its top-two competitors have shown a willingness to slash prices to stay competitive. That means any investor of DASH shares should remain vigilant. The stock has the makings of a breakout success. But if the hype wears off before DoorDash can beat back the competition, it’s a long way down from $102.
On the date of publication, Tom Yeung did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing.