California lawmakers recently passed Assembly Bill 5 (AB5), which would require "gig economy" workers to be reclassified from contractors to employees. The bill is backed by Gov. Gavin Newsom, and would go into effect next year if passed into law.
Most news stories about AB5 have focused on its implications for Uber (NYSE:UBER) and Lyft (NASDAQ:LYFT), which both adamantly oppose the bill. Both ride-sharing companies already face ongoing protests from drivers demanding higher wages.
However, the bill could also force Grubhub (NYSE:GRUB) and DoorDash, the two largest food delivery companies in America, to change their business models. DoorDash has already teamed up with Uber and Lyft on a ballot initiative to undermine AB5, but Grubhub has stayed mostly silent on the issue. Let's take a closer look at how AB5 could impact Grubhub, and whether or not investors in this tech company should worry.
What AB5 means for gig economy companies
Independent contractors generally don't have unemployment insurance, workers' compensation, healthcare plans, paid leave, a minimum wage, or the ability to unionize. Full-time employees are eligible for some of those benefits, so the conversion of contractors to employees would significantly increase operating expenses at gig economy companies.
The classification of contractors vs. employees in California is defined by the "ABC" test, which stipulates three conditions must be met for a company to classify a person as an independent contractor: First, the worker must be free from the company's direct control. Second, the worker must perform tasks which are outside the company's core business. Lastly, the worker should be engaged in an independently established trade, occupation, or business of the same nature as the work performed.
Uber recently argued that its drivers met all three conditions since its core business was its technology platform instead of ride-sharing and food deliveries. In other words, only the workers who run Uber's digital services should be classified as employees. That's a slippery argument since Uber's apps couldn't survive without drivers.
Meanwhile, Lyft recently started to warn drivers that they "may soon be required to drive specific shifts, stick to specific areas, and drive for only a single platform (such as Lyft, Uber, Doordash, or others)" if AB5 is passed into law.
What AB5 means for Grubhub
Grubhub is different from Uber, Lyft, and DoorDash in one major way: It's consistently profitable. Therefore, Grubhub could weather the AB5 storm much better than its contractor-dependent peers.
Grubhub is the second-largest food delivery platform in the U.S. after DoorDash, but it generates fewer sales from California than its rivals. Research firm Second Measure estimates that Grubhub only generated 11% of its U.S. sales from California in May, compared to 41% for Postmates, 30% for Uber (rides and food deliveries), 27% for DoorDash, 24% for Lyft, and 19% for Instacart.
The firm also notes that Grubhub remains far behind DoorDash in major California markets. Grubhub accounted for just 18% and 21% of the San Francisco and Los Angeles delivery markets, respectively, in July. DoorDash accounted for 49% of deliveries in San Francisco and 29% of deliveries in L.A.
AB5 could certainly hurt Grubhub if it becomes a law, but its rivals clearly have more to lose. That's probably why it's keeping quiet about the bill and letting Uber, Lyft, and DoorDash lead the charge.
AB5 could spark similar legislation in other states
If AB5 becomes law next year, other states could also pass similar laws. A major soft spot for Grubhub is New York City, its biggest market.
Grubhub accounted for 72% of New York City's food deliveries in July, according to Second Measure. Back in June, New York lawmakers proposed creating a third category of workers called "dependent workers" between contractors and employees. Those workers wouldn't receive the same benefits as employees, but they would be given the right to unionize.
Other states which use some form of the ABC test (including Massachusetts, Virginia, and New Jersey) could also pass similar bills. If that happens, Grubhub could struggle just as much as its peers, and its profits -- which are already being weighed down by heavy spending on marketing, logistics, and the expansion of its digital ecosystem -- could quickly evaporate.
Grubhub might be purposely ignoring the AB5 debate for now, but investors still need to keep a close eye on these developments.