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Why Uber Is Willing to Pay a Premium for Grubhub

By Adam Levy - May 19, 2020 at 10:51AM

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A merger of these food delivery competitors could lower expenses and increase revenue.

Uber (UBER -0.74%) and Grubhub (GRUB) -- two of the largest names in food delivery -- are reportedly in acquisition talks. Uber could acquire its rival in an all-stock deal. While Grubhub was seeking 2.15 Uber shares per share of its own company, the larger business countered with 1.9 shares. Grubhub said that's not enough, but the two companies continue to talk. Uber would effectively pay over $60 per share for Grubhub, a steep premium over the $47 price tag shares traded at before The Wall Street Journal reported on the two companies' talks.

But Uber has good reason to pay a premium for Grubhub. It fits perfectly within its strategy, which CEO Dara Khosrowshahi explained on its third-quarter earnings call last year. "Our strategy for Eats is simple: Invest aggressively into markets where we're confident we can establish or defend a No. 1 or No. 2 position over the next 18 months."

In other words, Uber needs scale in order to be profitable. Greater scale improves its acquisition and per-transaction economics, Khosrowshahi explained. 

Uber sees potential for $300 million in immediate cost savings at Grubhub by utilizing its superior logistics technology. But the synergies could be even greater as Grubhub helps expand all three pieces of its network: customers, couriers, and restaurants.

A woman in a car holding an Uber Eats bag.

Image source: Uber

The network effect

Uber's competitive advantage is its network. In ride-sharing there are only two pieces of that network: drivers and riders. Both sides of the network reinforce each other. More riders provide more opportunities for drivers; more drivers increase availability for riders and keeps prices low.

Uber Eats adds a third element: restaurants. The value proposition for restaurants to work with Uber Eats is access to a sizable customer base and fast delivery with no overhead. In Uber Eats, all three pieces work together to reinforce each other and build the network.

That's why scale is important (as it is for nearly any growth stock). Being the biggest food-delivery service in a market means lower acquisition costs for all three parts of the network. Anything less than No. 1 or No. 2 in the market means Uber is leaking efficiency in customer acquisition costs. So, it has divested assets or closed up shop in markets where it can't reach that scale, and it's investing in markets where it's seeing success.

Adding Grubhub in the United States will make Uber Eats the biggest in the market. With more customers, it'll attract more restaurants and drivers. With more food delivery requests, Uber will retain more of its ride-sharing drivers. And it could more easily cross-sell Uber Eats users on its ride-hailing service and vice versa.

Improving take rate

Aside from lower acquisition costs for customers, couriers, and restaurants, increased scale should improve Uber's take rate on Uber Eats orders. The company's long-term goal is to achieve a 15% take rate on Uber Eats, which CFO Nelson Chai says will translate into a 33% EBITDA margin.

Improving the take rate doesn't necessarily mean Uber will just charge restaurants more for delivery. Chai points out several areas that impact its take rate, which could be improved with the integration of Grubhub's network.

First, the mix of restaurants on its platform has a profound impact on Uber's take rate. Big national chains have much more negotiating leverage over Uber Eats than small local restaurants. And that makes sense: Uber's service is more valuable to smaller restaurants that couldn't efficiently manage deliveries on their own.

Second is unit economics. There's a much smaller percentage leftover for Uber to take from smaller orders than from larger orders. While adding popular quick-service restaurants with low average order values is key to increasing consumer use, they can be a drag on profit. To the extent Grubhub adds more diverse restaurants with higher average order values, it'll help boost Uber's take rate.

Finally, the efficiency with which the service can deploy couriers to restaurants will dramatically improve Uber's take rate. A driver that spends less time driving to the restaurant to pick up an order can make more deliveries per hour and thus can accept a lower rate per delivery. A denser network of couriers and better logistics technology will improve the take rate.

An Uber-Grubhub merger makes sense because it would result in lower acquisition expenses and higher revenue per order. Uber should be willing to pay a premium to get a deal done. That said, the combined company would control about 50% of the food delivery market in the U.S., which could raise antitrust concerns. So, even if the two sides reach an agreement, there's still a lot of work to be done.

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Stocks Mentioned

Uber Technologies, Inc. Stock Quote
Uber Technologies, Inc.
UBER
$22.86 (-0.74%) $0.17
GrubHub Inc. Stock Quote
GrubHub Inc.
GRUB

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