It's a great time to be a DoorDash (NYSE:DASH) insider.
Shares of the hot food delivery start-up jumped 86% on its IPO day, rising off of an already elevated listing price. The eye-popping surge comes as restaurant delivery apps have been among the big winners during the pandemic and amid speculation of a broader bubble in tech stocks.
Still, at a valuation around $72 billion now, double that of well-established restaurant chains like Chipotle, for example, it seems too hard to justify DoorDash's market cap. The company is still unprofitable, even as it's experienced significant tailwinds from the pandemic. Beyond valuation concerns, there are a number of other reasons to avoid DoorDash and its food delivery peers.
1. Competition is intense
None of the major food delivery apps -- DoorDash, Uber (NYSE:UBER) Eats, or Grubhub (NYSE:GRUB) -- have managed to achieve consistent profitability. The industry is intensely competitive, with each provider spending lavishly on promotions and advertising to attract new customers. The flurry of spending has forced the industry into consolidation, with Uber acquiring Postmates, Grubhub selling itself to European food delivery giant Just Eat Takeaway, Amazon shutting its own restaurant delivery app, and Square selling Caviar to DoorDash.
But even as a duopoly or triopoly, that competition isn't going away. There's little customer loyalty in this market. In fact, Grubhub CEO Matt Maloney even called customers "promiscuous" not long ago as Grubhub starting losing its base to newer food delivery apps. While delivery companies have tried to form strategic partnerships with restaurant chains, those haven't proven to be a source of competitive advantage either, as restaurants like McDonald's have shown they're willing to leave one provider for another when a better deal comes along -- which it did when it added DoorDash as a delivery partner, ending its exclusive relationship with Uber Eats.
Revenue growth has been surging in the industry, especially during the pandemic, but lack of a clear competitive advantage for any player means that the sector will remain a dogfight for market share for the foreseeable future.
2. The economics are bad
Unlike ridesharing or other types of third-party delivery that are not as time sensitive, restaurant delivery has a number of unique challenges. Companies like DoorDash have to balance the interests of restaurants, customers, and the drivers it calls Dashers. It's easy to run into problems like food getting cold, negotiating with restaurants that want delivery to be incremental to regular sales, and customers who don't want to pay steep delivery fees.
In 2019, before the pandemic, DoorDash had an operating loss of $616 million on revenue of $885 million. Revenue tripled from the year before as the company experienced a surge in demand and grabbed market share in a fast-growing market, but it needed to spend two-thirds of its revenue on marketing to achieve that growth. Through the first three quarters of 2020, those results have greatly improved with revenue of $1.92 billion, again up more than 200% from the prior year, and an operating loss of just $131 million, a much better margin. DoorDash even posted a $95 million adjusted EBITDA for the first three months.
However, the company has gotten a huge tailwind from the pandemic, as order value doubled sequentially from the first to second quarter of this year as the pandemic struck. In other words, the business is likely to experience a hangover next year as Americans feel safe visiting restaurants once again when the pandemic ends.
Uber, the No. 2 restaurant delivery provider in the U.S., has also seen explosive growth in its global delivery segment this year, with revenue up 125% to $1.45 billion in the quarter. But it still had an adjusted EBITDA loss of $183 million. Due to consistent losses in Eats, Uber has been retrenching the business, pulling out of markets where it isn't the No. 1 or No. 2 provider.
3. Restaurants hate them
Third-party delivery services have been something of a lifeline for the restaurant industry during the pandemic as restaurants have had to convert most of their business to takeout. However, a number of restaurants, especially independent ones, resent the impact that these delivery apps are having on the industry as they squeeze already tight margins and their interests aren't necessarily aligned with restaurants. Some apps, for example, misrepresent restaurants that haven't even agreed to deliver through them.
Apps like DoorDash, Uber Eats, and Grubhub can charge as much as 30% or more per order, and restaurants often feel like they're stuck listing with these apps since that's the first place so many customers go when they want to order food. Still, most independent eateries, it seems, would prefer diners to order directly through them -- they have more control of the order, receive payment directly, and can choose to outsource delivery if needed.
Earlier in the pandemic, some cities even stepped in to impose 15% caps on food delivery fees, essentially implying that the services are monopolistic and putting restaurants out of business.
Restaurants are highly dependent on third-party apps for now, but the situation seems untenable over the long run. Independent restaurants are exploring ways to fight back, including taking delivery in-house and educating customers to order from them directly or even offering incentives to do so.
In order for third-party apps to continue to grow, they need buy-in from restaurants. Without that, DoorDash and the rest of the industry could be in trouble. That risk, along with the poor unit economics, intense competition, and overinflated valuations makes the sector one that's best avoided.