Deliveroo Holdings PLC (LON:ROO) was left red-faced on its market debut despite launching one of the most hotly anticipated and largest IPOs seen in London recently.
The food delivery service placed 384mln shares at 390p each, but the stock was trading at as low as 271p earlier on Wednesday after opening at 331p.
There has been bad publicity after a governance scandal prompted big investors to declare publicly they wouldn’t subscribe for any shares, but the market is also spooked by the profit outlook.
Meanwhile, the tech unicorn has remained loss-making despite a boom in takeaways when people were forced to stay home during lockdowns for the past year or so.
An expensive model
That’s because Deliveroo pays its riders, such as Uber Eats, which is expensive and makes it more difficult to compete outside major centres.
Just Eat Takeaway.com NV (LON:JET), instead, operates on a marketplace model where it takes a commission for the order but leaves it to the restaurant to deliver.
“JET does delivery (and it impacts margins) but it is really done as a loss-leader to stop Deliveroo/Uber Eats gaining traction. Its main model is marketplace, which explains why it leads outside big areas,” said independent analyst Ian Whattaker.
Competition is hard to bite
The Food Delivery marketplace is similar to Google Search, noted Whattaker, where the leader gains disproportionate benefits thanks to a virtuous circle: more restaurants attract more consumers, which then attract more restaurants and so on.
Conversely, if you are lower on the podium as Deliveroo, you face the opposite effect, where it is harder and more costly to gain traction.
In this sort of market, it tends to be almost impossible to displace the number 1 player, which is in Just Eat the UK, “unless they do something fundamentally stupid”, Whattaker added.
What’s more, the valuation of £7.6bn means Deliveroo is worth 6.4 times last year’s revenue, compared to Just Eat’s 4.8 times, so there will be more pressure to catch up on that to protect the share price.
Others attributed Wednesday’s flop to bad timing, especially as Deliveroo emerged as a pandemic winner but investors are looking for recovery stocks.
For its supporters, there is hope that the COVID-19 habit of ordering food online will remain once restrictions are lifted.
“Sharp moves on IPO day are typically attributed to a bank either overvaluing or undervaluing a stock, and this is no exception,” commented Joshua Mahony, senior market analyst at IG.
“This listing comes at exactly the wrong time for shareholders, with rising treasury yields bringing pressure on growth/tech stocks, and valuations based on a period of massive upheaval for the restaurant business. No doubt, the company has the ability to grow into their valuation over time, but the expectation that we will see poor momentum for pumped up growth stocks doesn’t exactly fill investors with complete confidence.”
Back to the governance troubles, the prospectus highlighted its drivers are paid as contractors but in the future there is the possibility the company might have to classify them as employees with benefits such as sick pay and holidays, as it recently happened with Uber Technologies Inc (NYSE:UBER).
This is expected to push costs up as the flexible employee model is a huge pillar of the group’s plans for success, according to Sophie Lund-Yates, analyst at Hargreaves Lansdown.
“If forced to offer more traditional employee benefits, like company pension contributions, Deliveroo’s already thin margins would struggle to climb, and the road to profitability would look very tough indeed. Throw in the recent developments at Uber, and general market volatility, and the net effect is one of increased anxiety,” she said.
What’s sweet on the menu
But there are reasons to remain optimistic on growth prospects, some say, especially as Deliveroo is now £1.5bn richer after the flotation.
“It offers higher quality restaurant options than some peers, which, coupled with its personalised app content and hyper-localised delivery approach, could hold it in better stead,” Lund-Yates said.
“The cash hoard from the IPO will be used to fund expansion too, particularly in areas like its delivery-only ‘dark’ kitchens, which offer restaurants a way to expand without having to invest lots of cash. It could also be used to pay for acquisitions. All in, Deliveroo should have decent firepower to chase growth.”
Time will tell if Wednesday’s knee-jerk reaction was simply a short-term issue, analysts at AJ Bell, which may even invite investors who like the long-term growth opportunity to buy stock at the even cheaper price.
As of lunchtime on the first day of trading, the stock plunged 27% to 284p.