Dead On Arrival?
Dead On Arrival?
Instacart filed its IPO paperwork at the end of last week to much anticipation. But certain unit economics of the business should raise alarm bells.
Instacart, the online grocery delivery service, is stepping onto the IPO stage - in what is an echoey, empty auditorium. However, this isn't just another run-of-the-mill IPO; it's a moment that could reveal whether investors are truly changing their priorities in the face of very uncertain macroeconomic conditions. Are they now more interested in solid profits than reckless growth-at-all-cost expansion?
Let's dive into the numbers and try to decipher whether Instacart is primed for success or whether it’s dead on arrival.
Unexpected Positives
Instacart's IPO filing reveals a healthy bottom line. The company has shown it can make money by operating efficiently over time. In fact, it has managed to maintain several profitable quarters, and achieved a 14% operating margin for the last 12 months ending in June.
Blue bars are great, but one must factor in the macroeconomic conditions contributing to the swing from red to blue. We’ll look at these factors a little bit later in this note, but one thing to think about for now is whether pre-IPO investors want to see declining operating profits?
Comparing with Other Gig-Economy Players
In contrast to the likes of Uber, Lyft, and DoorDash, which are still grappling with annual losses, Instacart's approach is unique. By offering prime digital space to brands for advertising, they've managed to beef up their profits. PepsiCo even invested $175 million in Instacart before a potential IPO, snagging premium real estate for its products. Advertising now makes up over a quarter of Instacart's annual revenue, bridging commerce and marketing.
This is interesting because unlike the optimism surrounding other IPOs over the last few years, today's investors don't easily forgive companies that burn through money for market share. This shift in sentiment has led to fewer major new IPOs. This year, only a handful of venture-backed IPOs exceeded $1 billion, compared to previous years.
The Good and the Not-So-Good
But it's not all smooth sailing - and this is a concerning chart by all DCF measures. Instacart's growth rate, measured by gross transaction volume, has slowed down considerably. It only rose by 4% in the first half of this year compared to the same period last year. In contrast, during the first half of 2022, growth was a solid 15%. On top of that, the number of orders has plateaued, stubbornly sticking around 66 million for three quarters in a row.
Think about projecting our cash flows over time for a moment. In what world does this chart make for good reading from an investor’s standpoint? Consumers were flush with cash right through Instacart’s growth period. Where will the growth come from going forward?
Decoding the Factors
The reasons behind these trends are a mix of factors. Inflation has boosted order values but has also caused customers to buy fewer items per order. On top of that, competition is fierce. Walmart dominates the online grocery sales market, accounting for 62% of sales in July, compared to 54% the previous year.
Other players are also vying for their slice of the market. Kroger, a major player in groceries, holds 10% of the U.S. market, using Instacart for fast deliveries while having its own delivery service. Uber and DoorDash have entered the grocery arena, boasting about big growth numbers. Yet, both are still small players, holding less than 1% of the U.S. online grocery market.
The Real Challenge
While Instacart's profits are applause-worthy, there's a bigger challenge. Relying too much on advertising could create complications. Analysts think that most of Instacart's profits come from ads. But this isn't separate from their main grocery delivery business. To keep their ad business growing, Instacart needs to focus on increasing their gross transaction volume. It's a tricky balancing act. Profits are great, but they might need to make some quick moves to keep up with a changing market.
It’s important to remember, when a company has a convoluted business model, the public markets tend to tack on the relevant multiple to the least attractive part of the business and extend that to value the entire business. Is this what Instacart wants?
What a weird yet wonderful world,
