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Fund managers express doubts ahead of Deliveroo’s IPO

The investment case for the food delivery app may not be as tasty as it seems
Fund managers express doubts ahead of Deliveroo’s IPO
  • A growing list of institutional investors including Aberdeen Standard and Legal & General will not be investing in Deliveroo
  • Concerns include employment rights and the dual-class share structure

Hailed as a “true British tech success story” by chancellor Rishi Sunak, Deliveroo is shaping up to be London’s biggest IPO since miner Glencore (GLEN) went public in 2011.

But the food delivery platform has recently come under pressure after a raft of institutional investors announced that they would not be investing in the company. As asset managers increasingly adopt ‘environmental, social and governance’ (ESG) investment criteria, it appears that the Amazon (US:AMZN)-backed unicorn does not pass their taste test.

Andrew Millington, head of UK equities at Aberdeen Standard Investments, says “[w]e will not be taking part in the Deliveroo IPO as we are concerned about the sustainability of the business model, including but not limited to its employment practices, and also the broader governance of the business.”

 

A recipe for ESG disaster?

The backlash follows a report by the Bureau of Investigative Journalism (BIJ), which, after analysing the invoices of over 300 Deliveroo riders in the UK, found that a third of them were earning less than the national minimum wage. One rider was paid just £2 an hour for 180 hours of work.

Deliveroo says the findings are “unverifiable, misleading claims”, based on data from less than 1 per cent of UK riders. It asserts that riders enjoy flexible working arrangements and earn £13 per hour on average during peak times.

Even if that is true, Deliveroo’s reliance on the gig economy is a significant regulatory risk, especially after the UK Supreme Court’s ruling that Uber (US:UBER) drivers are workers rather than independent third-party contractors. The ride-hailing company will now offer its UK drivers basic employment rights, such as the statutory minimum wage and a workplace pension, although these won’t apply to its food delivery business.

Still, Uber Eats and Deliveroo shouldn’t get too comfortable as scrutiny of the gig economy is increasing. The European Commission is looking to introduce legislation to improve labour conditions for gig workers by the end of year.

“At some point in time – and we don't know when – you could get a sort of sideswipe to the business model,” warns Phil Webster, director in the European Equity team at BMO Global Asset Management.

Competitor Just Eat Takeaway.com (JET) has tried to get ahead of the curve, rolling out the minimum wage and paid holiday to its UK ‘Scoober’ couriers. But Deliveroo has been more resistant. Embroiled in numerous legal cases over its riders’ employment status, it has set aside over £100m to cover potential claims. Additional costs from regulatory changes could make profitability a more distant prospect.

Deliveroo has yet to turn a profit, even as the pandemic has arguably created the ideal conditions for food delivery apps. Despite its revenue rising by over 50 per cent in 2020, to £1.2bn, the company still reported a £221m operating loss.

 

 

From riders’ rights to shareholders’ rights

Institutional investors often try to influence a company from the inside, but Deliveroo’s “time-limited” dual-class share structure would make that difficult. Rather than ‘one share, one vote’, the ‘Class B’ shares of founder Will Shu have 20 times the voting power of ‘Class A’ shares and he can block any shareholder resolution.

Legal & General – which says it is “unlikely to participate in the IPO” – points to the importance of “protect[ing] minority and end-investors against potential poor management behaviour, that could lead to value destruction and avoidable investor loss.”

Akin to The Hut Group (THG), Deliveroo will be restricted to a standard listing on the London Stock Exchange and excluded from the FTSE 100 and 250. Still, it could find itself promoted to the premium segment in due course should the listings shakeup proposed by the Lord Hill Review come to pass.

 

Beyond ESG

Many institutional investors avoiding Deliveroo hold shares in peers Just Eat, Delivery Hero (DE:DHER) and China-based Meituan Dianping (HK:3690), suggesting that ESG anxieties may not be their only priority.

Food delivery is highly competitive and Deliveroo is not the number one player. According to Edison Trends, Just Eat is the UK market leader, with a 45 per cent share of customers’ weekly spend on food delivery services, while Deliveroo is currently third behind Uber Eats.

“Your competitive advantage is really your coverage and your choice,” says Webster. “But Just Eat is using the profitability from its marketplace business to undercut Deliveroo on delivery. It is using it as a bit of a loss leader for now to expand coverage and make sure that in roughly 18 to 24 months it will have a supply of restaurants that looks very similar to Deliveroo.”

 

 

In a scathing assessment, Webster says there is “literally nothing that I am comfortable with about Deliveroo”. He believes the company is “wholly uninvestable from a business model and risk perspective, and from a valuation standpoint, I couldn’t even begin to make it stack up against what are significantly better players with Just Eat and Delivery Hero.”

James Bevan, chief investment officer at CCLA – which manages funds on behalf of the Church of England – presents a similar bear base: “no current profits, sustainable profitability [or] free cash flow, and a barrow load of risks including significant social risk that’s presently extra-financial, but which may end up hitting the company’s P&L [profit and loss] and balance sheet as a result of legislation and regulation.”

 

Scaled back ambitions

Amid the mounting scepticism, Deliveroo trimmed the target price range of its IPO from between 390p-460p, to 390p-410p. It has now set the final float price at the bottom end of this range, at 390p, giving it a valuation of £7.6bn.

The company insists this decision was down to “volatile global market conditions for IPOs” – logic that does hold some merit. Looking at the recent debut of online review platform Trustpilot (TRST), after an initial burst of excitement, the shares fell back to their 265p IPO price.

But Susannah Streeter, senior investment and markets analyst at Hargreaves Lansdown (HL), believes the negative reaction from institutional investors will have caused some unease. “It’s likely initial orders for the IPO have come in nearer the bottom of the target range, and by setting its sights nearer those prices, it is managing expectations,” she says.

 

So, should retail investors take a bite?

Webster says “the one thing that Deliveroo has done well” is set aside £50m-worth of shares for a ‘community offer’ on the PrimaryBid platform. Retail investors have historically been excluded from IPOs, but Deliveroo customers can purchase up to £1,000-worth of shares.

While that is a lean slice of the total offering, it could set a precedent for greater retail investor involvement in IPOs in the future.

It remains to be seen if ordinary investors share fund managers’ misgivings about Deliveroo, although some may spot an opportunity for a short-term trade of the ‘IPO bounce’ rather than a long-term investment.

Russ Mould, investment director at AJ Bell, says that “some investors will see it as an easy way to make a quick 10 per cent to 20 per cent gain, the level at which shares in newly listed companies often ‘pop’ on the first day of dealings.”

Ultimately, Deliveroo is a high risk bet whose post-pandemic prospects and ability to withstand competitive and regulatory threats remain unclear.