Couch Potato #4 - Predicting Instacart IPO Valuation (S-1 Teardown)

Hello fellow Couch Potatoes!

Last week, both Instacart and Klaviyo filed their S-1s, signifying a resurgence in tech public listings after a two-year hiatus. While public markets are improving, they are still not rolling out the red carpet like in 2020 and 2021. If Instacart and Klaviyo do well initially, it might open the floodgates for the subset of well capitalized private companies (like Stripe) that have been delaying their IPO.

In this article, I share my notes and takeaways from Instacart’s S-1 filing. Then, I use different valuation methodologies to predict Instacart’s IPO valuation. The S-1 did not give any direct guidance on forward projections or IPO pricing. I try to use three different methodologies applied to historical performance to determine my valuation prediction for Instacart’s IPO. This is my first time publicly trying to determine an IPO valuation - any feedback and suggestions are appreciated. Scroll to the bottom to “Predicting Instacart’s IPO Valuation” section to skip the S-1 review and go straight to the numbers.

Instacart Business Summary

In its S-1 Instacart calls itself a “grocery technology company”. Started in 2012, Instacart has built a three sided marketplace for on-demand online grocery shopping. In this model you havethree key players: the grocers (Kroger, Publix etc.), the consumers (people ordering the groceries and paying for them) and the shoppers (individuals who picks up the order on the consumers’ behalf). Simply put, you order groceries from Walmart, a shopper physically goes to the nearest Walmart location, picks up your groceries, delivers them to you and gets paid. But over the years, Instacart has become much more than a marketplace. They have expanded to enterprise-grade seller tools for grocers to power their ecommerce, fulfillment, and loyalty and retention. They have also built an ad platform on top of this marketplace. Marektplace transactions are still the primary source of revenue, but 30% of revenue now comes from advertising and non-core marketplace sources.

Financial Performance

Instacart has grown to incredible scale as a private company. In the past 4 years, the company has gone through two flavors of growth. First in 2020 and 2021, the global pandemic rapidly accelerated their adoption. Take a look at the YoY transaction volume graph below. Truly a founder’s (and investor’s) dream - a near vertical line up in 2020. As COVID’s effects slowly wear off, growth has started to slow down. In this same period, Instacart has had a stunning turnaround from negative gross margins to profitability.

Instacart’s model has three layers: gross marketplace transactions, net marketplace revenue, and ad revenue. Then, it’s worth looking at unit economics and profitability.

Gross Transaction Volume

Instacart’s description of GTV from the S-1:

We define GTV as the value of the products sold based on prices shown on Instacart, in addition to applicable taxes, deposits and other local fees, customer tips, which go directly to shoppers, customer fees, which include flat subscription fees related to Instacart+ that are charged monthly or annually, and other fees. GTV consists of orders completed through Instacart Marketplace or services that are part of the Instacart Enterprise Platform. GTV consists of orders completed through Instacart Marketplace or services that are part of the Instacart Enterprise Platform. We believe that GTV indicates the health of our business, including our ability to drive revenue and profits, and the value we provide to our constituents.

Instacart’s GTV growth has drastically slowed down in the last 6 quarters. GTV has two drivers: average order value (AOV) and number of orders. AOV has been steady since 2021. As a result, I don’t expect Instacart to materially increase AOV over time. The slowdown in order growth is concerning. Instacart’ overall growth is being driven more by advertising, than transactions (their core business unit). This is my primary area of concern for Instacart’s future prospects. Customer acquisition costs continue to degrade and any network effects are hard to ascertain. With slower growth, Instacart would be forced to further spend more on promotions to maintain existing cohort performance and drive incremental growth.

Revenue

Net revenue comprises of two main revenue streams - transaction revenue and ad revenue. Transaction revenue is what remains after deducing the cost of goods from the GTV and compensating the shopper for their service. In essence, this is Instacart’s “take rate”, representing the percentage of GTV they retain. Presently, Instacart’s net revenue is 6.3% of GTV. In addition to transaction revenue, Instacart also makes money through advertising, This business unit is 2.7% of GTV and together transaction and ads lead Instacart to taking 8.8% of GTV on a blended basis.

Marketplace net revenue often mirrors the gross margin profile commonly seen in SaaS topline revenues. Here, Instacart has 74%-77% gross margins on net revenue which is in line with what I expected. In 2022, a 150 bps increase in gross margin as a percentage of GTV partially drove their uptick in profitability. However, management anticipates a gradual decline in their gross margin as a percent of GTV as they ramp up promotions and customer incentives.

Some other highlights on financial performance:

• 80,000 stores on Instacart implies $360k worth of spend per store or 3270 orders / store / year (assuming $110 GTV / order)

• 5500 brands using Instacart ads drove $740M in advertising revenue (~$134k implied spend per brand)

• Ads are a key driver for both growth and profitability. This business unit grew 29% in 2022 compared to 16% GTV growth - however active brand partner growth seems to have stabilized (only 6% in 2022) which means brands are expanding their ad spend which is a good sign. The question is, what is the max amount of ad spend per brand could Instacart realistically capture here given narrow, targeted parameters? In theory, this is a complement or a substitute for in-store advertising.

• Robust cohort retention, especially when we exclude the exceptional 2020 cohort. This is expected since Instacart had almost non-organic growth spurred by shelter in place laws and a strong public response to a global pandemic. Even then, Instacart has managed to retain 85% of that large, uncommon spike which is impressive. This suggests to me that once customers use it a few times, it ends up being sticky and drives repeat usage across a cohort.

Predicting Instacart’s IPO Valuation

Instacart’s S-1 didn’t provide explicity valuation targets for its upcoming IPO. According to reports from Reuters, Instacart’s recent private valuations have been in the $12B - $13B range. In anticipation of this announcement, I analyze Instacart’s valuation using a few different approaches to predict a possible IPO valuation.

a) Multiple of Trailing Financials

The basic premise of this first methodology is to take mean and median marketplace revenue multiples and apply them to Instacart’s trailing financials to determine a valuation range.

Given that these marketplace multiples are currently at historic lows, this framework heavily penalizes Instacart in suggesting a range at a 36% - 53% discount to their last private valuation. This framework, while straightforward, is nonetheless a blunt instrument. For instance, the comp set includes several flat / shrinking marketplaces and those with substantial unprofitability. Even the high growth compset has companies being penalized for continued unprofitability.

b) FCF Multiple

Since cash generation is the primary valuation driver for businesses, examining FCF multiples offers a better approach. Here we get a much tigher multiple range both for all marketplaces, as well as filtering for comparable companies that meet three criteria: (a) >0% growth, (b) >0% FCF margin, (c) >0% EBITDA margin. Given the lack of 2023/2024 guidance, I have based this analysis on the FCF data from 2022. As a result, we get a valuation in the $6.1B-$6.5B which is effectively a 50% discount to their last round valuation.

Iddeally, I’d prefer to use forward multiples. But (a) Instacart is not public yet, so we don’t have forward looking guidance, (b) I could make assumptions but then the whole article would be spent explaining my assumptions, and (c) since Instacart’s growth has meaningfully slowed down, don’t expect forward analysis to be drastically different.

Before moving to the next methodology, I want to put out a quick outlier analysis. Four companies - Amazon, Uber, Doordash, and Upwork - present large outlier FCF multiples. They are outliers because Amazon is a massive business with several large sub business units contributing to the bottom line and to their enterprise value multiple, while others have just turned FCF positive leading to inflated early multiples. If Instacart were to trade at these outlier multples, it’s valuation would soar to $17.6B, a dream scenario for its newest shareholders. But, realistically, this valuation seems improbable.

 c) Sum of Parts

In my third approach, I have evaluated each business unit individually, viewing the company as an amalgamation of two distinct businesses: the transactional (marketplace) and advertising. Each unit is valied based on comparable revenue benchmarks and combining the ranges to determine Instacart’s valuation range. The resultant range is broad, mostly due to the variation in marketplace and fintech multiples.

For the transactional business unit, in addition to the marketplace multiple used above, I also looked at fintech multiples. These businesses are similar because of their transactional business model. I used the F-Prime index as a proxy for these businesses and used 20%-40% annual growth businesses as the ideal comp set for Instacart.

d) Combining Valuation Methodologies

Now, let’s consolidate the three methodologies above. Valuing based on historical revenue and FCF using the mid range of market multiples, we arrive ta a valuation range of $7.3B - $7.4B, marking a 42% dip from their last reported valuation. For the sum-of-parts approach, I believe a midpoint between marketplace and fintech multiples is apt. Instacart’s advertising business unit likely commands a premium given strong growth profile, which is why I chose the upper end of its valuation range. Weighting these methods, I converge on a $9.4B valuation.

This seems plausible, as Instacart would likely aim to reduce markdowns from the last round, if it can. A 27% discount, while not ideal, might be palatable to shareholders, especially if they anticipate a post-IPO pop.

Once Instacart announces its IPO price in a few weeks, I will revisit this analysis to gauge its accuracy. I am eager to hear your feedback - both on refining this valuation analysis and enhancing its presentation.

Marketplace Multiples 8/31/2023

Vertical Software Multiples 8/31/2023

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