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GrubHub (Buy, $49 PO) Stock view: Marketing ramp should drive diner growth re-acceleration In recent quarters, GrubHub has been leveraging a series of recent investments, including expanded delivery, more restaurants on the platform, repositioned brand driving more effective advertising, and product optimization, which is driving higher conversion rates. We think GrubHub is well-positioned to continue to leverage these investments to drive growth in 2017 and beyond. GrubHub’s delivery business is reaching scale in more markets, and delivered gross food sales run-rate increased from $500mn in 3Q to nearly S600mn in 4Q (20% of ’16 food sales). Delivered orders were 40% higher than in 3Q. We think delivery will continue to drive take rate higher and be EBITDA accretive by YE17 as efficiencies are gained. Competition remains a key concern for investors and weighs on sentiment. However, we believe that GrubHub’s user base is sticky and its repeat order rate (>90%) is defensible. In 2016, as UberEats, Amazon Prime Now, DoorDash, and Postmates invested in expansion, GrubHub’s active diner growth and order growth remained solid. Google Trends indicates that over the past 12 months, though competitors have expanded to more cities in the US, GRUB remains the overwhelming leader in the market, with both of its core brands (GrubHub and Seamless) many times the size of any of its competitors. GrubHub 1Q results may also face a modest growth headwind from warmer weather in key markets like NYC and Chicago. For context, in 4Q15, GrubHub called out warmer weather was a 200bps y/y order growth drag (~$2mn in revenue, $12.7mn in gross food sales). Warmer weather can impact order volume and new diner growth, though new diners can partially shift to 2Q. We forecast 26% y/y gross food sales and 36% y/y revenue growth in 1Q’17. We think active diner growth will accelerate in 2017 as the company invests more heavily in marketing and it comps out against its “quality over quantity” marketing strategy started in 1Q16. Investors, however, should expect that accelerating active diner growth will be counterbalance by lower order frequency as newer diners to the system tend to order less frequently. At the same time, we expect take rate will continue to expand as the delivery business grows. Key theme/metric(s) for 1Q: gross food sales growth We forecast gross food sales growth in 1Q of 26%, a modest deceleration from 27% in 40 (flat with 4Q less the 1% hit from the lack of Leap Day in 1Q17}. Though we think there is likely upside to our forecast given a 500bps easier y/y comp in 1Q vs. 4Q. We expect 1Q active diner growth of 25%, Grubs per Diner decline of 3%, and average order size growth of 5%. Biggest 1Q issues/risks: - Despite positive Google Trends data and commentary from management, mounting competition eats away at GRUB’s growth and take rate, driving diner acquisition costs higher. e Warmer weather during 1Q, particularly in GrubHub’s core NYC and Chicago markets, may be a headwind to growth. « RDS (restaurant delivery service) investments weigh on earnings at a rate higher than the $3mn in EBITDA drag that we have in our model for 1Q’17. e Site and conversion rate improvements turn out to be one-time in nature rather than an ongoing, longer-term focus for management. 24 Internet/e-Commerce | 06 April 2017 Bankof America <2 Merrill Lynch HOUSE_OVERSIGHT_014910