2023-11-29 12:45:35 ET
Summary
- Grab is the leading on-demand service player in Southeast Asia. First-mover advantage, coupled with its hyperlocal approaches and inorganic expansions, helps establish its dominant position.
- We argue that Grab has built customer loyalty after years of massive spending on promotions and discounts. New entrants will find it challenging to take on Grab's dominance.
- Grab focuses on profitability for its on-demand service, and growth is likely to be modest. But Digibank and the ads business will drive growth.
- According to our SOTP valuation, Grab's fair value is $3.6 per share, implying a 17% upside. We assume a modest 7% annual GMV growth and a reduction in incentives to nearly 6% of GMV.
- While we like the fact that losses have been narrowing, shares remain risky as Grab has not demonstrated profitability, and positive operating cash flow was driven by deposits.
Investment Thesis
Grab Holdings Limited (GRAB) is the on-demand market leader in Southeast Asia. We argue that the company has built customer loyalty after years of spending massively on discounts and promotions. Digibank and the ads business are likely to drive growth, while Grab focuses on improving the efficiency of its on-demand services. Indeed, the decrease in operating losses is a positive sign. Yet, shares remain risky as Grab has not demonstrated historical profitability, and its cash flow was driven by deposits. Our estimated fair value is $3.6 per share (17% upside). Initiate with a HOLD rating.
Introduction
Grab, a Southeast Asia tech company went public following a business combination with Altimeter Growth Corp., a special purpose acquisition company ("SPAC"). Initially valued at almost $40 billion, Grab saw its market cap plunge to $12 billion. The reason is that Grab was a loss-making business and a cash-burning machine. However, is the stock currently a buy?
Solutions Within One App
Initially founded as a Malaysian company with taxi-hailing booking services "MyTeksi" or "GrabTaxi" outside Malaysia, Grab rapidly expanded its operations to introduce a range of new offerings in other Southeast Asian countries.
Grab's expansion history (Company)
Grab runs a super-app offering various solutions in the same app rather than functioning as a pure-play app. The main idea is to build an integrated "everyday everything" app that caters to consumers' daily needs without requiring them to switch from one app to another. For example, let's say you're commuting to work with GrabBike. At lunchtime, you are in the mood to order food online, but you don't bring any cash. Therefore, you can conveniently use the e-wallet to pay for it. All these solutions are integrated into a single app.
Grab's super-app display (Company)
How does Grab monetize its business? Grab receives commission fees from drivers and merchants. On the other hand, it also allocates incentives to customers, drivers, and merchants. Total Gross Merchandise Value ("GMV") is the sum of the total dollar value of all transactions, including other fees such as tips and platform fees. Incentives are subtracted from gross revenue (Grab's commissions in dollar value) to calculate net revenue.
How commission and incentives work (Company)
Grab divides its business into four segments: Deliveries, Mobility, Financial Services, and Enterprises and New Initiatives. The Deliveries segment, which includes food delivery and point-to-point package delivery services, contributed nearly half of Grab's GMV. This was caused by surging food delivery demand and social restrictions that hindered mobility during COVID years. These two segments, together often called on-demand service, made up of 90% of Grab's gross revenue.
Segment contribution to GMV (Vektor Research)
First-mover Advantage: A Key Factor in Cementing Market Dominance
Grab is leading the on-demand service market in Southeast Asia ("SEA"). According to Momentum Works, Grab had 54% market share in food delivery GMV, up from just under 50% in 2020. Meanwhile, Grab held a staggering 75% market share in ride-hailing market based on respondents' most frequently used app, a survey from Blackbox Research suggests.
The market share dominance over its competitors is likely because of Grab's first-mover advantage coupled with its "hyperlocal" strategies and inorganic expansions. For example, when Grab came into the Philippines, Thailand, Vietnam, and Indonesia, it always beat Uber Technologies, Inc. ( UBER ) by a couple of months. In 2018, Grab merged with Uber in Southeast Asia in exchange for a 27.5% stake in Grab.
Additionally, Delivery Hero SE ( DLVHF ), the parent company of Foodpanda-the second-largest food delivery brand in SEA, is reportedly in talks for partial sale of its SEA operations, with Grab and Meituan ( MPNGF ) likely one of the potential acquirers. Its APAC business finally turned adjusted EBITDA positive in October, but we note a slight market share erosion from 2020 to 2022, based on Momentum Works' research.
Delivery Hero KPIs (Delivery Hero)
As Delivery Hero's management said :
We are by no means we have put the business at a place where it's not burning cash for the group. So that's good, and that's helpful. And I think the best way if you want to sell a business is to not -- urgent to try to sell a business. It's operating as you will operate forever. And I think we have put our business in a position where we by no means have to sell Asia. But of course, we remain rational. And if we see that there is a price that can be agreed.
Nevertheless, things are slightly different in Indonesia, where Grab faces stiff competition from the local player Go-Jek, currently a part of GoTo following a merger with an Indonesian e-commerce Tokopedia. Historically, Go-Jek launched its app in early 2015, and Grab soon followed a few months later.
According to Measurable AI, Grab and Go-Jek were tied in ride-hailing market share by order in January 2023, and that was relatively unchanged in a year. And what Grab does, Go-Jek virtually does it too. For example, "Saver" by Grab and "Hemat" by Go-Jek aims to target a wider range of segments. The fee difference can range from 40% to over 60% cheaper than the regular one.
"Saver" by Grab and "Hemat" By Go-Jek (the distance is not comparable) (Vektor Research)
But the initial main strategy is to spend massively on promotions and subsidies to gain market share, leading to negative earnings and cash flows. This poses a big question: is this strategy sustainable? The argument is that once new entrants with deep pockets come in and aim to aggressively take market share, Grab will lose its dominant position. But will that be actually the case?
In a study conducted between January 2022 and January 2023, Measurable AI found that only 8% of Indonesian ride-hailing users have used both Grab and Go-Jek, indicating that those companies have effectively built customer loyalty . To support that finding, we talked to a couple of Grab and Go-Jek users and a food merchant in Indonesia. Please note that the survey results are evidently not representative of the entire population. Below are the key findings:
- Discounts continue to play an important role when choosing a super-app, but for some users, they have become " accustomed to " the ecosystem that super-app provides. For example, purchasing items on Tokopedia often yields cashback in the form of GoPay coins, which can then be used to order food on GoFood.
- The availability of drivers is also a key factor. Do I have to wait more than a couple of minutes to get a driver? This helps explain Grab's efforts to increase driver supply.
- For the merchant's perspective, customers opting for Grab or Go-Jek depend on their choice of primary e-wallet for payments. In one area, most customers prefer GrabFood, while in the others, they lean towards GoFood or ShopeeFood. This implies that the adoption of their respective e-wallet plays a crucial role in gaining and eventually retaining market share.
Indeed, we acknowledge the fact that providing subsidies has been arguably a quick and effective way to defend or even gain market share. But this is unsustainable in the long run. Fortunately, those super-apps have built customer loyalty after years of aggressive marketing and incentive spending, in our view. Grab and GoTo have reduced their on-demand subsidies as a percentage of GMV, implying that the industry is becoming more rational. Additionally, Figure 9 shows that as Grab decreased its on-demand service incentives, GMV remained strong.
Incentives as a % of GMV or GTV (Vektor Research) On-demand GMV and incentives as a % of GMV (Company, Vektor Research)
In conclusion, new players, even with deep pockets, will find it challenging to take on Grab's dominance in SEA, in our view. They could penetrate the market by offering aggressive discounts and promotions, but how compelling must those incentives be to break the "habit" that customers have developed over the years?
Balancing Between Growth and Profitability
Grab's growth story revolves around a large and expanding Total Addressable Market ("TAM") in SEA, but the penetration rate remains low. The management provided more color on TAM:
Now looking ahead, there's still a lot of potential to grow the total addressable market given, one, the sizable online population in the region, and yet if you look at our core services, that is still largely underpenetrated. The fundamentals also are strong with a large expanding and growing population and rising middle class and one that is rapidly digitalizing. Today, Grab only sells one in 20 people every month. So, this means there's still plenty of room for us to grow.
The following table shows the management's growth expectations on each segment. Let us delve into each one individually.
Grab's management growth expectations (Company)
In the third quarter of 2023, Grab delivered the highest quarterly Deliveries GMV at $2.6 billion, which grew 7% (Y/Y) and 8% (Y/Y) on a constant currency basis. But this pales in comparison to the ~50% CAGR from 2019 to 2022, a period during which food delivery services gained traction amid the COVID years. Now that people are going outside to dine following the end of social restrictions, people spend less ordering food online. But it is also worth noting that Grab has also been reducing its incentives for Deliveries while increasing the commission rate, as depicted in Figure 11.
Deliveries GMV, including incentives and commission rate (Company, Vektor Research)
By contrast, things differ in Mobility, as incentives and commission rates have remained relatively stable. We are seeing robust growth because Mobility has yet to reach pre-COVID levels, with GMV and driver supply at 91% and 87% of pre-COVID levels, respectively. Annualized GMV was ~8% lower than the 2019 levels, so we should expect a recovery next year.
Mobility GMV, including incentives and commission rate (Company, Vektor Research)
According to the management, providing customers with cheaper options, such as "Saver" and "Grab Share," helps Grab expand to ex-Tier 1 cities and increase its monthly transacting users ("MTU"). "Affordability" is the key term here, as the COO explained on the 2Q23 earnings call:
MTUs are at an all-time high. We are confident that the affordability push is the main driver of that. So there are plenty of untapped segments both in the large cities and then the outer cities that we haven't been able to penetrate because up until now. So we feel like affordability is really going to help us to continue to grow MTU.
But here's the thing. According to a study by Alpha JWC Ventures and Kearney, the ride and food penetration rate will be lower in Tier 2 and Tier 3 cities in Indonesia because "the importance of convenience is lower." The consultancies provided examples of sparse traffic jams and short distances between places that were likely to hinder a high adoption rate. On the other hand, over half of the residents in Tier 1 cities have already used those services. The online food delivery service is under pressure now that the social restrictions have ended. And while the ride-hailing service is poised to return to the pre-COVID levels, it does not function in the same way as food delivery or e-commerce, where people may make impulsive spending decisions.
Therefore, balancing between growth and profitability is crucial. Grab aims to build a profitable business that generates free cash flows without fully depending on incentives to drive spending and retain customers.
Firstly, drive towards a steady pace of adjusted EBITDA growth and generate free cash flows; secondly, establish strong competitive advantages that can reinforce our reliability and service quality to our users and partners; and finally, stay true to our commitment to deliver a triple bottom line, which is to simultaneously deliver financial performance for our shareholders and create a positive social and environmental impact for our home, Southeast Asia.
How? First, the management has consistently emphasized the strategy of " reducing our cost-to-serve " in recent earnings calls. Batched orders enable Grab to pass on cost savings to customers by reducing average delivery fees and resulting in higher earnings per transit hour for drivers. Batched orders were over one-third of total delivery orders.
For example, batched orders which now account for over one-third of delivery orders provided average delivery fees for users that were 8% lower than unbatched orders and resulted in 5% higher driver earnings per transit hour compared to unbatched orders. Improved allocation and navigation efficiencies among other factors also resulted in a corresponding reduction in driver wait times by 72% year-on-year and 47% quarter-on-quarter.
Example of Grab's batched orders (Vektor Research)
This also allows Grab to reduce incentives to customers.
We've been able to lower the consumer incentives. So as I talked about earlier to Alicia's question, you can see that we demonstrated that we can use cost-to-serve initiatives to provide affordable services without using incentives. And I think that will be our strategy to continue to do that in Indonesia.
Second, Grab introduced GrabUnlimited, a subscription program aimed at driving spending and customer retention . The management claimed that subscribers spent 4.2 times more on food deliveries than non-subscribers and exhibited an average retention rate approximately 2 times higher than non-subscribers in the first half of this year.
One is, it drives retention -- significantly drives retention. Of course, when we run the long-term value models, that's one of the biggest drivers of value for the platform. And then the other thing is that drives the GMV for customers further. So people spend more once they're in the program. There's a third lever, which is that it allows us to reduce the amount of promotion money , which is spent on promotion hunters, people that aren't really interested in loyalty, they'll just skip from promotion to promotion. So it allows us to filter those out as well.
Margin-wise, Grab generated a 3.4% adjusted EBITDA margin from Deliveries and nearly 13% from Mobility in 3Q23, already running at its steady-state margin targets of 3%+ and 12%+, respectively. As we look ahead, the management has not yet provided medium-term margin targets, but remained committed to sustaining margins at the steady-state levels.
On-demand services adjusted EBITDA margin (Company, Vektor Research)
Meanwhile, Financial Services posted a jaw-dropping 156% year-on-year revenue growth during the quarter, and its adjusted EBITDA losses narrowed, driven by lower overhead expenses in GrabFin. The management stated that the payment business would grow in line with GMV growth, but what really drove growth would be its lending business.
Financial Services KPIs (Company)
In August last year, Grab launched in Singapore the GXS Bank, a joint-venture digital bank between Grab and Singtel. Flexi-loan, the lending product from GXS, allows borrowers to customize their repayment amount and schedule. Looking forward, Grab will be launching two more digital banks in Malaysia and Indonesia. The rationale behind the expansion of banking business is to provide huge underbanked and unbanked populations, as well as micro, small and medium-sized companies ("MSME"), access to financial products.
But more importantly, this is intended to support the super-app ecosystem. As mentioned before, the general idea is to find solutions on the super-app without having to change apps. Owning customers' data allows Grab to seamlessly and quickly onboard customers to its financial products.
GrabFin and Digitbank (Company)
As the management said :
In the longer term, the five-year -- our vision is not to be the largest bank in our market. We are focused on supporting our own ecosystem. So, the size will be proportionate to the GMV and the MTU base that the ecosystem has we do believe that we can produce attractive returns because of the better risk management and the lower customer acquisition costs.
Digibank costs increased by 11% on a quarter-on-quarter basis, as Grab is setting up new digital banks. The company expects Digibank losses to peak this year and aims to achieve breakeven by the end of 2026.
Lastly, the high-margin ads business shows promise, as revenues in 3Q23 reached 1% of Deliveries GMV, primarily driven by F&B merchants. This business is still early in its journey, as Grab is looking to tap into Mobility and Financial Services. We believe that Digibank and the ads business will drive Grab's growth. Combined, Financial Services and the ads business made up 13% of Grab's net revenue.
Narrowing Losses, But Competition Is Likely to Intensify in the Fourth Quarter
We can see in Figure 17 that Grab has done well to reduce its operating losses. Earlier this year, the management guided for an adjusted EBITDA loss of between $275 million and $325 million. But they revised it for the third time to a loss of between $20 million and $25 million. Reducing incentives and improving the efficiency of its operations played crucial parts. Yet, GoTo's management said that the company would "preserve tactical flexibility" to defend market share. This means more subsidies, and Grab is likely to retaliate, potentially hurting its financials in the near term, in our view.
Grab's operating losses ($ million) (Company)
Valuation
We utilize the sum-of-the-part ("SOTP") valuation method to value each of Grab's business segments separately. Some of the comparable peers classify subsidies in the cost of revenue, while the others subtract subsidies from their revenue. Therefore, we conservatively value Grab by using its net revenue. Our estimated value for Grab based on 2025F revenue is $3.6 per share, which implies roughly a 17% upside potential. We assume a modest 7% annual GMV growth and a reduction in incentives as a percentage of GMV to nearly 6% in 2025F, down from the current levels of 7-8%.
Grab SOTP valuation (Vektor Research) Comparable peers multiple valuation (Koyfin)
Conclusion
Grab has established itself as the on-demand market leader in Southeast Asia thanks to its first-mover advantage, hyperlocal strategies, and inorganic expansion. Our view is that Grab has already built customer loyalty after years of spending massively on promotions and discounts. Batched orders and new initiatives, such as GrabUnlimited program, enable Grab to pass on cost savings to customers and increase retention rate, as Grab is trying to reduce customer dependency on subsidies.
What will happen in the next year or two? In the near term, we expect competition to intensify as players strive to protect their market share. Looking forward, we believe that Grab will gradually reduce its incentives and focus on improving efficiency in its on-demand service, with growth prospects being moderate. Meanwhile, we believe that Digibank and the ads business will drive Grab's growth. And it is possible that Grab will achieve profitability at the bottom line within the next two years.
According to the sum-of-the-part ("SOTP") valuation based on 2025F net revenue, shares should be valued at $3.6 per share, which implies approximately a 17% upside potential. However, it is worth noting that Grab has not demonstrated historical profitability. Second, Grab generated $322 million of operating cash flow in 3Q23. However, upon closer look, this was driven by deposits from its banking business, while they have been selling short-term investments to pay down debt.
For now, we will rate the stock "HOLD." We do not think that a 17% upside is attractive enough, given the risks. Yet, we will continue to monitor Grab in the meantime. If you have any thoughts, please do not hesitate to comment below.
For further details see:
Grab: Market Leader In Southeast Asia, Narrowing Losses, But Shares Remain Risky