Instacart is hard to value

Good morning. We were chuffed to see a piece on our favourite private credit backwater, business development corporations, on the front page of yesterday’s Wall Street Journal. If you’ve got an esoteric investment with high-dividend yields that we should write about, email us: robert.armstrong@ft.com and ethan.wu@ft.com. 

Instacart is hard to value 

Instacart has set the price range for its IPO at $26-$28 per share, which would raise more than $600mn and give the company an implied value of $9.3bn, on a fully diluted basis. Is that a fair price? I don’t know, and I’m not sure anyone else does, either.

Instacart is a US grocery delivery platform. It has its own shopping app and delivery operation, and it also runs the back end of grocery chains’ own apps. It makes money by charging fees to the grocer and the shopper, and by selling advertising to consumer brands on its platform. Last year Instacart delivered $29bn worth of groceries, 16 per cent more than 2021, and almost six times as much as in pre-pandemic 2019. It did a little better than break even on the operating profit line. 

All of this is straightforward enough but does not tell you a great deal about the potential profitability of the business. Like several other businesses, including Amazon and Uber, Instacart’s business is part digital technology (web interfaces, data collection/monetisation) and part brute logistics (moving heavy things around). So the unit economics are something of a mystery. How much of the business’s costs are digital and therefore fixed, such that they will grow much more slowly than revenue, and how much are logistical and therefore variable, growing right along with revenue? We won’t really know the answer to this question, and therefore how profitable the business will be, until the business is much, much bigger. 

The IPO filing says that US grocery sales were about $1.1tn in 2022, and that only 12 per cent of those sales are completed online. That makes Instacart’s addressable market $132bn but (the filings promise) “online penetration could double or more over time”. Let’s do some dumb math. Suppose that over 10 years, grocery sales grow 2 per cent a year and online grocery penetration rises to 30 per cent, while Instacart takes a third of that market (it already claims to have a fifth). Then, in 2033, the company will be delivering $135bn in groceries a year. How much of that will it be able to convert to profit? A logistics company’s 1 or 2 per cent? Or something much greater?

There is a simpler way of stating this question. This company looks like a delivery business but says it is a tech business. Is that bullshit?

It is worth recalling that Uber, which books rides at a pace of about $130bn a year, still has not conclusively answered this question, either. It still has not proven it can consistently make much money, as measured by accurate accounting. On the other hand, Uber does have a market cap of $100bn, which Instacart would be very happy to have 10 years down the road. 

Somewhat incidentally, anyone thinking about buying shares in the Instacart IPO should treat the revenue and profit margin numbers with some care. Instacart takes out a big expense before revenue: what it pays people to pick items for delivery off of store shelves. In 2022, more than 8 per cent of the average Instacart order went to pay the shopper. This may seem to be the kind of expense that would appear below revenue in the profit and loss statement. But Instacart reports revenue (that is, fees and advertising sales) net of shopper pay. This has no effect on absolute profit levels but makes profits look about twice as large relative to revenue. Gross or operating profits don’t mean much for investors in this company. Free cash flow or return on assets will be much better measures.

If readers have thoughts on Instacart, we’d be very keen to hear them. 

ESG does not work: an illustration

From the Financial Times, over the weekend: 

BlackRock and MFS Investment Management both voted against Glencore’s climate plan at the Swiss miner’s annual general meeting earlier this year . . . 

The new disclosures made in US securities filings show that many big institutional shareholders supported Glencore’s climate report, which passed with 70 per cent approval even though dissent increased to 30 per cent, up from 24 per cent in 2022. 

BlackRock is Glencore’s third-largest shareholder, holding an 8.2 per cent stake worth more than £4bn

The Glencore/ESG story, which has been rolling along for a while, is interesting. How the environmental, social and governance investment movement handles the world’s most profitable coal company is a fascinating test case. It is also a nice thumbnail illustration of one reason why ESG investing fails to have the positive impact it promises.

The main mechanism by which ESG hopes to change corporate behaviour is increasing the cost of capital of badly behaved companies. If the marginal investor refuses to invest in misbehaving companies, or threatens to do so, either management will be forced to make changes, or the company’s cost of equity and debt will rise. If the latter, the hurdle rate for new investments in “dirty” projects will increase, reducing the amount of investment.

But this is not how things work in a world awash in capital, hungry for high returns, and conflicted on basic questions of value, as the case of Glencore shows. The problem is that even if ESG shareholder pressure drives the cost of capital for poorly behaved companies up (it’s not totally clear that it does), it by definition drives expected returns and yields for that company up, drawing in capital with different scruples or no scruples at all. 

Glencore has had a lot of back and forth with investors over its coal business. It has spoken in the past about running down its coal mines and not replacing them. That seems an odd fit, however, with its decision to bid for the coal business of Teck Resources this summer. It’s not quite as odd as it seems at first, because the Teck unit produces mostly steelmaking coal rather than coal for power plants. Still, one can see why BlackRock has concerns about “inconsistencies” in Glencore’s climate strategy in light of the Teck bid. 

If the acquisition goes through, Glencore plans to spins off the combined coal units into a separate company. Part of the rationale for the provisional spin-off plan is presumably that having the dirty coal business, profitable as it is, drags down the valuation of Glencore’s other assets. The spin-off will therefore release value, and Glencore would become an ESG-friendlier company. 

Meanwhile, the whole exercise, from BlackRock’s meaningless vote to Glencore’s strategic vacillations, will have no effect whatsoever on the amount of global coal mining and coal burning.

Any pressure on Glencore’s cost of capital in the absence of a spin-off won’t make any difference to production levels: last year the company’s coal operations made $15bn in operating income, and capital expenditure was $1bn. The unit does not need new capital, so the price of capital hardly matters. 

Will the hypothetical SpinCo have a higher cost of capital (that is, a lower price/earnings valuation on its equity, or higher-cost debt financing), and therefore a higher hurdle rate for investment in new mines? And would the hurdle rate be sufficiently higher to make any difference? Perhaps; it depends on whether the return on new coal projects is anywhere close to the SpinCo’s cost of capital, which depends in turn on coal prices. More importantly, though, a pure-play coal company seems more likely to reinvest internal capital in new coal projects than a diversified commodities company like Glencore. Indeed, that may be part of the strategic logic here.

The previous Glencore CEO, Ivan Glasenberg, grasped the point that changing ownership structures does not change emissions, saying at an FT event in 2020 that “some competitors are selling their coal mines . . . but how does this help the world to meet the Paris accord? They’re going to the hands of other players in the industry which may have no intention of reducing their Scope 3 [indirect] emissions and may have a free hand to produce more.” 

After Glencore’s third-largest shareholder, and the most important asset manager in the world, voted — along with other shareholders — against the company climate plan, CEO Gary Nagle blamed the votes against on “some ESG person in the basement in office number 27”. This icy put-down of BlackRock and other ESG advocates stings because there is so much truth in it. The main impact of the ESG movement is the creation of a bureaucracy that companies must nod to and work around, while the real world of business spins on.

One good read

A nice analysis of the Canadian economy by Tej Parikh (with snarky comments by FT readers below the line).

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