Why Amazon-backed food delivery app Deliveroo flopped in its market debut

LONDON — When Deliveroo chose London for its hotly-anticipated IPO, the food delivery company was hailed as a “true British tech success story” by U.K. Finance Minister Rishi Sunak.

But the Amazon-backed company failed to deliver on its first day of trading Wednesday. Shares plunged sharply as markets opened, with investors questioning Deliveroo’s ability to generate profits and an eye-watering £7.6 billion ($10.5 billion) valuation.

“That path to profitability is what is potentially under threat if we see increased regulation around workers’ rights,” Sophie Lund-Yates, an equity analyst at Hargreaves Lansdown, told CNBC’s “Street Signs Europe.”

“I think that is the biggest reason we have seen so much anxiety injected into the trading this morning.”

The food delivery app — founded and led by American entrepreneur and former Morgan Stanley analyst Will Shu — has become one of the best-known start-ups in the U.K. It employs over 2,000 people across 12 markets, and uses a network of over 100,000 riders to deliver food from 115,000 restaurants and grocers. By market value, its IPO is the biggest to take place in London since Glencore went public nearly a decade ago.

But the stock got a frosty reception from investors. Deliveroo has been plagued by worries over the risks to its business model if regulators crack down on the gig economy. Uber reclassified all 70,000 of its U.K. drivers as workers entitled to a minimum wage and other benefits earlier this month, after the country’s Supreme Court ruled a group of the app’s drivers should be treated as workers.

Deliveroo issued its shares at just £3.90, right at the bottom of its initial range. However, shortly after trading commenced on the London Stock Exchange Wednesday, the firm’s share price had fallen 30% to around £2.73 and questions are now being asked about how much further it can fall. Theoretically, Deliveroo can cancel the IPO up until April 7 as it has opted for a “conditional offer.”

By comparison, U.S. rival DoorDash saw its shares surge more than 85% on the opening day of trading in December, giving it a market cap of over $60 billion at the time. Closer to home, Deliveroo faces fierce competition from the likes of Uber and Just Eat Takeaway. That rivalry has added to concerns about the ability of Deliveroo to grow its margins and eventually become profitable.

The Deliveroo listing was led by investment banks JPMorgan and Goldman Sachs, while Bank of America Merrill Lynch, Citi, Jefferies and Numis were also part of the syndicate. The stock was overallocated but that didn’t stop it tanking as it floated, leaving some early investors frustrated with how the investment banks priced the company’s shares.  

Several top institutional funds have shunned Deliveroo’s IPO, citing regulatory risks around its business model and governance. Deliveroo decided to opt for a dual-class share structure, meaning that its founder would have greater voting rights than other investors. 

While London is pushing for this type of structure to be permitted on the premium segment of its stock exchange — which makes firms eligible for inclusion in benchmark indexes like the FTSE 100  — top investment firms have complained that this may risk watering down investor protections.

“Deliveroo has gone from hero to zero as the much-hyped stock market debut falls flat on its face,” said Russ Mould, investment director at AJ Bell. “It had better get used to the nickname ‘Flopperoo.'”

“The narrative took a turn for the worst when multiple fund managers came out and said they wouldn’t back the business due to concerns about working practices,” Mould added. “This is likely to have spooked a lot of people who applied for shares in the IPO offer, meaning they are racing to dump them.”

Deliveroo tried to convince its customers in the U.K. to buy £50 million worth of shares in the IPO via its app. These retail investors —  who were able to spend between £250 and £1,000 on shares —  are locked in until April 7, meaning they can’t sell their shares until restrictions lift.

“RIP my investment,” wrote amateur investor and primatologist Sam Elliot on Twitter after seeing Deliveroo’s share price collapse.

“Thankfully I did the minimum investment of £250 as I knew it was a risky investment,” he told CNBC.

Fred Destin, a venture capital investor who backed Deliveroo in its early days, is optimistic the company will rebound. “Deliveroo might be facing some headwinds but I’m very bullish on the long term opportunity,” he told CNBC. “I think the market will over time recognize that it is a resilient and defensible business.”

Manish Madhvani, co-founder and managing partner at tech investment firm GP Bullhound, said the initial figures are a “bit of a setback” for London, which was “gaining momentum as a listings destination.”

However, he said it’s important to note that the company is still highly valued. “There may have been a mistake on the pricing given the market conditions, but we shouldn’t forget how truly pioneering the Deliveroo model is, rather than getting bogged down in the headlines,” he said.

Another big concern for investors is the sustainability of high-growth companies like Deliveroo as countries around the world seek to reopen their economies. The rollout of coronavirus vaccines has put pressure on U.S. tech stocks trading at significantly high multiples to revenue, such as Zoom, Netflix and Amazon.

Such companies benefited during the coronavirus pandemic due to lockdown restrictions that resulted in people spending much more of their time at home. Zoom, Netflix and Amazon are still up roughly 107%, 38% and 56% in the last 12 months, respectively.

“From a more cynical point of view, conditions are about as good as they will ever be when everyone is literally locked in their house,” Hargreaves’ Lund-Yates told CNBC, adding the company is “really banking on” stay-at-home trends continuing long after the pandemic.

“Is the current valuation justified?” she added. “It is sadly a case of wait and see there. It’s a big question.”