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DoorDash: Philosophical Clarity
In DoorDash's quarterly investor letter they laid out a masterwork in capital allocation, investing in growth, and is a must read for growth investors
Previously DoorDash allocated part of their investor letter to identifying Free Cash Flow per Share over the long-term as a guiding principal as I noted here:
And they’ve taken it a step further and focused their entire shareholder letter for Q2 on their philosophy around investing in new businesses, capital allocation, cost control, and employee compensation. It’s rare for a public company to do this with such detail and insight so I wanted to do a deep dive on what they said in their letter.
Investing in New Businesses
CEO Tony Xu and CFO Ravi Inukonda first laid out three things they evaluate when looking at new businesses:
“A problem, preferably a large one, that we believe we can solve better than others in the market”
“The availability of capital, technology, and people to build and scale our solution.”
“A path to a strong long-term return on investment (ROI)”
Now some of this is obvious, but as mentioned before, it’s rare for companies and executives to actually lay our their guiding principles. In 2021 there was no discipline among companies on how they went after new businesses or verticals. VC and Fed helicopter money was widely available and businesses were valued almost exclusively on future growth potential.
I spent a decade investing in industrials like United Airlines where the discipline laid out by DASH was the status quo. Internal projects were only approved if the NPV and ROI were above their WACC and ROIC was calculated and discussed by most management teams.
We’re seeing many companies who were beneficiaries of the free money era who are struggling to adapt to a world where FCF, ROIC, and actual profitability really matter. I appreciate the hyperfocus that the team at DoorDash are emphasizing on how and when they choose to invest.
An Illustrative Example
As part of the shareholder letter, DoorDash provided an illustrative example that I’m sure 90% of readers ignored but is important to drill down on.
Here are managements words on how they’d break this down:
“Business X requires $100 of investment over 4 years before generating $10 of FCF from Year 5+”
“If you capitalize Business X at a 5% FCF yield it generates an IRR of 17% over a 7 year period.”
“One Business X is good but if you have the capital, and people, 3 Business Xs are clearly better than one, and 5 Business Xs are even better than three”
Now to be fair, this is all fairly simplistic math and operates under a few assumptions:
Each incremental Business X is equivalent in quality and opportunity to the other Business Xs
Interest Rates and FCF generation of the original Business X are such that the company can justify the 15% discount rate used in the example.
FCF Yield of the overall business is 5% (approx 17.5x EV/FCF and 14x EV/EBITDA for DASH)
For many companies who were experts in the original Business X, it can be a struggle to rate quality and opportunity and often I see companies who expand into new verticals struggle as the new opportunity is inherently lower quality or margin (think BKNG going into flights or LMND going into pet insurance).
But when a company is successful in adding incremental Business Xs it creates an S-curve that looks like this:
Think of Google adding Search → Mail → Chat or Meta adding Facebook → Instagram → WhatsApp → Reels. It requires a belief in the quality of management and their ability to stack new S-curves on top as the older businesses mature. This in essence is exactly what DoorDash is arguing, that they can profitably and successfully add new verticals, businesses, and increase growth and the value of future FCF per Share and that the math works out. It’s up to the individual investor to determine whether they believe Tony and the team at DoorDash can achieve this.
A Long Term Approach
When the music stopped and the lights turned on from the era of free money in 2021 there was undoubtedly a rush to the exit. Unprofitable businesses were all disposed of by investors and certainly there were a few babies thrown out with the bathwater.
In their letter, DASH focuses on the ramp up of profitability on the US Restaurant Marketplace (the core business).
“We spent over six years investing in our U.S. restaurant marketplace before generating any meaningful cash. For a long period during our investment phase, our losses increased and our margins declined. Had we been operating to short-term margin or loss targets, we likely would have significantly under-invested or stopped entirely.”
From 2018 to 2019 absolute profitability and margins were declining as DoorDash invested:
While core unit economics and demand were improving:
DoorDash estimates they spent around $1B investing in the core US Restaurant Marketplace business before generating sustainably profitable contribution profit.
This is the exact same thing we’ve seen at peer Uber, where it takes a long time to ramp up and invest in your business before you start to sustainably generate profits. Certainly a company can be focused on profits from day one, but often that results in a materially smaller outcome. This is the reason that core unit economic profitability is the most important metric for a growing network or platform. With a base of unit profitability you can decide to lean into growth or pull back and focus on profitability. Without that you’re shit out of luck and there are numerous examples of bad businesses in the 2021 era that were losing money on every single transaction without a hope of profitability.
Creating Discipline in Our Path
The self awareness of the letter is something I’d like to call out. Often management teams use verbose language and charts to justify unprofitable or self-serving interests. This quote from the letter I think is a great call out for how self aware Tony and the team are about the realities of the market today and what investors are looking for:
“At this point you may be thinking, “great, they’re going to spend money forever.” The truth is, we hope to be that lucky, but we probably won’t. We have begun investing significant capital to build businesses in new verticals, international markets, and advertising, and we have a number of newer projects that are in various stages of testing. If we are able to find more new ideas that solve large and critical problems in local commerce and offer strong ROI potential, we will try to build businesses around them. However, we also expect our existing businesses to become larger and more efficient over time. If we execute to the plans we have established, it may become difficult to offset improving profitability with new investments.”
And the door is left open for change if things don’t proceed according to plan:
“Our international markets and new categories have demanding long-term plans, but we are encouraged by the progress we have made so far and believe we are on a path to generate strong long-term ROIs in both areas. In both our international markets3 and our U.S. third-party convenience and grocery categories, we are driving strong Y/Y growth in volume and improvements to unit economics that are on track with our long-term targets. We believe these areas have many of the same characteristics of long-term free cash flow generation and impact to local commerce that we saw in our U.S. restaurant marketplace, and we are comfortable investing in them as long as we continue to progress along the paths we have established.”
Said another way, DASH sees the investments in international and new categories as potentially huge opportunities, the early indicators of growth and unit economics are a) proceeding according to their internal plan and b) look similar to the US Restaurant Marketplace in it’s early days. But the door is left open in the wording at the end where we shouldn’t expect continued investment in new businesses if they are not progressing towards internal paths and targets.
A relevant quote from the earnings call was: "If we have good opportunities to invest, we're going to continue to drive efficient growth as long as we can stay within our discipline parameters."
Bonus: SBC Forecasting
As a bonus I wanted to thank the team for actually putting out estimates for Stock-Based Compensation. Usually management teams use vague comments on the earnings call saying they expect SBC expense to be down Y/Y or to grow in-line with overall expenses. DoorDash actually put out guidance for 2H23 and details on various components of the SBC expense line:
As I’ve mentioned in previous posts around Rideshare & Delivery SBC Dilution and how BKNG is a Tech Dilution Role Model, the more transparency and discipline around stock-based compensation there is, the better long term returns there are for investors. The first step is actually providing the information and creating an honest dialogue which is exactly what DASH has done.
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