The long-awaited Instacart IPO finally happened on Tuesday, Sep 19. The offering price was $30 a share, valuing the company at ~$10Bn on a fully diluted basis. This was a significant mark-down from the $39Bn valuation that private market investors ascribed to the company in early 2021 at the peak of the post-Covid tech cycle.
Given this is the first IPO of a notable venture-backed company since Dec 2021, I would like to share some nuances that other analysts and media reports might have missed, and which strongly underline the significance of this event in the current venture downcycle:
1/ Consumer Internet IPOs are tougher to pull off – compared to asset-backed brick-and-mortar industries, as well as enterprise software, Consumer Internet companies find it harder to go public given their business models don’t lend themselves well to sustainable profitability.
While these companies do show growth and scalability, they suffer from high marketing costs. The underlying metric that’s commonly used for this is Customer Acquisition Cost (CAC). Consumer Internet companies have high CACs, driven mainly by costs of FAANG distribution channels and discounts/ promotions to entice customers.
Public markets essentially evaluate companies on profitability (starting with EBITDA, but ultimately on Earnings), leading to Free Cash Flow (FCF). That’s why the standard valuation methods for public companies are the Price/Earnings Ratio (P/E) and Discounted Cash Flow (DCF).
Given the low or non-existent profitability of Consumer Internet companies, it becomes hard to robustly value them. That’s why they get held to a higher bar in public markets, as we have seen with the likes of Uber and Airbnb in recent years.
In that regard, it’s much more commendable when the management teams of say Instacart or Robinhood pull off an IPO vs. a Monday.com or Freshworks, given the default odds are stacked against the former.
2/ Bonus points for delivering a new IPO story in a tough space like Grocery – Several aspects make Grocery incredibly challenging as a space. It’s highly competitive with large incumbents (Walmart, Whole Foods, Target, Kroger, Costco etc.) coexisting with regional, mid-sized chains (Trader Joe’s, Ralphs, Gus’s Supermarket etc.) and mom-and-pop stores (eg. ethnic grocery stores like Asian, Indian, Mediterranean etc.). These players compete in an environment that is a lethal combination of low growth and low margins.
If one were to think of a legacy vertical that can be fruitfully disrupted by tech, Grocery wouldn’t even make the shortlist of most analysts and investors. That Instacart pulled this off and on top of it, also delivered a liquidity event, is a humongous achievement.
3/ A venture-backed IPO amidst super-tight macros – while fighting against the above odds, what makes this event even more significant is that it has been pulled off in a high-interest rate environment driven by a hawkish Fed, an IPO window that has been pretty much closed for typical venture-backed models since late 2021, and where late-stage private companies are hurting from inflated last-round valuations, weakening customer demand and lack of profitability (refer my post ‘When will the next venture bull run begin?‘).
To choose this environment to go public in shows real courage, and I congratulate the management team and shareholders for this brave call.
4/ Pulling off a non-AI IPO in 2023 – Instacart closely followed on the heels of the chip design company Arm’s IPO. Given AI is seeing a hype cycle right now, the outperformance of Arm’s IPO was expected. But kudos to Instacart for pulling off an online grocery IPO when the only thing investors seem to be wanting right now is AI.
5/ Setting strong precedence for prioritizing liquidity for employees – Interestingly, only ~8% of Instacart’s outstanding shares were floated in this IPO, with ~36% of those sold coming from existing shareholders. In the words of the company’s CEO:
“We felt that it was really important to give our employees liquidity. This IPO is not about raising money for us. It’s really about making sure that all employees can have liquidity on stocks that they work very hard for. We weren’t looking for a perfect market window.”Fidji Simo, Instacart CEO
This is an amazing stance taken by the company. As someone who has both founded and worked in early-stage startups, I have seen how demotivating holding illiquid stock can be for employees. In fact, this has been one of the major ecosystem-wide downsides of tech startups staying private for longer during the ZIRP decade.
Instacart has demonstrated that rewarding employees via liquidity events is at least as important as generating returns for VCs on the cap table and that it is the responsibility of Boards and management teams to make it happen.
6/ Proving that entry price matters – WSJ recently wrote about how almost all growth-stage investors in Instacart are at a loss on the IPO offering price. An even more insightful analysis was put together by the ‘Dean of Valuation’ – Aswath Damodaran, Prof. at NYU.
This analysis shows that at the offering price, only the Seed, Series A, and Series B investors are sitting on substantial profits that also beat the S&P500 benchmark returns during their respective hold periods. Series C onwards, none of the investors have beaten comparable benchmark returns, with the late-stage rounds in 2020 and 2021 sitting on substantial haircuts.
While a common VC narrative is that “irrespective of the price, the only thing that matters is getting into the best companies”, my own experience is contrary to this (I wrote about it in my post ‘An angel’s struggle with entry valuations‘).
The actual returns profile of various types of VCs and Growth Investors who invested in Instacart at different stages of maturity and valuations provides more evidence for this age-old wisdom of OG investors like Buffet, Munger, and Howard Marks.
Sobering thoughts for Instacart’s way forward:
As an active participant in the venture ecosystem, while I am wholeheartedly celebrating Instacart’s IPO and the way it has overcome all the above odds, it’s important to acknowledge that the business faces significant risks going forward.
1/ Market share – will it be able to grow, or even retain market share, as traditional grocers expand their online shopping experiences?
2/ Topline metrics – Instacart’s AOV has been pretty much static at ~$100 over the last five years. Given grocery is a low-margin business, it will also find it hard to significantly increase its take rate from the current ~7.5% levels*.
Further, while Covid saw a massive spike in customers leveraging online grocery, it seems that the use case seems to be settling down at relatively lower levels of purchase frequency.
Given these dynamics, what are the levers at Instacart’s disposal to improve its cohort metrics?
*As a comparison, Airbnb and Doordash have much higher take rates at 14% and 11.79% respectively. These reflect the higher operating margin profiles of the underlying businesses (both hospitality and restaurants operate in the ~15% range).
3/ Bottom line metrics – Instacart’s Selling Cost (Marketing + Incentives and promotion) as % of Revenue has been steadily going up (from ~12% in 2020 to 24.50% in 2022).
Though its customer retention is strong, will the company be able to convince these customers to buy more frequently, as well as keep attracting new customers, without a commensurate increase in CAC?
4/ Talent – While it’s tempting to perceive an IPO event as the finish line, it’s rarely so. In fact, as Yahoo, Google and Facebook have shown in the past, exponentially more value gets created in the years post-IPO, compared to pre.
This especially applies to Instacart, where the IPO valuation is much lower than the last private round, and therefore, much work needs to be put in to generate returns for these late-stage investors. See the amount of post-IPO heavy lifting that the likes of Dara at Uber and Brian Chesky at Airbnb have had to do to create shareholder value.
From here on, Instacart will need to ‘grow up’ as a public company and attract a fresh set of talent that can design & execute its next phase of growth. Will it be able to create a culture and working environment that can help achieve this?
All in all, Instacart’s IPO being a milestone for Silicon Valley is beyond doubt, especially considering the tough macroeconomic and venture environment over the last year. But I can also say with equal confidence that a lot of value still remains to be captured by the company, and the next few years are going to be a tough execution grind for the management team.
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