Instacart's stock falls below the IPO price. Here are 7 reasons why.

• Instacart shares recently fell below its $30 IPO price.
• Finance professor Aswath Damodaran posted a harsh analysis of the company's core business.

To have a healthy digital advertising business, you actually have to have something else substantial sitting behind it, luring customers to visit your site and hopefully spend money.

This is one of the concerns that has turned Instacart's IPO into a flop. The stock recently fell below the company's original $30 per share listing price.

To be successful, an IPO must deliver a big pop to the investors who signed on to buy stock when it debuts. Gains of 20% or more are pretty solid. Instacart has so far delivered its new shareholders nothing.

The company is valued at just over $8 billion, down from $39 billion a few years ago during the pandemic. Several late-stage investors, including D1, Fidelity, DST Global and T. Rowe Price, are likely sitting on losses now, according to estimates from Aswath Damodaran, a professor of finance at NYU's Stern School of Business.

He came out with an analysis of Instacart's business valuing the company at $29 a share.

Instacart, and its relatively new CEO Fidji Simo, built an impressive advertising business on top of the company's core grocery delivery operation. That addition has generated new revenue and even profits.

But the future growth of Instacart will ultimately depend on how many customers it has and how much they spend. Without that, there's no one to advertise to. So Damodaran rightly focused his analysis mostly on the grocery delivery business.

The main takeaway is that grocery delivery is a tough business. I pulled out some highlights from Damodaran's blog to illustrate this.

Instacart declined to comment about its share price decline and Damodaran's analysis.

Grocery is a low-margin business

Instacart's take rate was 7.5% over the past 12 months. That's much lower than Airbnb and Doordash, Damodaran wrote. The reason: The grocery business is low-margin, so there's not a lot of room for Instacart to skim more fees.

"If you are an intermediary in a business with slim operating margins, as Instacart is, the low operating profitability of the grocery business will limit how much you can claim as a price for intermediation, in service fees," Damodaran wrote.

Most people like to go to grocery stores

For non-processed food, especially fresh meats and produce, being able to see and touch items before you buy them is part of the shopping experience. Online photos don't cut it. I personally like to feel the avocados before I buy them. And those endless product substitution messages from rushed Instacart Shoppers are infuriating.

COVID hangover

Instacart saw orders and revenue surge dramatically when everyone was stuck at home during COVID-19. Makes sense. But once the pandemic ebbed, a lot of consumers went back to their local grocery store (see the section above).

"Caught up in the mood of the moment, it is easy to see why so many extrapolated Instacart's success in 2020 into the future, forecasting that the shift to online grocery shopping would be permanent, and that Instacart would dominate that business," Damodaran wrote.

Growth is capped

Some Instacart customers have stayed with the service, judging the convenience to be worth it over the downsides. However, the grocery industry is not a growth sector, unlike other parts of e-commerce.

"The ceiling on online grocery retail will remain much lower than the ceiling on online shopping in other areas in retail, with even optimists capping the share at 20%," Damodaran said. "In short, the growth in online grocery sales will be higher than total grocery sales growth, but not overwhelmingly so."

Competition

During the pandemic, grocers woke up and started offering online shopping services directly to their own customers, often preferring to have consumers pick-up their orders rather than deliver them. These offerings are pretty cost competitive because most grocery stores nixed the extra service fees and used existing employees as shoppers.

Instacart is also starting to face competition from Uber Eats, DoorDash, and GrubHub.

"In short, Instacart will be lucky to hold on to its existing market share, even if it plays its cards right, leaving its growth at or below the growth in the overall online grocery shopping market," Damodaran wrote.

Costs

Instacart usually pays its Shoppers based on the number of orders they handle and how many deliveries they make. This is a major expense for the company and it is variable, rising and falling with revenue.

That reduces risk, but it means Instacart can't benefit much from economies of scale. This is a core feature of most tech companies that investors love. As sales rise, expenses usually don't rise as much for a software company, which often means big profits over time. Instacart doesn't really have this, according to Damodaran.

Growth has slowed

Tech companies are expected to grow quickly. Instacart's core business isn't really doing that.

The company handled 262.6 million orders in 2022 versus 263.20 million in the last 12 months. Gross transaction volume was $28.8 billion in 2022 versus $29.4 billion in the past 12 months, according to Damodaran's blog.