Should you buy Uber or Lyft’s stock following the IPO? Both have caught a lot of attention in the wave of tech IPO’s that have hit the market this spring. Lyft already IPO’d and surged initially, but has since fallen 33%, which in turn hurt Uber’s expected valuation. Uber priced its IPO at $45 – the low end of its valuation range.
I’ll try to help provide some insights into the businesses and “what you need to believe” to invest in these companies. The bull case for Uber and Lyft is that “transportation-as-a-service” or “TaaS” is a new market. While Uber and Lyft are fiercely competitive today, and unprofitable, the market is really 2 players (in the US) and that should ease over time (“think of the great duopoly’s of Visa and Mastercard” the bulls will tell you).
So let’s rehash the investment case:
- “TaaS” is a large market and growing
- Upside possible from the “end” of car ownership (and entry of autonomous cars)
- These are “platform businesses” that can leverage their user base to expand into adjacent markets (UberFreight, UberEats, third-party delivery, scooters, bikes etc.)
- Only two players today. Now that they are public, competitive behavior should cool as the CEOs will be beholden to new investors
I struggle with the last point for several reasons. Uber and Lyft are not actually the only two players – taxi’s do still exist. While you may not take one every time to the airport, they wait for you when you arrive in a new city as the marginal provider of transportation. When the Uber wait is too long or there is surge pricing, yellow cab is still there… My point is that pricing for Uber and Lyft can only go so high. And who knows if the companies that have succeeded in China and elsewhere are waiting in the wings to enter the US market (and drive down prices).
If Uber and Lyft can’t raise the the price of your ride, maybe they take more of the driver’s fare. That’s possible, but they also have to incentize the drivers to drive
and beat the hell out of their car. As I calculated in my post on what driver’s might make, it is a decent wage, but if you squeeze that too much, they just won’t drive anymore.
Do I think Uber is the Facebook of transportation? No. Facebook increased the return on investment for all advertisers and increased the total pie. Uber drove down the price of taxi medallions because it added significant supply to the market (everyone can now be a driver) and drove down prices.
The other bull case is that Uber or Lyft win the race to autonomy. The reason why this would be so important to the stocks is that autonomy is viewed as a winner-take-all business (think google maps – do you really need another provider?).
There again, I struggle. Calling the winner in autonomy is anyone’s guess. Why would I bet on Uber or Lyft winning vs. Google? I can’t, I can only speculate. And to speculate, I would have to bet that others are not pricing it into the stock. Google spends over $1bn on Waymo a year. I have no insight into this market
Next, to the notion of Uber reducing car ownership. There have been anecdotes of people forgoing car ownership, but that doesn’t seem to be impacting car purchases yet. Car sales, measured by units, are at all-time highs. It’s slowing, but its because we are selling nearly 17MM cars per year and have been for ~5 years.
Prices too have marched up since the Great Recession. In December 2018, the average price paid for a car was $37.5k, up from $30K in 2013. If Uber and Lyft are having an impact, it is hard to decipher this from the data.
Indeed, while Uber is growing bookings significantly and reported revenue, their growth rates have slowed dramatically. As shown below, Q1’19 adj. rideshare revenue growth is only +9%.
That is materially different than the +21% for the reported bookings. This is revenue that is adjusted to reflect driver earnings as well as incentive comp. An example is provided below:
As you can see, the driver pay and incentives matter materially here. “Excess” incentives are defined as “payments, including incentives but excluding Driver Referrals, to a Driver that exceed the cumulative revenue that we recognize from a Driver with no future guarantee of additional revenue.”
Is this number improving for the Company? Hmmm…
Granted, this does include incentives for UberEats and Rideshare incentives are expected to improve for Q1’18 compared Q1’19, but hard to see that the conditions overall are less competitive.
As an aside, I recently had an Uber driver tell me he was going to buy the Uber IPO (he admitted he didn’t study it much, just knew they were growing). That actually could be an interesting employment hedge… if the drivers are hurting, Uber may be doing well – and vice versa!
There are two players so we should compare what they look like. For starters, Uber is much bigger than Lyft and is global. How has that scale played out on the financials? Still a bit too early to see benefits. It’s clear you can see Uber expanding into other markets, while Lyft is focused on the core.
Clearly, they both burn cash. This actually surprised me a bit. Before the financials were released, I would have viewed the companies as platforms and apps, or asset-light businesses, whereas all the asset-heavy stuff is left to the drivers. Similar to AirBNB, where the homeowner faces the cost of serving the guest and the platform just takes a fee.
Clearly, that is not the case. They spend a lot on data centers and other infrastructure (more on cash flow at the bottom of this post)
We should compare and contrast the two players as well (feel free to add anything in the comments):
Pros of Uber:
- Larger scale – ride sharing is 5x the size of Lyft.
- More diverse business with options – UberEats, UberFreight, autonomous… with the added scale. You could argue Lyft is also entering these, but Uber appears to have the lead
- Valuation seems less demanding – basing that only on Lyft’s valuation and other travel comps
Cons of Uber:
- Clearly losing share to Lyft
- Operates in highly competitive markets – as if ride sharing wasn’t competitive enough, Uber got into UberEats (a zero barrier to entry business, but I get why they did it), and freight brokerage
Pros of Lyft:
- Singular Focus – nothing other than “transportation-as-a-service”. There is some support of companies that focus on one goal tend to execute on that rather than be stretched in all directions
- Increasing Share – overthe past 2 years, Lyft’s share has grown from 22% to 39%, taking advantage of Uber’s PR mishaps while also being competitive
- More Upside in Core Market – Similar to the bullet above, if Lyft continues to take share, it seems clear that it will be at the expense of Uber. Given Lyft is 1/5 the size of Uber, there is plenty of share to give
Cons of Lyft:
- Smaller company / less scale
- No “other bets” – Similar to google’s “other bets” segment, Uber benefits from its core delivery business, cross-synergies with UberEats, and other bets. Lyft has autonomous capability, but its anyone’s guess on who wins the war here.
- Entering more capital intensive businesses – with the entry into scooters and bikes in scale, it appears Lyft is going to now be reinvesting in that business. (Funny enough, I saw a piece that said Bird Scooters last less than a month)
Perhaps Uber should trade at a significant premium to Lyft due to scale, global presence, and “Amazon” view of transportation. Jeff Bezos wanted the everything store, Uber will be the transportation store. Conquer all, forget profits in the near term, it is all about the next 10+ years…
At $45/share, that means Uber is valued at $82.4BN while Lyft is valued at $15.7BN at $55/share. That places them both at exactly 7.3x 2018 sales…
Perhaps investors are saying Lyft will grow core earnings faster. Perhaps they like the market share gains. Perhaps they view Uber’s other ventures as dilutive. Maybe there is negative view on autonomous given Otto was caught stealing trade secrets and that put them behind. Either way, I am a bit surprised to see Uber trading for the same price (long UBER / short LYFT anyone?).
I will be passing on both. I just don’t see this as a great market and I think it will be forever competitive. It seems like a race to the bottom for both attempts to gain and retain riders and drivers. Yet, there is nothing binding one to either. Therefore, I don’t see much pricing power here, as noted above.
Interesting Insurance Dynamic Not Discussed Often
One last thing — as I was building the cash flow statement for these companies, I noticed working capital changes were an inflow of cash, largely due to changes in an insurance reserve.
At first, it seems that Uber and Lyft are negative working capital businesses (i.e. the more sales grow, they actually get cash in the door like an insurance company that they can reinvest). That could possibly be a great thing. Lo and behold, I learned Lyft and Uber actually have self-insurance.
In other words, when a driver accepts a rider on Lyft, up until the ride is finished, Lyft is responsible for insuring the trip. This is a huge cost.
In fact, cost of revenue is really made up of two main items: Insurance costs and payment processing charges. Payment processing is the merchant fees that credit cards charge. Insurance costs include estimated losses and allocated lost adjustment expense on claims that occurred in the quarter. It also includes changes to the insurance reserves. These latter two items make up the bulk of COGS.
Lyft says in its S-1 that, “By leveraging our data and technology, we are seeking to reduce cycle times, improve settlement results, provide a better user experience, drive down our cost of claims and have fewer accidents by drivers on our platform.”
Clearly, this would be great. But insurance is also one of the items that can be gamed in the future. By reserving less, Lyft and Uber and report higher earnings. This often happens in good times for banks, where they reserve less for bad loans to boots EPS until a recession hits and they realize they didn’t reserve enough.
Analysts typically are wrong in their expectations, but this could be something where they are especially wrong. If analysts think they can leverage COGS more than reality, the forward estimates people are baking in could be too high.