Monday, April 15, 2019

Uber's Coming out Party: Personal Mobility Pioneer or Car Service on Steroids?

After Lyft’s IPO on March 29, 2019, it was only a matter of time before Uber threw its hat in the public market ring, and on Friday, April 12, 2019, the company filed its prospectus. It is the first time that this company, which has been in the news more frequently in the last few years than almost any publicly traded company, has opened its books for investors, journalists and curiosity seekers. As someone who has valued Uber with the tidbits of information that have hitherto been available about the company, mostly leaked and unofficial, I was interested in seeing how much my perspective would change, when confronted with a fuller accounting of its performance.

Backing up!
To get a sense of where Uber stands now, just ahead of its IPO, I started with the prospectus, which weighing in at 285 pages, not counting appendices, and filled with pages of details, can be daunting. It is a testimonial to how information disclosure requirements have had the perverse consequence of making the disclosures useless, by drowning investors in data and meaningless legalese. I know that there are many who have latched on to the statement that "we may not achieve profitability" that Uber makes in the prospectus (on page 27) as an indication of its worthlessness, but I view it more as evidence that lawyers should never be allowed to write about investing risk.

Uber's Business
Just as Lyft did everything it could, in its prospectus, to relabel itself as a transportation services (not just car services) company, Uber's catchword, repeatedly multiple times in its prospectus, is that it is a personal mobility business, with the tantalizing follow up that its total market could be as large as $2 trillion, if you count the cost of all money spent on transportation (cars, public transit etc.)
Uber Prospectus: Page 11
While the cynic in me pushes me back on this over reach (I am surprised that they did not include the calories burnt by the most common transportation mode on the face of the earth, which is walking from point A to point B, as part of the total market), I understand why both Lyft and Uber have to relabel themselves as more than car service companies. Big market stories generally yield higher valuation and pricing than small market stories!

The Operating History
Uber went through some major restructuring in the three years leading into the IPO, as it exited cash burning investments in China (settling for a 20% stake in Didi), South East Asia (receiving a 23.2% share of Grab) and Russia (with 38% of Yandex Taxi the prize received for that exit). It is thus not surprising that there are large distortions in the financial statements during the last three years, with losses in the billions flowing from these divestitures. In the last few weeks, Uber announced a major acquisition, spending $3.1 billion to acquire Careem, a Middle Eastern ride sharing firm. Taking the company at its word, i.e., that the large divestiture-related losses are truly divestiture-related, let’s start by tracing the growth of Uber in the parts of the world where it had continuing operations in 2016, 2017 and 2018:
Uber Prospectus: Page 21
The numbers in this table are the strongest backing for Uber’s growth story, with gross billings, net revenues, riders and rides all increasing strongly between 2016 and 2018. That good news on growing operations has to be tempered by the recognition that Uber has been unable to make money, as the table below indicates:
Uber Prospectus: Pages 21 & 24
The adjusted EBITDA column contains numbers estimated and reported for the company, with a list of adjustments they made to even bigger losses to arrive at the reported values. I convert this adjusted EBITDA to an operating income (loss) by first netting out depreciation and amortization (for obvious reasons) and then reversing the company’s attempt to add back stock based compensation. The company is clearly a money loser, but if there is anything positive that can be extracted from this table, it is that the losses are decreasing as a percent of sales, over time.

The Rider Numbers
One of Uber’s selling points lies in its non-accounting numbers, as the company reported having 91 million monthly riders (defined as riders who used either Uber or Uber delivery at least once in a month) and completing 5.2 billion rides. To break down those daunting numbers, I focus on the per rider statistics to see the engines driving Uber’s growth over time:
Uber Prospectus: Page 21
There is good and bad news in this table. The good news is that Uber’s annual gross billings per rider rose almost 28% over the three year period, but the sobering companion finding is that the billings/ride are decreasing. Boiled down to basics, it suggests that the growth in overall billings for the company is at least partially driven by existing riders using more of the service, albeit for shorter rides. It could also reflect the fact the new riders for the company are coming from parts of the world (Latin America, for instance), where rides are less expensive.  Finally, I took Uber’s expense breakdown in their income statement, and used it to extract information about what the company is spending money on, and how effectively:
Uber Prospectus: F-4 (income statement in appendix)
I make some assumptions here which will play out in the valuation that you will see below.
  1. User Acquisition costs: Using the assumption that user change over a year can be attributed to selling expenses during the year, I computed the user acquisition cost each year by dividing the selling expenses by the number of riders added during the year.
  2. Operating Expenses for Existing Rides: I have included the cost of revenues (not including depreciation) and operations and support as expenses associated with current riders. 
  3. Corporate Expenses; These are expenses that I assume are general expenses, not directly related to either servicing existing users or acquiring new ones and I include R&D, G&A and depreciation in this grouping.
The good news is that the expenses associated with servicing existing users has been decreasing, as a percent of revenues, indicating that not all of these costs are variable or at least directly linked to more rider usage. Also, corporate expenses are showing evidence of economies of scale, decreasing as a percent of revenues. The bad new is that the cost of acquiring new users has been increasing, at least over this time period, suggesting that the ride sharing market is maturing or that competition is picking up for riders.

More than ride sharing?
Uber is a more complicated company to value than Lyft, for two reasons. The first is that Uber is not a pure ride sharing company, since it derives revenues from its food delivery service (Uber Eats) and an assortment of other smaller bets (like Uber Freight). In the graph below, you can see the evolution of these businesses:
Uber Prospectus: Page 114

It is worth noting this table while suggests that while some of Uber’s more ambitious reaches into logistics have not borne fruit, its foray into food delivery seems to be picking up steam. Uber Eats has expanded from 2.68% of Uber’s net revenues to 13.12%. There is some additional information in another portion of the prospectus, where Uber reports its "adjusted" net revenue and gross Billings by business, and it does look like Uber's net take from Uber Eats is lower than its take from ride sharing:
Uber Prospectus: Pages 102 & 103
While it is clear that Uber's ride sharing customers have been quick to adopt Uber Eats, there are subtle differences in the economics of the two businesses that will play out in future profitability, especially if Uber Eats continues to grow at a disproportionate rate.

Unlike Lyft, which has kept its focus on the US and Canadian markets, Uber's ambitions have been more global, though reality has put a crimp on some of its expansion plans. While Uber's initial plans were to be everywhere in the world, large losses have led Uber to abandon much of Asia, leaving China to Didi and South East Asia to Grab, with India being the one big market where Uber has stayed, fighting Ola for market share and who can lose more money. The fastest growing overseas market for Uber has been Latin America, as you can see in the graph below:

Uber does not provide a breakdown of profitability by geographical region, but the magnitude of the losses that they wrote off when they closed their Chinese and South East Asian operations suggests that the US remains their most lucrative ride sharing market, in terms of profitability. 

The Road Ahead : Crafting a story and value for Uber
1. A Top Down Valuation
In valuing Lyft, I used a top-down approach, starting with US transportation services as my total accessible market and working down through market share, margins and reinvestment to derive a value of $13.9 billion for its operating assets and $16.4 billion with the IPO proceeds counted in. Using a similar approach is trickier for Uber, since its decision to be in multiple parts of the logistics business and its global ambitions require assessment of a global logistics market, a challenge. I did an initial assessment of Uber, using a much larger total market and arrived at a value of $44.4 billion for its operating assets, but adding the portions of Didi, Grab and Yandex Taxi pushed this number up to $55.3 billion. Adding the cash balance on hand as well as the IPO proceeds that will remain in the firm (rumored to be $9 billion), before subtracting out debt yields a value for equity of about $61.7 billion.
The share count is still hazy (as the multiple blank areas in the prospectus indicate) but starting with the 903.6 million shares of common stock that will result from the conversion of redeemable convertible preferred shares at the time of the IPO, and adding in additional shares that will result from option exercises, RSUs (restricted stock units issued to employees) and new shares being issued to raise approximately $10 billion in proceeds, I arrive at a value per share of about $54/share, though  that the updated version of the prospectus, which should come out with the offering price, should allow for more precision on the share count. (Update: Based upon news stories today (4/26/19), it looks like the share count will be closer to 1.8 billion to 2 billion shares, which will result in a value per share closer to $31-$33/share).

2. A Rider-based Valuation
The uncertainty about the total accessible market, though, makes me uneasy with my top down valuation. So, I decided to try another route. In June 2017, I presented a different approach to valuing companies like Uber, that derive their value from users, subcribers or members. In that approach, I began by valuing an existing user (rider), by looking at the revenues and cash flows that Uber would generate over the user’s lifetime and then extended the approach to valuing a new user, where the cost of user acquisition has to be netted out against the user value. I completed the assessment by computing the value drag created by non-rider related costs (like G&A and R&D). In the June 2017 valuation, I had to make do with minimalist detail on expenses but the prospectus provides a much richer break down, allowing me to update my user-based valuation of Uber. The valuation picture is below:
This approach yields a value for the equity of about $58.6 billion for Uber’s equity, which again depending on the share count would translate into a share price of $51/share. (Update: Based upon news stories today (4/26/19), it looks like the share count will be closer to 1.8 billion to 2 billion shares, which will result in a value per share closer to $30/share).

Value Dynamics
The benefits of the rider-based valuation is that it allows us to isolate the variables that will determine whether Uber turns the corner quickly and can make enough money to justify the rumored $100 billion value. The value of existing riders is determined by the growth rate in per-user revenues and the cost of servicing a user, with increases in the former and decreases in the latter driving up user value.  The value of new riders, in the aggregate, is determined by the increase in rider count and the cost of acquiring a new rider. One troubling aspect of the growth in users over the last three years has been the increase in user acquisition costs, perhaps reflecting a more saturated market. In the table below, I estimate the value of Uber's equity, using a range of assumptions for the growth rate in per user revenues and the cost of acquiring a new user:
Download spreadsheet
There are two ways that you can read this table. If you are a trader, deeply suspicious of intrinsic value, you may look at this table as confirmation that intrinsic value models can be used to deliver whatever value you want them to, and your suspicions would be well founded. I am a believer in value and I see this table in a different light.
  • First, I view it as a reminder that my estimate of value is just mine, based on my story and inputs, and that there are others with different stories for the company that may explain why they would pay much more or much less than I would for the company. 
  • Second, this table suggests to me that Uber is a company that is poised on a knife's edge. If it just continues to just add to its rider count, but pushes up its cost of acquiring riders as it goes along, and existing riders do not increase the usage of the service, its value implodes. If it can get riders to significantly increase usage (either in the form of more rides or other add on services), it can find a way to justify a value that exceeds $100 billion. 
  • Third, the table also indicates that if Uber has to pick between spending money on acquiring more riders or getting existing riders to buy more of its services, the latter provides a much bigger bang for the buck than the former. 
Put simply, I hope Dara Khoshrowshahi means it when he says that Uber has to show a pathway to profitability, but I think that is what is more critical is that he acts on those words. In my view, this remains a business, whether you define it to be ride sharing, transportation services or personal mobility, without a business model that can generate sustained profits, precisely because the existing model was designed to deliver exponential growth and little else, and Uber, and the other players in this game), have only a limited window to fix it.

Refreshing the Pricing
Having spent all of this time on Uber's valuation, let me concede to the reality that Uber will be priced by the market, and it will be priced relative to Lyft. That is why Uber has probably been pulling harder than almost any one else in the market for the Lyft IPO to be well received and for its stock to continue to do well in the aftermarket. In the table below, I compare key operating numbers for Uber and Lyft, with Lyft's pricing in the market in place:

In computing the metrics, it is worth remembering that Uber and Lyft use different definitions for basic metrics and I have tried to adjust. For instance, Uber defines riders as those who use the service at least once a month and the closest number that I can get for Lyft is their estimate that they had 18.6 million active quarterly riders. Uber is bigger on every single dimension, including losses, then Lyft. I convert Lyft's current market pricing (on April 12, 2019) into multiples, scaling them to different metrics and applying these metrics to Uber:
Download pricing spreadsheet
In computing Uber's equity value from its enterprise value, I have added the cash ($6.4 billion of cash on hand plus the $9 billion in expected IPO proceeds) $ and Uber's cross holdings ($8.7 billion) to the value and netted out debt ($6.5 billion). To get the value per share, I have used the estimated 1175 million shares that I believe will be outstanding, including options and RSUs, after the offering. Depending on the metric that I can scale it to, you can get values ranging from $47 billion to $124 billion for Uber's equity, though each comes with a catch. If you believe that there are no games that are played with pricing, you should think again! Also, as Lyft's price moves, so will Uber's, and I am sure that there are many at Uber (and its investment banks) who are hoping and praying that Lyft's stock does not have many more days like last Thursday, before the Uber IPO hits the market.

I am sure that there are many who understand the ride sharing business much better than I do, and see obvious limitations and pitfalls in my valuations of both Uber and Lyft.  In fact, I have been wrong before on Uber, as Bill Gurley (who knows more about Uber than I ever will) publicly pointed out,  and I am sure that I will be wrong again.  I hope that even if you disagree with me on my numbers, the spreadsheets that are linked are flexible enough for you to take your stories about these companies to arrive at your value judgments.

YouTube Video

Spreadsheets (for valuation)
  1. Uber Valuation - Top Down
  2. Uber Valuation - User-based
  3. Uber Pricing

Other Links
  1. Uber Prospectus (April 2019)
  2. My first and fatally flawed valuation of Uber (June 2014)
  3. Bill Gurley's take down of my Uber valuation (July 2014)
  4. My post on the future of ride sharing (August 2016)
  5. My first user-based valuation of Uber (June 2017)

1 comment:

Anonymous said...

Uber in their S-1 says:

We derive our revenue principally from service fees paid by our Driver and restaurant partners for the use of our platform in connection with our Ridesharing products and Uber Eats offering provided by our partners to end-users. Our sole performance obligation in the transaction is to connect partners with end-users to facilitate the completion of a successful Ridesharing trip or Uber Eats meal delivery. Because end-users access our platform for free and we have no performance obligation to end-users, end-users are not our customers.

So, for profitability they need to -

1. Earn more per driver - By charging bigger commissions which requires pricing power which they don't have because of lack of driver stickiness or by charging more from users which again requires pricing power. Or last option is introduction of owned self driving cars where they get to keep all of the ride money.

2. Get more drivers - which requires them to spend more money and without VC money this looks unlikely

Lyft made a similar point in their S-1 too. So, I think per driver metric is the best one to use for ride sharing companies.