“I have no way to value it and neither does Steve because they need to increase prices to have a sustainable (presumably smaller) business … I just see that y’all are long garbage like that and [Forager is] plainly uninvestable for me unless you get your act together.”
That’s one investor’s feedback on our recent investment in Uber. He isn’t alone. We’ve never had a more visceral response to a new portfolio addition.
Uber is not the first unprofitable company we’ve invested in. In fact, some of our International Fund’s most successful stocks, Lotto24, Bonheur, Blancco Technologies and Betfair were loss-making at the time of investment. But Uber seems to be the most controversial.
Perhaps that is part of the opportunity. But I’ll come to that at the end.
The aim of this blog is to raise and address some of the key questions. And get some considered feedback (I’m guessing there will be plenty of feedback, considered or not).
Here are my answers to the main issues people have with the investment.
Issue 1: This business shouldn’t even exist. People only use it because it is cheap. The service is only cheap because Uber subsidises it.
Forget about all the economic rationale Uber puts forward for its existence. There might be some benefits to utilising a car fleet that is mostly idle. There are definitely benefits to a workforce that can flex depending on demand, as anyone who has tried to get a cab home on New Year’s Eve can attest. But these are not the main reasons ridesharing has a place in the world.
The ridesharing segment exists for two reasons.
One is regulatory arbitrage. Prior to the arrival of Uber in Sydney, a set of taxi plates cost as much as $400,000 to buy. That’s a lot of money for two small pieces of aluminium. They were worth so much because their supply was constrained by the NSW government and the pricing of taxi rides artificially inflated.
For a driver who wanted to lease some taxi plates, the going rate was $300 a week (roughly a 4% annual return for the plate owner). So before worrying about fuel, depreciation, Cabcharge’s take, insurance and the like, a driver had to earn $300 in fares just to cover the economic rent.
Along comes ridesharing and says “how about we split this $300 between customers (lower prices), drivers and the booking platform?” Wherever supply of taxi plates is constrained (everywhere, basically), you can offer lower fares and still make a profit.
The second is because it is a better service. I’m guessing you’ve had the same taxi experiences as me. Bookings that don’t turn up. Drivers that don’t know the way. Drivers that do know the way but intentionally take you the long way around. Drivers that won’t take you at all because it’s a busy night and the fare isn’t long enough. Cars that stink and rattle.
I’ve had the odd bad experience with Uber, too. But they are few and far between. For the most part, from booking to leaving the car, the experience is seamless.
According to a recent UBS survey, only half of users cite cost as the main reason for using a ridesharing service:
Convenience matters, a lot. With the recent addition of government charges, it is hardly cheaper for me to use Uber relative to a cab. I do it because I prefer it.
More than 100 million different people used an Uber service in the last quarter of 2019, suggesting I’m not the only one who values it.
Issue 2: There are no barriers to entry. A constant stream of new competitors means Uber is always losing money.
It’s true. Pay a driver enough and they will put your app on their phone and a sign in the back window. Offer free rides and you will undoubtedly get a few users to try your new ridesharing service. That bit is not difficult. But this is a scale game.
Very small differences in UI and UX (user interface and user experience) matter immensely … if you are 0.5% better, that can be the foundation of hundreds of billions of dollars in market value.
– Gavin Baker on the Invest Like the Best Podcast
To offer a competing service, you need the same infrastructure as the large, established player. You need an app that is at least as good. Useability is hugely underrated, difficult and only noticed when it is bad. You need the same number of drivers, so that there is always availability. You need marketing, distribution and customer services teams.
If one participant can reach a dominant market share, they are almost impossible to dislodge. With roughly similar overheads, the largest player makes more money (or loses less) at every single pricing level.
‘if you build it, they will come’ pretty much only works in the movies. Demand aggregation is really, really hard @bgurley https://t.co/9TAneHm5j5
— christian dahlen (@mercurygod) April 21, 2020
That’s why every city ended up with one highly profitable newspaper in the twentieth century. It’s why Virgin Australia could never make a profit. And it’s why Uber’s competitor Lyft, with roughly one third of the ridesharing market, is struggling in the US.
It’s also why the competition is so ferocious in the early years. Everyone knows that only the largest player is going to make money at maturity, so they are willing to spend a fortune trying to get there.
It’s a fight that Uber has won in most of the western world.
Source: Uber 2020 Investor Presentation as at 31 January 2020
Having withdrawn from expensive forays into Asia, Uber is now number one in every market that it operates in, with market shares higher than 65%. Trying to dislodge them now is pointless, and that’s why you are seeing a lot fewer companies try.
Issue 3: They are just going to waste money on hare-brained schemes like driverless cars.
This is going to surprise quite a few people. Uber’s ridesharing business (Rides) is already profitable. And not just a little bit. It contributed $742m of EBITDA (earnings before interest, tax, depreciation and amortisation) in the December 2019 quarter, almost four times the $195m it made in the same period the previous year.
Source: Uber 2020 Investor Presentation
Yes, there is $644m in corporate expense. And there’s another $350m of operating expenses that come underneath the EBITDA line. But the profitability of Rides was growing fast prior to COVID-19. It will resume growing fast once the world economy starts to recover. The business as a whole was expected to break even at the EBITDA level in 2020, thanks to significantly reduced losses in its Eats business (see below).
This is not the Uber of old. It is not the Uber most people think it is.
Uber was founded by, Travis Kalanick. Uber would not be what it is without him. First mover advantage was crucial and his single-minded vision of global domination meant that it was Uber, not one of its many copycats, that ended up dominating most Western markets.
Backed by seemingly unlimited funds from Softbank’s Masayoshi Son, Kalanick’s ego became a significant liability from 2016 on. His attempts to dominate eastern markets and build driverless cars were costing a fortune. His disrespect for drivers, customers and anyone else who crossed him was a giant public relations disaster.
It was the middle of winter of 2017, and Jeff Jones, the man responsible for Uber’s public perception, was trying to shake everyone in the top ranks of the company awake. Uber didn’t have an image problem. Uber had a Travis problem.
– Super Pumped: The Battle for Uber by Mike Isaac
You might not have read much about Uber lately. I doubt many would be able to cite its CEO’s first name, let alone his surname. That’s a good thing.
Kalanick has been out the door since August 2017. Masayoshi has his tail between his legs after the meltdown of his futuristic Vision Fund.
Uber’s other shareholders were fed up with the damage Kalanick was doing to their investment and appointed Dara Khosrowshahi to point the company on a path to profitability and respectability.
Dara has been delivering. Uber has exited markets where it doesn’t see a clear path to being the number one player. In most cases, that has been in exchange for a significant percentage of the remaining dominant player. Today the company owns stakes in market leading regional players such as Didi (China), Grab (South East Asia), Zomato (India) and Yandex (Russia). Uber recently announced a COVID-19 related writedown of these investments, but still pegs their collective value at more than $10bn.
He has worked tirelessly to improve the company’s public reputation and relationship with drivers, introducing tips for drivers (something Kalanick refused to budge on) and working on new legislation to provide drivers and passengers more protection. The more this industry is regulated, the higher the barriers to entry.
The path to profitability and beyond has been clearly, transparently and consistently presented to investors.
Source: Uber 2020 Investor Presentation
The last remaining significant impediment to profitability is its food delivery business, UberEats. Progress has been highly encouraging.
The South Korean and Indian food delivery landscapes have already rationalised over recent months, thanks to Uber’s sale to Zomato. The Indian business alone was costing Uber $350m of annual losses. Its sale was the reason for EBITDA breakeven being brought forward by one year to the end of 2020 (prior to the impact of COVID-19).
UberEats’ key market is the US where there are four large players and consolidation is likely, perhaps even accelerated by the current environment. Two of the four (Postmates and DoorDash) are private. Postmates has attempted to IPO twice, unsuccessfully, and there is a clear urgency to sell or merge given it is a sub-scale player in a highly competitive, cash-burning market.
DoorDash has been aggressively using discounting to drive growth, all funded by cheap venture capital money. The company had raised a total of $2bn through December 2019 and lost $450m of EBITDA in 2019. Estimates suggest that Doordash is likely to have at most $550-650m of cash as of the start of 2020 and, given the COVID-19 situation, they are likely to be forced to merge or raise further capital at a discount and attempt to become more price rational.
We need to just look at burn rate relative to available cash. Using estimates from others on Twitter, you divide current burn rate by available cash (the numbers are estimates, if you have better ones plug them in), and look at who has the most “breathing room.” Answers attached: pic.twitter.com/LqktMJR39P
— Bill Gurley (@bgurley) January 17, 2020
Bill Gurley is a former Uber board member and partner at venture capital firm Benchmark, an early Uber investor still on the register
In January 2020 GrubHub said they are considering alternative strategies including a possible sale of the business amid increasing competition and continued share loss to the likes of Uber.
This theme is unfolding the same way in other key markets around the world. And when the war ends, industry profitability changes dramatically. China’s Meituan went from losing $200m per quarter to making $300m per quarter following industry consolidation (it took just 12 months). Uber’s CFO recently said that Eats is already profitable in more than 100 cities, and that just 15% of bookings contribute half of its EBITDA losses in that segment.
Rationalisation is well under way and, in a few years’ time, this market will be no different to ridesharing. There will be one or two profitable players in each geographic market, and Uber will own more than a few of them.
Source: Uber 2020 Investor Presentation
I’d argue the permanently loss-making question was still open for debate at the time of Uber’s IPO in May 2019. But the steps taken in the 12 months since leave no room for doubt. Shareholders and management are committed to making money. They are on a very clear path to doing so.
Issue 4: How can you possibly buy Uber and call yourselves value investors?
This question perplexes me somewhat. It’s ok to buy Facebook at $190 a share now that it is profitable, but it wasn’t ok to buy it at $25 when it was losing money?
Uber is no different to any other investment we have made. We estimate how much it is worth, based on future cashflows the business is expected to generate, and compare that to the current share price.
The IPO price was $45 a share. At that price (and at that time), you needed a lot of growth and/or optimistic profit margins in the near future. You also had a lot of unanswered questions, particularly whether management’s focus on profitability was genuine.
We missed the bottom by a couple of days, but our entry price into Uber is approximately $23 a share. We have had a year of disposals, exits and improving margins. Governance and capital allocation gets a tick. And at half the price, the assumptions are a lot less heroic.
Here’s our base case. That $23 share price equates to a market capitalisation of about $40bn. Those minority shareholdings in Didi, Grab, Yandex and Zomato are worth $10bn, leaving us with a $30bn purchase price for the core Uber business.
Our expectation is that revenue will double over the next five years to more than $30bn. EBITDA margins will continue rising to 15% or more. That’s $4.8bn of EBITDA, from which we subtract $1.8bn of share based compensation and depreciation. We’re expecting at least $3bn of EBIT by 2025, flowing into the coffers as cash.
Source: Forager estimates
There is clearly a wide range of potential future outcomes. That’s why Uber is 3% of our portfolio, a relatively small weighting. But those are numbers you can hold us to. I expect the business to do better. And, if it is making $3bn of EBIT and still growing, it is going to be worth a lot more than $30bn in 2025.
A stock that people love to hate
None of this is wildly different to analyst expectations on the stock. Almost all investment banks have valuations of $40 or more. Which makes you wonder why it was selling for $23.
We’re about to experience a gigantic global recession and Uber’s Rides business will suffer accordingly. There’s one good reason. But I think it’s more than that.
The views of our critics are widely held. The perception is that Uber is an uneconomic business run by a nutter who is happy to lose money forever. I’ve engaged with a few of our clients who feel this way, and haven’t yet come across one who has read last year’s annual report.
It’s a view that was accurate three years ago. The fact that Uber has changed so much is where the opportunity lies.
If we’re wrong, we’re going to get crucified. That’s a risk I’m happy to take.
*All currency is USD unless otherwise stated
Xtremely well written & convincing article.Double up>
Hell, I usually have a view on company propects.
I just don’t know what to think on this one.
One thing I am clear on, I will be glad to see the total demise of fetid, overpriced taxis and their surly drivers.
A couple of thoughts in response…
1. In becoming more ‘respectable’, Uber is having to adopt traditional (and more costly) practices. One of the reasons they were “cheaper” initially is that they skirted a lot of the administrative and regulatory burdens which shaped the taxi industry. From driver screening, insurance premiums, to worker entitlements, they are being forced to stop pretending they are not just another type of taxi service.
2. The taxi industry has been changed and is catching up. One of the benefits of the introduction of Uber was to see many taxi companies lift their game. Newer cars, better apps, etc mean that the difference between the experience for users is diminished.
In Australia at least, the costs and experience between Uber and taxi services (like 13cabs) is on par. And with ride sharing apps drawing fringe benefits tax for corporate users, it makes using a taxi a far more attractive proposition.
Uber Eats is a different kettle of fish, but it remains to be seen whether venues will continue to use the service in light of the huge cut they take from the restaurants.
So with the playing field becoming more level, it’s hard to see how Uber continues to reduce its costs and increase revenue to drive profit. Arguably, the market for them has become tougher, and any gains will be small and incremental not a step change. It’s a big jump from minus 16-17% EBITDA to break even in a more mature, more competitive market which is increasingly less favourable for Uber.
There is one thing that bothers me about an investment in UBER. When Tesla and others finally get their autonomous electric vehicles working (and this could be as early as 2030), how does UBER even have a business? Just call a car via my mobile and it will arrive to deliver me where I want. I will pay $150-$200 per month as a subscription and never have to own or insure or maintain a car again. Fleet owners will be the ones making the money.
^^^ Agreed! How you gonna compete with a service that doesn’t have to pay a driver!?
Thanks for the thoughtful & value add article.
A few points of hopefully constructive rebuttal if I may:
1. While there is indeed a profit pool to be captured from taxi plate arb, only a subset of taxi markets have this market structure, so you can’t extrapolate it to the entire global taxi market (ex Asia). Furthermore, local governments were the primary beneficiary of selling those plates in past, which explains the considerable resistance they have faced in many markets. While regulatory risk has subsided, it has not gone away, and it is always within the power of governments to insist they pay levies for a license to operate that levels the playing field.
2. There is no discussion of the TAM in the article. They still have growth runway but trees don’t grow to the sky. The global taxi industry is apparently some US$108bn. Uber does not play in all markets, and it won’t achieve 100% market share – not even in ride sharing, let alone including traditional taxi companies which still have a considerable presence & scale. So while Uber still has room to grow, it is already quite highly penetrated relative to the substantial growth already built into the price.
This is one of the key reasons Uber has always pitched itself as being the ‘future of mobility’, and offering ‘transportation as a service’. They know that the TAM – if defined as the size of the taxi market – isn’t large enough to get investors excited at a US$60bn price tag. This is where the problem of them selling rides at a loss emerges – they had larger ambitions of wanting to displace private vehicle ownership/operation/mobility. Unfortunately for UBER, but there is a reason taxis never became more than a niche portion of total vehicle transport: it is far more costly/economically inefficient to have everyone chauffeured around town by a private driver than it is for them to drive themselves. In order to capture this portion of the market (i.e. not just taking share from taxis), they have been pricing aggressively. A big part of this demand will go away if they have to raise prices, which will significantly slow top-line growth.
3. Even on your numbers, they will be only making US$2.25bn NPAT (assuming 25% tax) in 2025. To generate a 10% annual return (ignoring both the US$10bn other investments, and the earnings related to those investments), that US$30bn would have to increase to 30 x 1.1^5 = US$48bn by 2025 (as there are unlikely to be dividends paid on the way) which would place the stock on 21x earnings. This is also before adjusting for ongoing stock comp dilution which will have raised the share count meaningfully by 2025, and the US$10bn valuation applied to their other assets is also far from conservative. This is also not to mention that Uber’s definition of ride sharing profitability is highly dubious, as a lot of costs are taken below the line which should not be, including ‘driver incentives’.
But at this point they would be doing, on your numbers, US$32bn of revenue, which represents a 30% global market share of the taxi industry. While it is feasible (though far from assured) they could get to that level, growth will likely be significantly slowing at this point as market saturation beckons. In addition, traditional taxi companies will fight back; develop their own apps (or partner with other tech players); and lobby governments to level the regulatory playing field (including forcing Uber to provide drivers with employee benefits, as California has now done). Some markets will likely see new competitors emerge – even if you’re right about market consolidation overall, it won’t happen uniformally everywhere.
4. Finally, and possibly most importantly, at some point autonomous vehicles are going to become a reality, and when that happens, Uber’s business model is going to be disrupted – quite possibly fatally so. It is even possible that by 2025, just when the company is finally getting to the point where you might be able to get a 5% dividend yield on your time-value adjusted purchase price (a run-rate that would require to 2040 for you to break even and get your initial capital back), that this starts to become a serious issue and the stock de-rates. It is highly unlikely it takes until 2040 for AVs to become widespread, which means you may never get your initial capital back.
Even ignoring disruption threats, on your numbers, 21x 2025 earnings (perhaps 25x adjusted for stock dilution in the interim), required to generate a 10% return, is far from cheap given that market saturation will be starting to beckon & growth significantly slowing. If markets are still at lofty levels in 2025, it might trade at 30-40x, but it is just as possible we’ve had a significant tech/VC downturn between then and now.
It looks to me like it is possible to justify UBER’s price, as you’ve ably done here, but it does seem to require a fairly heroic assumptions to get there, and for mine, I certainly can’t see any margin of safety whatsoever.
Just my 2c.
LT
Just a couple of quick ones:
Re 2, the overall market is growing a lot. The Australian taxi industry has not experienced significant declines in revenue (see the Cabcharge numbers) even though ridesharing has clearly grown a lot. The demographics here are very helpful, if you look at percentage penetration by age cohort, there is plenty of growth to come. And plenty of people not bothering with owning a car.
Re 3, I already have share based comp in the profit. No need to count it twice. And I have a much more optimistic view of margins if and when this business is ex growth.
And on 4, it’s a risk I’ll watch closely but I’ll be surprised if Uber isn’t part of that ecosystem. The rollout is going to happen slowly and will need to integrate with existing infrastructure for a significant amount of time. It makes a lot more sense to slowly plug autonomous vehicles into the existing Uber network than build it from scratch. But again, I’m willing to change my mind here. And it’s already a different tradeoff at $31 than $23.
PS Those revenue and margin numbers of mine include Eats. It’s not just Ridesharing.
Thanks Steve,
On 3, I’m not double counting as I’m referring here to the stock dilution between now and 2025, rather than the ongoing stock dilution post 2025 which as you rightly note is already in the 2025 earnings estimates.
You might be right. Your entry was certainly well timed. It just seems to me there are so many lower risk & far cheaper alternatives available atm. But i guess it does help to have some portfolio diversity in terms of sector & theme exposure.
Cheers,
lyall
28 April: Uber to lay off 20% of its employees, CTO pops smoke. Not exactly an alpha growth move…
While not necessarily taking away from the benefits of scale, one observation and one thought about future developments:
1/ I have noticed and discussed with local drivers. They are now often subscribing to multiple platforms, as well as operating as a traditional taxi. They then take the best fares available across all platforms when they are looking for their next fare. This will differ depending on time of day, and their location when they begin searching for a fare. So, being an Uber driver (in our location), does not preclude them from operating on any other platform, or from operating as a taxi concurrently.
2/ If we end up in a multi ride platform environment, then I can envisage the emergence of a consolidation platform that enables consumers to search for the best ride option on any platform (similar to travel consolidation websites)
Both of these shift power to 1/ drivers and 2/ consumers, and level the playing field for platforms
Yes on 2. this would be an example of the platform companies being platformed, which is something that is happening more and more often, and will likely continue.
This seems like good on-the-ground investment research JBH.
I understand it is tough for Uber drivers to make a good living so seems fair for them to push for a “level playing field”.
In Steve’s defense though I doubt Uber would share the app to a 3rd party engine if they have the benefits of scale to monopolise the industry, which I suppose is the long thesis.
I don’t apologise for being “visceral”, this is a characteristic of good and passionate short-sellers striving to bring balance to financial markets by exposing the crooks. If I see a risk of someone losing money then I will call it as I see it.
I want money managers to be passionate about not losing money & I think Steve is whilst remaining polite.
“Regulatory arbitrage” is a classic quote that I need to remember and crack out regularly. It seems like something Elon Musk would do.
Like selling “Full Self Driving” cars that require attentive drivers at all times.
Or stamps.com selling bulk postal reseller discounts from the U.S. postal service to retail customers.
Or sub-prime lenders (like TGA, not sure??) who make short-sellers particularly visceral (as documented in the big short). Talk to me about lending at high interest to desperately poor people if you really want an earful.
I hope my concerns are unfounded and I haven’t laid out the short value case as I have no position in the stock.
I respect those like Steve who put their money where their mouth is and hope it turns out well, I know how it feels to have everyone call you crazy on a position but it’s worth it when you are ultimately – as Ben Graham would say – vindicated by the sequel.
“Regulatory arbitrage”.
https://edition.cnn.com/2020/05/05/tech/california-ag-sues-uber-lyft/index.html
Steve,
It matters nought that others disagree with you. What matters is that you have done the work and have the conviction to back up your analysis.
Well written.
A well written case showing you’ve carefully researched this investment. Fingers crossed that the thesis works out (profitably).
Cheers, keep up the good research and conviction to commit.
Steve, I won’t comment on this post, as I don’t follow the business and have no value to add. I will just say this: there is one thing that is more important than whether or not you get this one right. That is, that you keep on having the courage of your convictions and that you have the balls to keep on keeping on. For that, I salute you.
Great analysis and write up guys. Keep up the good work!
I just watched your weekly video update on the International Fund where you guys talked about GMS and the struggle of finding good ideas in the oil space. Have a look at London-listed RockRose Energy (RRE LN). Company is trading at 50% below its net cash position, has a lifting cost that is superior to the majors at $30/bbl and an owner-CEO that is smart about capital allocation (keen on addressing the public market mispricing gap) and aligned with minority shareholders. They listed as a SPAC in 2016 focused on acquiring non-controlling interests in low cost producing oilfields in the North Sea for 60-70c on the dollar as these fields become non-core for the majors and bigger players, basically cigar butts investing.
Hello Steve
Do you have KPIs for Uber that if there not met you will sell your investment and for Uber what are you looking out for in the future to check if your original assessment is broken
Regards
Anthony
If they are price competing with idiots like DoorDash, then even the food delivery business is flawed.
https://www.theverge.com/2020/5/18/21262316/doordash-pizza-profits-venture-capital-the-margins-ranjan-roy
Disclosure, I HATE the food delivery app business model. All they do is charge restaurants 30% to fund stealing market share from each other.