Nicholas Hyett, Equity Analyst 22 May 2019
Uber and its rival Lyft both went public recently, in two of the most hotly anticipated stock market listings of the year. But how have they done since then, and what are their prospects for the future?
Lyft won the Initial Public Offering (IPO) drag race, making it to market in March. Its shares promptly plummeted, and are currently trading 28.7% below their opening price. The larger, and perhaps more mature, Uber took longer to make its public debut, but has fared little better, with shares sliding 7.6% in their first day’s trading.
The question is, is this just a stall, or are we looking at a total car crash?
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What’s all the fuss about?
Despite their share price falls since listing, Uber and Lyft are still valued at $71.4bn and $15.9bn respectively. Clearly there are plenty of investors out there who still consider the two businesses attractive. So what is it that makes these (let’s face it) giant taxi companies so attractive?
First off we should be clear that the recent run of tech IPOs, and Uber and Lyft in particular, are not a repeat of the dotcom boom.
Back then you needed little more than an internet domain and a flashy idea to attract investors’ money. Last year Uber and Lyft generated annual sales of $13.4bn between them, and grew sales at 42.1% and 103.8% respectively. Love them or loathe them, the ride hailing groups are big businesses delivering a genuine service that customers are prepared to pay for.
While reported numbers show an operating loss of $3bn in 2018, on some level Uber can even make a claim to be profitable. Uber’s core business, which includes ride hailing and UberEats, generated sales of $10bn in 2018, and delivered a “Contribution profit” of $940m. Unfortunately that excludes a whole host of very real R&D, compensation and legal costs.
Still, the beauty of the Uber model means that lots of its costs are comparatively fixed. It charges a fee for matching self-employed drivers to would-be passengers, and the number of trips taken has only a limited impact on cost. The revenue from every trip may be small, but once you have enough trips to cover the admittedly large cost base, every subsequent trip is pure profit.
If Uber can continue to deliver the spectacular growth it’s reported so far, then the eventual profits could be huge.
There is a certain logic to continued growth in ride hailing apps. Buying a car is expensive, and most of the time it sits on a driveway or car park doing nothing. It’s a bit like leaving thousands of pounds in a bank account that pays no interest. In fact it’s worse.
Because cars depreciate in value so quickly, and insurance and road tax must be paid regardless of how often you drive the car, buying a car is more like putting money in a bank account and then paying for the privilege. Not ideal.
Uber’s expansion into food delivery and freight can be seen as applying the same logic on a corporate level. Why spend money on logistics infrastructure or a delivery driver, when you can share the costs through Uber?
For infrequent car users in big cities, the occasional taxi journey in an Uber may not only be convenient, it might even be relatively inexpensive. Of course the same is true of Lyft. And in that lies the rub.
Some potentially fatal flaws?
Perhaps our biggest concern with the ride hailing Apps is that there’s an awful lot of them.
How do consumers decide whether to Uber, Ola or Lyft? All perform the fairly basic function of moving passengers from A to B when they’re running late for the train or had one too many glasses of wine. And the cost of switching from one provider to another is the time it takes to download an app. The key determinants seem to be either convenience or cost.
Competition on cost alone is never good news for an industry, but we’ll get to that. Let’s start with convenience.
Convenience is determined by how quickly a driver can get to you – and that depends on how many drivers are available in your area, and, crucially, how many of them are currently unengaged elsewhere. At any given time Uber needs a portion of its drivers to be sitting in cars without a passenger. That’s great for the consumer, but not for a driver. If there’s a rival app that has a shortage of driver’s you’re likely to get more passengers on there. At least on paper there’s nothing to stop a driver working for Uber on a Wednesday and Lyft on a Friday, equalling out convenience for the consumer.
Of course companies can always try giving drivers a larger slice of the pie to keep them loyal. Uber do precisely that in competitive markets – sometimes paying drivers more for the lift than the consumer pays Uber! Even that hasn’t been enough to keep drivers fully onside. Both Lyft and Uber have seen drivers go on strike in the last couple of months over pay and job security.
The prices and convenience of the ride hailing revolution may be fantastic, but they also look unsustainable. Take a look at the graphs below – created using data from the Uber IPO prospectus. Not only has the average cost of an Uber trip fallen in the last year, but Uber’s share of the pie has been falling too. Some of that’s down to the increasing contribution of lower margin Uber Eats – but not all of it. It looks like competition is already taking a toll on price.
Gross Booking per trip ($)
Source: Uber IPO prospectus
Revenue per trip ($)
Source: Uber IPO prospectus
Finally there’s the issue of driverless cars.
Now an Uber/Lyft/Ola owned fleet driverless cars could resolve the industry’s driver and convenience issues. Unfortunately it would also undermine the very capital-light model that makes the industry attractive.
If Uber has to fork out to buy, maintain and clean cars then every trip and every mile driven creates incremental costs. Driverless cars wouldn’t solve the issue of competition either.
Ultimately a capital-intensive car business with low barriers to entry starts to look less and less like a high margin, FAANG-style tech company, and much more like an old school taxi company.
Of course taxi companies make plenty of money the world over, and larger, global taxi companies are likely to have cost advantages from scale. But if the barriers to entry are low, and competition is intense, those savings are likely to be traded away – ultimately benefiting the consumer more than the business as companies compete on price.
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