Why investors can't wait to buy into Uber, a company that's never made money — and maybe never will
Uber just the latest tech company to try to cash in before making any profits
It's one of the fastest growing technology companies in the world.
Customers took more than five billion rides on the service last year, spending almost $50 billion US in the process.
And each and every time someone ordered up one of the company's services — the company lost about 58 cents.
Sound like a good investment? With most companies, the intuitive answer to the question above would likely be no. But Uber isn't like most companies.
Founded in Silicon Valley a decade ago after its two co-founders reportedly couldn't find a taxi on a cold night in Paris, Uber pioneered the concept of ride-sharing, with drivers operating as independent contractors, by coming up with a smartphone app that allows users to request a ride, and easily pay for it via a linked-up credit card.
It has since grown to include food and package delivery services, waged an all-out war with the taxi industry while becoming an eponym for the sharing economy as a whole, prompting a slew of imitators to pitch themselves along the way as "the Uber of" whatever industry they are attempting to shake up.
It's quite an impressive feat for a company that has burned through $20 billion worth of venture capital money since its founding in 2009 — and, by its own admission — may never turn a profit.
"We have incurred significant losses since inception," the company acknowledges in paperwork it filed with regulators in April, on the road to going public in Friday's IPO. "We expect our operating expenses to increase significantly in the foreseeable future, and we may not achieve profitability."
Trifling details like actually making money don't seem to be a hindrance to investors, who have been eagerly awaiting the company's IPO, which gives the public its first opportunity to buy into the hyped-up company.
At the end of business Thursday, Uber set the IPO at $45 a share, on the lower end of its targeted range of $44 to $50 per share.
The company will raise $8.1 billion in the IPO, giving Uber a valuation of $82.4 billion. But despite those eye-popping numbers, not everyone is convinced the company will get five stars with investors over the long term.
Look at what's happened with Uber's main rival, Lyft, which went public in March in an IPO that raised billions and valued the company at $72 a share.
The shares roared out of the gate to almost $90, but quickly reversed course. Today they're under $60 a share as investors have started to realize there's a sea of red ink below the sky-high expectations of ride-sharing companies.
Mike Ward, an analyst with Seaport Global, is the lone analyst with a sell rating on Lyft, and a lot of the reasons for his cynicism about Lyft can be said of Uber, too.
Namely, they burn through far more cash than they bring in. In Lyft's case, the company booked $8 billion worth of rides last year, and kept about a quarter of that money for itself — the rest went to drivers.
Within that $2 billion, Lyft has to pay myriad expenses, including marketing, insurance, regulatory and legal costs in new markets that are usually resistant to their entry, and other expenses. Add it all up, and Lyft lost $911 million last year — or $1.47 for each and every one of their more than 616 million rides last year.
So why buy? For investors, the case in favour of these companies basically boils down to two ideas: They will make money as more people ditch car ownership and opt for ride sharing instead, and self-driving cars will turn them into autonomous cash machines.
Both of these arguments are far from certain. Ward, for one, doesn't buy the first argument at all.
"In our view, in order for the company to justify its current market valuation, investors need to take a big leap of faith that millennials and later generations will forego ownership of a car and opt instead for reliance on a ride-sharing service."
And he doesn't see that happening. He cites U.S. census data showing that while the number of young people with a driver's licence declined for a few years after the financial crisis, today about three quarters of millennials have a driver's licence — not exactly backing up that theory that they have no need of driving themselves.
"The bull case for the ride-sharing industry is that the younger generations will substitute ride-sharing for vehicle ownership," he said. "We disagree with this thesis, and recent licensed driver and home ownership data, in our opinion, supports our thesis."
Despite heady predictions that millennials will soon kill the car, Ward "believes people will continue to own their own vehicles as primary transportation and instead rely on the ride-sharing services as a convenient supplement."
Uber's prospectus pegs the theoretical market for its ride-sharing service at $5.7 trillion annually, but Ward thinks it's far smaller — about $70 billion in the U.S., by his calculations.
To the second point, a fully autonomous fleet of driverless cars would obviously allow the company to keep a lot more of its revenue, but even that is no sure thing. When an autonomously controlled Uber struck and killed a pedestrian in Arizona last year, the company hit the brakes on the whole self-driving experiment and has only recently started it up again, on an even more limited basis.
No widespread use of self-driving cars?
Both companies spend a small fortune on insurance, and self-driving technology would help them a lot there, too, but Ward says realistically that is still a long ways off. "At some point, the option for a fully autonomous vehicle could provide a solution, but in our view, widescale, fully autonomous vehicles are unlikely to be available for a decade or more."
To be fair, Uber is far from the only technology company that has tried to cash in before making any actual money. Twitter, Snapchat, Spotify and many others all came to market before they'd earned a penny — and the stock charts of all three since their IPOs should be reason enough to give would-be Uber investors some pause.
Because things didn't used to be this way. Finance professor Jay Ritter at the University of Florida crunched numbers dating back almost 40 years, covering more than 3,000 large technology companies that have gone public since 1980.
For most of those early years, about 90 per cent of tech companies were profitable before they tried to go public. That ratio plunged to barely one in seven during the tech bubble of 2000 as worse and worse companies rushed to market to cash in while they could.
The ratio recovered somewhat during the mid-2000s to about 70 per cent profitability. But today? It's back to barely one out of every six tech companies that bothers to turn a profit before going public.
That's a problem, according to Jawad Mian, the founder of macroeconomic research firm Stray Reflections.
In addition to Uber and Lyft, technology companies such as Airbnb, Pinterest, Slack and many more are believed to be rushing to market in the coming months, with stratospheric valuations based on impossibly high growth prospects.
The fervour is so intense that it reminds Mian of another era — one that didn't end well for investors.
A hundred years ago, American railroad companies raised millions of dollars from stock market investors happy to buy in based on breathless projections about the infinite size of a nebulous untapped market.
"This ended badly, of course, as shares collapsed once valuations reached bubble territory and investors realized that railroads were not as lucrative as they were led to believe," Mian says.
We have long argued the biggest risk to the bull market is an Uber IPO- Jawad Mian, macroeconomics research firm Stray Reflections
"And railroads have more parallels to today's ride-sharing companies than we might like," he deadpans.
While the industry may evolve into a viable one at some point, the hyped-up valuations of companies like Lyft and Uber makes him worry. "We have long argued the biggest risk to the bull market is an Uber IPO," he says.
Some thoughts on Silicon Valley's endgame. We have long said the biggest risk to the bull market is an Uber IPO. That is now upon us.—@jsmian
"As these companies go public, investors will want to see a clearer route to long-term profitability even at the expense of growth [but] the dilemma is that there are not many levers to pull to make that happen," he says.
Uber, he notes, has internally been referring to its IPO plans under the ominous codename of "Project Liberty" — a nod to the thousands of employees and early investors who have waited years to sell their stakes for a profit.
"If history repeats, perhaps it was so named to liberate fools from their dollars," he said.
"It won't be long before we find out."