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Business Commentary Uber’s horrendous losses make its high equity valuation a fantasy

Passengers love the fares charged by Uber. Why wouldn’t they? Uber loses money on almost every ride. When you’re sitting in the back of an Uber car, you can take pleasure in knowing that the company’s business concept relied on taking money from the rich – the private investors who subsidized the amazing growth of the ride-hailing service – to the unrich, which would be you and me and anyone else who finds the cost of regular licensed taxis excessive.

Uber Technologies Inc. needs to stop subsidizing fares if it’s ever going to make a profit and keep attracting investors. But judging from the company’s initial public offering (IPO) prospectus, published last week, that day isn’t coming any time soon – and may never come. Even Uber admits its operating expenses will “increase significantly in the foreseeable future, and we may not achieve profitability.”

When you consider Uber’s deep losses – past, present and to come – you have to wonder whether the company’s expected equity value is wildly exaggerated. While the prospectus gave no details of the IPO price, the company next month is widely expected to raise US$10-billion, valuing it at about US$100-billion. At that valuation, Uber would be worth more than five times Lyft, its nearest competitor, which began trading on Nasdaq on March 29 (and has drifted south since then, but that’s another story).

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Still, Uber’s IPO will draw scads of tech lovers who are spellbound by its growth story. In their view, Uber is the next Amazon, of the transportation variety. They will be patient as Uber invests many more billions in growth, to the point it will have commanding market shares wherever it operates. Once it sends the competition packing, it can raise prices and the profits will roll in.

It’s a nice fantasy that will forever remain a fantasy. There is no way Uber’s new breed of competitors (Lyft among them) is going to allow it to take full control of big cities. Nor are municipal governments. Some cities are banning or restricting Uber. (In Rome, where I live, only the most expensive Uber services are available – Uber Black, Lux and Van – ones that don’t compete with regular taxis and charge about twice as much as them.)

And if any of these cities develop ride-hailing apps of their own, Uber would be in trouble.

Uber’s proficiency for dumping cheap fares into the market has made it one of the most prolific money losers in tech history as it tried to put regular taxis, which traditionally operated under the licensed “medallion” system, out of business and divert as many commuters as it could from public transportation. In 2018, Uber’s operating losses were US$3-billion, taking its total operating losses over three years to US$10-billion. Its 2018 net income of US$997-million was largely the result of asset sales in Russia and Southeast Asia, as well as gains from its investment in China’s biggest ride-hailing company, Didi Chuxing.

Uber’s new public investors are unlikely to be put off by the horrendous loss figures. Instead, they are dazzled by the growth, and Uber is indeed a phenomenal growth story. Since 2016, revenues have climbed from US$3.8-billion to US$11.3-billion.

But it you dive into the nether regions of the 185-page prospectus, you will find an ominous sign that Uber’s growth, while still strong, might be slowing. Evidence of this comes from what the company calls “core platform adjusted net revenue,” a key metric defined as fares less driver incentives, driver referrals and a few other miscellaneous expenses related to the main business. Between 2016 and 2017, that revenue figure more than doubled. But in 2018, the rise over the previous year was only 39 per cent. In the fourth quarter of 2018, the figure actually fell slightly, to US$2.54-billion, over the third quarter.

Uber has a dilemma. If it raises fares to try to reduce losses, it will forfeit market just as the competition is heating up. But to gain market share, it will have to take heavy losses by keeping fares low, or dropping them further, and giving drivers a bigger cut of the fares to reduce their horrendous attrition rate (most Uber drivers don’t last a year). How long can it afford to sustain these losses? Another way of asking this question is: How many more billions are investors willing to pump into the company?

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Competition is one serious threat. The other is governments, many of which have no love for Uber.

Governments dislike the company because its business model is based on wrecking the monopoly taxi medallion system that allows them to regulate the market. The tens of thousands of Uber drivers in big cities increase traffic congestion. Governments generally think Uber drivers, who are technically freelancers, not employees, are underpaid and lack essential benefits such as pensions and medical insurance. In some countries, Uber faces court challenges over the status of its drivers. If the courts determine that they are proper employees, Uber would face an existential threat. The company essentially admitted that in its prospectus.

Uber can only be profitable if it succeeds in re-creating the very monopolies – the licensed taxi services – it is trying to destroy. But the bigger Uber gets, the more incentive governments will have to hit it with costly regulations. Offering low fares to the masses was a great idea, until it worked so well that Uber lost billions. Now that governments and competitors such as Lyft have Uber in their gunsights, it’s hard to make the case that the company’s equity value is US$100-billion. Or anywhere close to it.

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