Capital markets are supposedly full of brilliant people doing brilliant things. You have to wonder, though. Sometimes the best financial minds of our generation look an awful lot like the folks who once bought Abdomenizers on the Shopping Channel.
Consider, for example, how venture capitalists have swooned over Uber, the car-hire company that was supposed to make kajillions by disrupting the taxi business. Investors have poured roughly US$24-billion into the private company since it was founded a decade ago. So far, though, the kajillions in profit are nowhere to be seen.
Instead, Uber is bleeding hundreds of millions of dollars a year in losses.
Many of us might regard this as a slight problem. But venture capitalists see things differently. When Uber goes public at some point this year, it is likely to be valued at US$100-billion or more.
Why would investors pay through the nose for the privilege of owning a stake in a business that has lost staggering amounts of money for years? That's an excellent question. It has a lot to do with the notion that attracting customers matters more than making short-term profits.
Eventually, you will find some way to turn their loyalty into earnings.
Maybe so. Amazon and Netflix have demonstrated that companies can become enormously valuable by ignoring profits in the short term or even in the medium term.
Instead of focusing on the gritty business of churning out the biggest possible earnings, these giants have plowed cash back into their enterprises for decades to make them bigger and better. Their goal has been to build near-monopoly positions in their chosen markets and reap profits.
But what happens if the future doesn't work out quite as neatly as Silicon Valley imagines? Many of today's hottest tech plays would have a tough time living up to their inflated share prices.
Blame it on too much long-term thinking. Critics often lambaste investors for their obsession with quarterly results. Yet the opposite can also be the case. Many of the people hunting for the next great digital disrupter are focusing only on the long haul. Maybe, just maybe, these far-sighted optimists are being too indulgent with sexy multidecade monopoly plays that have mundane prospects for profitability.
To be sure, Amazon looks like it has built an impregnable, if not hugely profitable, position in retailing. Netflix, though, is a dicier prospect. It faces stiff competition from longtime rival HBO, as well as newer streaming services being rolled out by Apple, Disney and, yes, Amazon. It's not clear how you build a monopoly position in a business where people can switch among competitors with relative ease.
Uber should fuel even more skepticism.
It is being touted as a fast-growing success story, but one that is based only on its galloping growth in revenue. Take a gander at its entire income statement, and a different story emerges. The company is simply proving it is possible to buy a large amount of market share if you're prepared to endure staggering losses year after year.
In its most recent quarter, the company lost US$865-million. This was hailed as a victory because it was down from US$1.1-billion in the same quarter a year earlier.
Talk about a reality distortion field: What counts as success for a tech upstart looks an awful lot like failure anywhere else.
Investors are assuming Uber will one day be able to stop spending so much on expansion and reap a steady stream of lush profits. This looks hopeful. The company is already having to reduce its “take rate” from drivers in many markets to keep them loyal. Meanwhile, it faces growing competition from Lyft, DoorDash and others.
A regulatory backlash is also building.
One remarkable aspect of Uber's rise over the past decade is that it has lost so much money while driving down drivers' wages and playing fast and loose with regulators. Now the jig is up. Many cities want to force Uber to pay drivers decent wages, with reasonable benefits. They also want stricter controls on who drives for the company.
The going for Uber will only get tougher from here. No doubt it can squeeze out some profitable quarters by temporarily curtailing its spending, but eventually it has to confront the reality that it is difficult to pay drivers reasonable compensation while still undercutting traditional car-hire services. Taxis and food delivery services were never regarded as particularly profitable businesses. It’s not clear that adding a level of technology improves the picture.
Could my Uber skepticism be wrong? Maybe. Facebook proves that tech companies can sometimes grow profits rapidly if investors demand it. But Facebook has no equivalent to Uber’s drivers – independent suppliers who must be kept satisfied lest they defect to a competitor. When it comes to Uber, I’m proud to say I’m a short-term investor, and I don’t like what the short term is saying.