• Investors are paying a premium for disruption when they invest in Uber
• The decline in value after the IPO means the company has left no money on the table
• Uber is betting on a vision of the future, with focus on shared and on-demand services
• Uber labels themselves as a “personal mobility business” in an attempt to create a big market story and it will pay off
• There are ways to get exposure to Uber without investing directly in Uber stock.

Everyone has their own opinion on Uber and the other 2019 IPOs. Lyft went public back in late March, and the stock has plummeted 46.5% from all-time highs. Uber went public at $45 per share on May 9th at a market cap of $75.5B, which was far below the initial $120B prior valuation.

Since then, Uber’s performance has made headlines. The stock has tanked, and a lot of investors are understandably unhappy with the performance of the company. But this flop is actually a good thing. Uber left no money on the table in their IPO. This initial underperformance isn’t pretty, but Uber has strong fundamentals, a good business plan, and is evolving into a super app, a trend that will serve them well into the future.

The Ridesharing Market: Strong Growth Both Domestic and Abroad

The market that the two companies are in is expected to grow quickly, with number of trips and total market size increasing four-fold and three-fold, respectively. Competition is fierce in the space, especially abroad.

According to the Uber’s S1, they are prevented from competing with their minority-owned affiliates abroad, including China and Southeast Asia until 2023 and Russia until 2025. Both Didi, based out of China, and Yandex Taxi, based out of Russia, have no restrictions on competing with Uber.

However, 74% of all Uber trips were outside of the United States for Q4 2018, and they currently operate in 63 different countries. The company has a strong reliance on metropolitan area revenues, with 24% gross booking concentration in Los Angeles, New York City, San Francisco, London, and Sao Paulo. 15% of gross bookings are airport transportation, to and from.

Lyft has remained focused on the US and Canada but Uber has elected to venture abroad, getting destroyed by Didi in China. In India, the company faces competition from Ola, with both companies burning through cash in an attempt to gain market share. In the graph below, their fastest growing market is in Latin America, especially Brazil, but they face competition from Didi there as well. Domestically, Lyft is closing the gap, gaining 3% market share on Uber into Q1 2019.

The Nosedive: Why The Company Underperformed

Uber had a tough Q4 2018, primarily because of this increase in competition. Revenues compressed across the board, with Uber Eats declining 13.6% quarter over quarter, and ridesharing declining 0.8%.

In 2018, their average contribution margin, profit as a percentage of revenue, was 12.75%, which was a stellar increase from 2017’s average margin of -0.5%. It went negative again in the last quarter of 2018, where it is expected to stay due to “competition and investment to expand Uber Eats“.

When they expand to new cities, they have to make substantial investments, which compresses their revenue. As their gross bookings increase $10, they actually post a net loss of $1, because they have to provide more incentives in that new city to build out a new network of drivers.

If there are no driver incentives, the company makes ~20% on each ride. In the early years, new drivers got bonuses between $2,000 and $5,000 for completing a few rides with the app. However, at almost 4M drivers, such bonuses are no longer feasible, especially as the company adds ~450k new drivers every month, and the average driver costs ~$650 to acquire.

Factoring in gross booking of $3.4B, of which Uber profits $900M, the company makes ~$230 per driver. They lose about 33% of their drivers every three months, at a 12.5% monthly churn rate. Those three months are what it takes for them to earn back what it cost to acquire that driver in the first place. The company barely has time to recoup the cost of acquiring the driver before the driver leaves. That will be something they need to improve in the future, especially if they want to become profitable.

When the data are broken down per rider, it is a pretty strong growth story. They had 91M monthly riders, and 5.2B rides. They’ve been able to build out their net revenue per rider, but the annual gross billings per trip has declined. That could mean that their international expansion could be working against them, as rides abroad tend to be less expensive.

The cost of acquiring new users has increased, meaning the overall industry has gotten more competitive. However, when compared to the cost of acquiring drivers, it doesn’t cost much to acquire customers, especially as the app continues to grow in popularity. Network effects are strong for the company, and most people learn about it through a friend.

Their ride-hailing business generated $9.2B in revenue in 2018, which was a 33% increase from 2017. However, that was a large compression from the 95% growth into 2017 from 2016. This makes sense as the company becomes more mature as capturing each additional segment of the market will become more and more expensive, and growth will be slower and slower.

Why Uber Eats Really Matters for Growth

But Uber is not just a ride sharing platform. The combination of Uber Eats and Ridesharing gives Uber a unique position in the industry. They get exposure to both types of geographies, with ridesharing more popular in large, metropolitan areas, whereas Uber Eats is more popular in “smaller, more suburban or rural areas” according to Janelle Sallenave, the head of Uber Eats.

Their food delivery business was valued around $20B at the end of 2018, with estimates to generate $1B in revenue for 2019. But the space is extremely competitive, with rivals like Grubhub, Caviar, DoorDash, Postmates, and Amazon.

Grubhub controlled half of the food delivery market in 2016, a metric that dropped to 34% in 2018. Grubhub has been profitable since 2011, so there is an opportunity to actually make money in this industry. Uber Eats is gaining share, growing from 3% in 2016 to 24% in 2018, the fastest growing out of all the competition.

Uber has huge opportunity here. 40% of users who used Eats had never used Uber before, meaning that they could potentially become ridesharing customers on top of Eats customers, driving overall platform growth. They also have the opportunity to build out a last-mile delivery network, taking grocery stores as well as restaurants entirely digital.

The Growth of Virtual Restaurants: Keep it Digital

Uber Eats is running virtual restaurants or “cloud kitchens”, which are brands that exist only in Uber’s app, giving it an air of exclusivity. The products are delivery-only, and it’s no up-front investment from the restaurants, according to Elyse Propis, an Uber Eats program manager.

The company pulls search data, seeing what people are looking for in the surrounding areas. That gives the company the opportunity to offer that food, sometimes at a lower price point than the nearest competition. It’s food arbitrage.

“How do we use the data that we have to allow our restaurateurs to utilize the spare kitchen capacity that they already have?”

Source: Jason Droege, head of UberEverything

It’s a inexpensive opportunity for the restaurants to expand upon too. There’s no cost outside of the ingredients, because there is no restaurant lease to take on. The main focus is on developing products and analyzing customer data to determine what people really want.

It’s been successful. Brooklyn Burger Factory saw a 28x revenue increase due to their cloud kitchen, and MIA Wings, operated out of Venezia Pizza and Lounge, has increased their restaurant revenue by 80%.

Uber concentrates demand and orders through time-gated discounts, allowing the company to batch orders, assigning one driver to pick up several orders at once. That allows for cost savings, while keeping quality intact.

Uber Eats claims to cover 70% of the US population, and 85% of the urban US population. But the total US market is relatively untapped, generating $19B in revenue currently, but only with a 32.1% penetration rate. That leaves plenty of room for expansion.

The growth can come from a combination of things. Transparency is high in food delivery, as customers can track their orders, communicate with the restaurant, get refunds, and rate and review, all within the app. Also, in the US, there is a culture that celebrates convenience, preferring to order on Amazon, watch Netflix, and date online.

All that translates well into the success of food delivery services. Morgan Stanley estimates that 40% of restaurant sales, totaling $220B, could be through food delivery by 2020, which is a 7.3x increase from current sales numbers of $30B. Restaurants are embracing the concept too, with more than 90% of public restaurant companies open to food delivery services.

Uber Eats delivers $22 in gross bookings for each order, which is substantially more compared to the $10 of gross bookings for each ride share. 61% of that goes to the restaurant, and 27% goes to the driver, leaving Uber with approximately 11.36% margins after everything is calculated out.

Uber Eats increased 86.6% year over year, and 20.8% quarter over quarter into Q1 2019. Bookings increased by 107.4% and 19.3% year over year and quarter over quarter. Those metrics are actually a compression from their previous growth numbers, with the company posting ~30% growth in revenue for Uber Eats over the past several quarters. This 13.6% slump was primarily because Uber has spent more on financial incentives for drivers, and has posted more delivery deals with bigger restaurant chains. The costs of acquiring riders and partners are high.

They expanded by over 300 cities in 2018, growing by 220 cities in Q4 2018 alone. That type of growth does not come without cost, and it takes a while for those new cities to become profitable. Approximately 150-180 cities were profitable by FY2018, according to calculations from Turner Novak. As UberEats stabilizes in terms of growth, more cities will become profitable, which will improve the stability and profitability of the company itself.

Other Bets: The Growth of Autonomous Vehicles and Micromobility

Food delivery will be transformed by the age of autonomous vehicles. Removing labor costs will make the entire process less expensive, and speed, quality and consistency should theoretically improve as the process from restaurant to consumer is streamlined.

Uber has spent a lot of time discussing autonomous driving opportunities, specifically concentrated in their Advanced Technologies Group (ATG). They hope to add autonomous vehicles, delivery drones, and vertical takeoff and landing vehicles to their network, as well as dockless e-bikes and e-scooters.

But the autonomous vehicle space is quickly growing crowded. Cruise, a company mostly owned by General Motors, has raised $7.25B over the past year at a $19B valuation, primarily from T Rowe Price, Honda, GM, and Softbank Vision Fund. They haven’t sold a single car.

Argo AI, funded by Ford and Volkswagen, is t a $4B valuation. Uber’s ATG is at a $7.3B valuation. Nuro, a robotic delivery startup sits at a $2.7B valuation, and Aurora, funded by Amazon, is valued at $2B. Tesla plans to raise $2.7B, with plans to release “fully functioning self-driving software by 2020.” Finally, Waymo, a Google Spinoff, is spending billions of dollars per year to develop AVs.

Uber received a $1B influx from a group led by Toyota into their self-driving car research unit, with Toyota committing to pay $300M per year into R&D for the next 3 years. Their ATG unit cost $457M in R&D expenses in 2018, which was up 19.01% from $384M in 2017. The unit loses anywhere from $1M to $2M a day.

They have a fleet of 250 vehicles, which have driven “millions of testing miles and have completed tens of thousands of passenger trips”, according to the company’s prospectus. The company has faced scandal for their AV work in the past, with one of their vehicles striking and killing a pedestrian in Arizona last year.

According to the company’s new safeguards, training programs will be implemented to focus on monitoring systems and safer driving, as well as employing mission specialists to drive the autonomous vehicles. If Uber can somehow manage to truly get their ATG off the ground, removing the need for drivers, they could keep 75% more of the total fare, which would be a good way to improve their overall profitability.

Concentration on Micromobility: Higher Margins Through Shorter Trips

The company will more than likely focus on micromobility in the future as well, continuing to build out their dockless e-bikes and scooter line up. Right now, the company estimates that 46% of trips are under 3 miles, giving them the opportunity to build out into “new mobility”. This also eliminates the need for drivers on some of the shorter, less profitable trips, and can bring about higher margins.

It’s about creating a cheaper form of transportation for users. Jump, the dockless bicycle startup they acquired last year, is a great example of this. 30-40% of San Francisco trips are less than 2.6 miles, and Jump allows the users to utilize a cheaper form of transportation, while still remaining within the Uber ecosystem. Right now, the conversion rate from car to e-bike is 15% in San Francisco, so they have plenty of opportunity to expand, as regulations allow.

Is This 1999? Unprofitable Companies Go Public

Despite Uber Eats, ATG, ridesharing, and micromobility, Uber still does not make any money. In 2018, more than 80% of US companies were unprofitable in the 12 months prior to their IPO. That’s almost at the level of the dotcom bubble. People are willing to pay for disruptors, or for companies that appear to have “long-term future expansion” opportunities, believing that “the companies’ future profits will eclipse these current losses”.

Uber’s CEO sent an email to employees on May 13th, stating “Obviously our stock did not trade as well as we had hoped post-IPO… remember that the Facebook and Amazon post-IPO trading was incredibly difficult for those companies… We will be judged by our long term performance”. Read the whole letter here.

Uber is using their IPO to achieve profitability and gain capital. Uber did not leave any money on the table in their IPO, and they captured all available money in the market. Also, their offering week was a relatively rough week for all stocks, Uber included, primarily because of further trade disputes.

A good quote by Luke Stein states “winning the IPO game is not equal to winning the game“. There’s a lot more that comes after the first few trading days. In fact, this underperformance might be better in the long run. The investment game is longer than just a few days. But it’s still ugly. No one likes to lose money. A lot of people have a lot of skin in the Uber game, and daily trading declines are not what they want to see.

But it’s tough. No one likes to lose money. A lot of people have a lot of skin in the Uber game, and daily trading declines are not what they want to see. Morgan Stanley, especially.

Morgan Stanley: New Riders LP

Some of the bankers involved in Uber’s IPO executed a naked short, providing extra support for the stock in the face of downward pressure. Right now, 11.51% of its float is held by short sellers, with short interest totaling $768M on its third day of trading. This is less than Lyft’s short interest of $1.07B, representing 59.96% of its float, but it’s still ugly.

Morgan Stanley provided exposure to Uber for their wealth management clients for $48.77 a share, at a minimum investment of $250k and a $62.5B company valuation. The stock traded at $37.10 3 days after its IPO opened at $42. The clients have to hold the shares for 180 days after the offering as part of the New Riders LP agreement.

If the stock doesn’t get back up to above $48, Morgan Stanley will have a lot of angry clients on the phone. Morgan Stanley is also under fire for overpricing the company at a valuation of $120B last year, especially compared to the IPO valuation of $75B, a 60% difference. However, the company has experience in dealing with angry clients and IPOs that underperformed, such as Facebook. Uber might not be the same success story as Facebook, which has returned almost 500% since its IPO, but they have the fundamentals to deliver positive returns in the coming months.

The Creation of a Super App

Uber is a platform. They are not a ride sharing company. They are not a food delivery company. And they are not a freight company.

They are a combination of all three, and more. The company is able to leverage the data that they have on consumers to attract more, and to figure out what the customer actually wants. The value of good data analysis is priceless in the age of everything, and that’s what Uber offers investors.

They are willing to expand into being more than a one-trick pony. They are willing to overstep market boundaries, lose money, and insert themselves into an industry, and fundamentally disrupt it. Their focus on continuing to build out verticals will lead to their eventual success.

What investors have to ask at this point is if they want to invest in a company that doesn’t make money? Is the path to profitability worth it, or believable at all? The company is trying to make it so it is, combining cross-product rewards and subscriptions to “increase the barrier to entry and increase customer spend / stickiness as it adds products.” Basically, it creates an entire Uber ecosystem, where customers can theoretically access all the tools and services that they might need.

The company will have to dampen out driver churn, as only 20% of drivers remain on the platform after one year. It costs money to acquire new drivers and provide them incentives, totaling approximately $427M in cost. But that’s the point of Uber Eats and other bets. It gives the drivers an opportunity to stay utilized, and provide alternative opportunities for work and keep them within the Uber platform.

Uber is not without controversy. Within the past two years, they’ve had sexual harassment scandals, intellectual property problems, and problems with governments, just to name a few. But as a company, and as a platform, they look promising.

The Catch-22: Recessionary Exposure

Uber is in a unique position if a Recession happens. The company is inherently exposed to revenue fluctuations due to a compression in discretionary spending during times of economic decline. People would choose cheaper ride-share options, and are less likely to use a tool such as Uber Eats. But if the economy improves substantially, then the company might lose some of the drivers to alternative work opportunities.

The big question that investors need to ask when they consider Uber’s risk of a fallout in a recession is how inelastic ridesharing services are considered to be. Is this something that people will continue to do in the face of an economic slowdown? Will there be more drivers than riders? Will rates have to be slashed to zero-margin?

Their success will be dependent on consumer tastes and the amount of the market that they have been able to capture. Only time will tell.

Conclusion:

It’s tough to value Uber. Aswath Damodaran, a professor at NYU, has done an excellent job at looking at different methods to value the company. Based on the company metrics available, Uber can be valued anywhere between $39.89, based on number of cities, to $105.61, based on number of rides.

Trefis has a similar forecast, using monthly active riders, number of rides per user, gross revenue per ride, and net revenues. They value the company around ~$75.8B, which works out to be around $45 per share based on the 1.68B shares outstanding.

To see my full analysis of the IPO ETF and Uber, check out my full article on Seeking Alpha.

Disclaimer: These views are not investment advice, and should not be interpreted as such. These views are my own, and do not represent my employer. Trading has risk. Big risk. Make sure that you can balance your risk/reward, and trade small, and trade often.