I am going to share with you the Uber analysis that I wrote early this summer for my letter to IMA clients. It is still very relevant today, and thankfully some of my conclusions have already came to fruition.
We originally bought Uber stock a few months before the pandemic. I’ve written a lengthy primer on the company (you can read it here). As the great American philosopher Mike Tyson said, “Everyone has a plan until they get punched in the mouth.” Punched in the mouth we were, time and time again. As you can imagine, ownership of Uber has so far come with plenty of volatility (I’ll discuss that further in my writeup).
Earlier in 2022 I wrote about the importance of thoughtful arrogance, especially when one faces tremendous volatility. Our Uber investment required an extra dose of thoughtful arrogance.
Why we bought more Uber shares as the stock fell
Uber is the second most controversial stock we’ve ever owned (first place goes to Softbank). Most people have used Uber’s service, and thus everyone has an opinion and the media loves writing articles about Uber. The company has a history of not making any money. I’ve written a long research piece on why Uber, despite (or maybe because of) being a controversial company, has the makings of being a terrific long-term investment.
The pandemic had a mixed impact on Uber. Its core ridesharing business, which was supposed to turn profitable right before the pandemic, was significantly affected by the virus. The impact was immediate – people stopped traveling and started socially distancing.
But even after the economy reopened and people were willing to take Ubers again, the company did not just snap to profitability; it had to rebuild its driver network. Uber had to pay extra bonuses to drivers, whose pockets had just been stuffed with government stimulus checks, to get them to put their Netflix remote controls down, get off the couch, and start driving again. This was very expensive but necessary – one of Uber’s competitive advantages lies in the depth of its driver network. Without drivers, Uber rideshare has no product. Consumers expect to push the button on their Uber app and get a car in 15 minutes or less. I remember worrying in spring 2021 that Uber would take a conservative stance in bringing their drivers back, in order to preserve cash. Uber did anything but – it showered its drivers with cash, burning billions of dollars in the process. It was the right thing to do. Lyft has been slower to respond and today is still struggling with a driver shortage, where Uber doesn’t have this problem. We are glad that we bet on the right company and the right management.
At this point in time, Uber’s international rideshare business has recovered to the pre-pandemic level, but the US business is lagging behind at 70% of its pre-pandemic highs.
The pandemic was a tremendous help to Uber Eats, which at the time was still a nascent food delivery business. Today Eats generates similar revenues to the rideshare business. During the pandemic Uber Eats was fighting with US competitor Doordash for market share and losing a lot of money in the process, but its profitability turned positive in the latest quarter.
Today, Uber Eats is barely profitable, but management believes this business has the potential to be very profitable, and it is profitable outside of the US. We’ll believe it when we see it. But we think Uber can build a very profitable advertising business on top of this. The Uber Eats app is a giant marketplace for restaurants, where they are competing for consumers’ dollars throughout the day. Just as Amazon is making billions on advertising on its platform, so can Uber. These advertising dollars come with an 80-90% margin, and it takes little effort (cost) to generate them. The bulk of these revenues will fall straight to Uber’s bottom line.
Uber reported a terrific quarter in May. Its revenues and bookings were up 39%. It was the third positive EBITDA quarter in a row. The market yawned at these results and sent the stock down with the rest of the NASDAQ.
A week later, in a memo to Uber employees, CEO Dara Khosrowshahi admitted that the environment has changed – the market doesn’t want EBITDA profitability, it wants cash flows. EBITDA is an acronym; it stands for “earnings before a lot of important stuff,” like interest expense, taxes, depreciation, and amortization.
Dara pointed out in his memo that the company needs to pay attention to costs, to slow down driver incentives, to be more cautious in hiring (he wrote, “working at Uber is a privilege”); and the company needs to learn how to do more with less. In other words, EBITDA and the unlimited funding party are over; investors want the company to show them the money – free cash flows.
(Uber’s EBITDA is about $1 billion greater than the company’s free cash flows. Uber is guiding to be free cash flow positive by the end of 2022. It looks like an achievable goal.)
I feel somewhat conflicted about this memo. I really don’t like it when a company takes cues from the market on what to do. On one side, the company is owned by shareholders, so the management is hired by shareholders, so it should listen to them.
Uber has roughly 2 billion shares outstanding. 35 million Uber shares change hands daily. A simple calculation would show that the Uber shareholder base turns over every 57 trading days. The reality is that maybe 20-40% of shares are owned by long-term shareholders (like us) and the rest of the volume comes from short-term renters who have never opened the company’s annual report and treat the stock as a four-letter trading vehicle.
Uber’s management works for this silent minority that does not vote every day on the stock market with their buys and sells. Those who trade Uber’s shares three times a day, the ones who sent Uber’s stock down, don’t know how to spell EBITDA or care about Uber’s free cash flows.
In Dara’s defense, I think he was reacting not just to the lower stock price but also to the meeting with shareholders he’d had the previous week (with the silent minority). Also, he was right with his message, which applies not only to Uber but to a lot of tech companies. The environment has changed.
Companies are complex organizations that are run not by computer-like superhumans but by regular people who are given as many hours in the day as everyone else. People who, in addition to managing thousands of employees, have families, drive kids to school, fight with their spouses, worry about their careers and retirement, etc. Yes, they may project the confidence of Greek gods; they may be more eloquent speakers, live in bigger houses, drive more luxurious cars than you and I and their poodles may get fancier haircuts; but their world is actually not all that different from ours. They are humans.
These people can only focus on so many things at a time. In a high-growth phase, when capital is abundant for everyone, their focus shifts to growth at any cost. There is a lot of competition for limited talent, and their hiring practices get loose. A lot of exciting ideas land on their desks, which results in too many balls in the air, too many projects with questionable profitability being funded. But more revenue rolls in every day. Capital markets are throwing money at you and everyone is fighting for market share, ignoring the cost.
I run a much smaller company, but I observed this in my own behavior a few years ago. As our growth accelerated, I found that I started paying less attention to our cost structure; I started working ungodly hours; I made questionable hiring decisions (which I have since resolved). I can only do so many things well. I have learned since to put many projects in the future pile, realizing that my team and I can only have so many balls in the air before we start dropping them.
Similar dynamics happen to executives of larger companies, just on a grander scale with more external pressure and more constituents to deal with.
Low interest rates are very stimulative to investors’ imagination. Low interest rates love the promised land, far far away. Nothing brings this imagination back to mother earth like rising interest rates. Uber and the rest of Silicon Valley have entered into “show me the (free cash flow) money” land. I would not be surprised if we started seeing minor layoffs coming from Uber as it rationalizes some of its pie in the sky projects and focuses on doing more with less.
This is great news for shareholders, not so good news for tech workers who got used to the idea of making three hundred thousand dollars a few years after college, and not so good for the Silicon Valley housing market.
Let me explain why we are not swayed by the recent decline in Uber’s stock price but actually welcomed it and bought more shares.
Uber is a dominant global business with a significant growth runway and an insurmountable competitive advantage. The rideshare and eats businesses still have a tiny share of the potential market and will be growing at a high rate for a long, long time (especially the rideshare business).
Uber’s competitive advantage comes from several sources:
Today a consumer pulls up an Uber app, taps a button, and a car shows up in 15 minutes or less. This two-sided network of consumers and drivers is incredibly difficult to build and disrupt.
Uber has the largest global platform. It is in 10,000 cities in 71 countries; thus it can spread its R&D across a large revenue base. Being in different markets allows the company to tinker with different business models and adapt what it learns in one market to others. For instance, in Japan Uber doesn’t have its own drivers but the service is used to hail taxis. In 2022 Uber announced that by 2025 it will do the unthinkable; it will bring taxis onto its app in all of its markets. Taxi drivers love this, because how much they make per ride will not change, but they’ll spend a lot less time driving without passengers. The user experience will not change, except that when you order a car, instead of a Toyota Corolla you’ll get picked by a taxi. Uber’s profit per ride will remain the same, but it will double the supply side of drivers in its network in 3 years.
On the last earnings call, Uber also announced that it will start pricing rides based not on miles traveled but on the attractiveness of the trip for the driver. For instance, when a driver drops off passenger at the airport, he can get pick up another passenger in a matter of minutes. Thus, he won’t be driving back empty. This ride is more attractive and will be priced on a lower per-mile basis. However, if the passenger is going to the outskirts of a city, where the driver would have to drive back for half an hour without a passenger, this ride will be more expensive on a per-mile basis, compensating the driver for lower utilization. This is a very difficult math and data problem that requires a tremendous amount of R&D effort. Uber can solve it for the US market and apply the algorithm to the rest of the world. Its competitors may not have the ability to do this.
Being in different markets also diversifies Uber’s regulatory and competitive risks. If a competitor in one market starts a price war, Uber can successfully wage this fight with other markets subsidizing the at-war market.
Uber is synonymous with rideshare. Uber is not the company that invented the rideshare business model – that was created by a company called Sidecar, which borrowed the concept from a nonprofit company called Homobile, which provided rideshare services for that LGBTQ community in San Francisco. Both Homobile and Sidecar are lost as footnotes in the history books. Uber is the app most people think of when they… actually, Uber is trying to expand what people think about when they think of Uber. Today in some markets you can order a ride, food, alcohol, and groceries; send a package across town; rent a car from other private owners and rent-a-car companies; and even buy bus tickets.
Providing all these services helps to increase drivers’ earnings, as they drive people in the morning and evening and deliver food, packages, and groceries in between. Uber is achieving this by developing a super app – one app for everything. Super apps are very popular in China.
This brings us to another important advantage: UberOne, Uber’s version of Amazon Prime – you pay $9.99 a month or $99 a year and you get discounts across all of Uber’s offerings. Per Uber management, UberOne’s users spend 2.7 times more than an average user of Uber. Amazon trained us to default to its website when we need to buy something. We stopped comparison shopping (especially for low-ticket items) and now we just hop on Amazon and buy. Uber’s goal is to create a similar muscle memory with Uber customers, and UberOne may lead us there.
Uber competitors are coming out with their versions of loyalty products. This is good for the industry overall, as it will cement market shares and stop price wars.
To value a company, it needs to have earnings (free cash flow). This means that the company will stop relying on the kindness of strangers – capital markets. Very good news. But this doesn’t mean that the company is worth much above zero. Uber will be free cash flow breakeven by the end of 2022. Uber’s significant earnings (free cash flow) power doesn’t lie that far in the future.
Unlike a traditional digital business, Uber lives in both the analog (real) world and the digital one. The analog business (recruiting and supporting drivers) brings a higher fixed-cost structure, and this is why, till this day, Uber has been losing money.
Our analytical model is very simple: Today Uber is at scale, and so 40-60 cents of every incremental revenue dollar fall directly to Uber’s bottom line. Thus, Uber’s profitability will grow not at a linear but at an exponential rate. Wall Street estimates that Uber will generate $7 billion of free cash flows in 2026 (or about $3.50 per share). Our own estimates are not much different, though Dara’s focus on “showing the money” may lead to achieving this number sooner.
Uber owns a chunk of China’s Didi and other rideshare businesses, which a few months were worth as much as $7 per share.
We find ourselves in the somewhat uncomfortable place of not knowing how much Uber stock is worth. But, we know it is worth a lot more than the current price. Uber has a lot of optionality that lies in the future. For instance, grocery and alcohol delivery are in a nascent state which may turn into real businesses. Uber Freight has the potential to become a larger business than rideshare and food delivery combined. Freight shipping (think of all those semi-trucks you see out on the interstate) is a very fragmented market that is mostly operated with technological efficiencies from the 1970s. Uber has a good shot at transforming and dominating this market. This business broke even last quarter and has about $600 million of revenues.
A client asked about the risk of investing in autonomous driving. I spent a lot of time thinking about autonomous when I researched Tesla (we’d be delighted to mail you my Tesla book). It will be a long time before it becomes ubiquitous. The technology is not ready for prime time unless the weather is perfect (God forbid it rains or snows) and the car operates in a very discrete environment (within a few city blocks).
We still need to develop a legal framework to answer a simple question: Who is responsible for an accident caused by an autonomous vehicle? But let’s say autonomous cars hit the market tomorrow. There are 150 million cars on the road in the US today. You’ll need to have millions of auto-cars on the road to be a threat to Uber. Remember, the key to a successful rideshare business is the car showing up in less than 15 minutes after you request it. It would take a long time to build an autonomous fleet. The most likely scenario is that autonomous cars will join Uber’s platform as another, likely cheaper, service for brave souls.
We look at a portfolio as a portfolio. I know, this is the tritest sentence ever written. But it is important to remember that value comes in different shapes and sizes. Our goal is to build a diversified portfolio of high-quality, undervalued businesses. For a lot of stocks we own, value stares you in the face in the form of the earnings that are right in front of you. In fact, that is the case with almost all the stocks we own. Uber requires us to look a bit further, as its earnings power will be unveiled by revenue growth and time. In the context of the portfolio, Uber makes a lot of sense; and over the years, as the company shows us the money, it will look like a perfect fit in our portfolio; but at that point the stock price will, hopefully, be a lot higher.