🔒 WORLDVIEW: Uber IPO suggests ride hailing is a rubbish business

By Felicity Duncan 

Uber was supposed to be the IPO of the century. At the end of last year, talking heads were confidently predicting it would list at $48-$50 a share, with a valuation of between $90 and $100bn.

But by the time the IPO officially priced, it was down to $45 a share, for a valuation of $82bn. After a couple of brutal days on the stock market, the company was down to just under $40 a share – and that’s after the stock recovered from its Tuesday low of $36.
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This performance closely resembles that of fellow ride hailing firm Lyft, which priced its IPO at $72 a share and is now trading at about $50. Clearly, the IPO market is having a hard time pricing ride hailing companies correctly. Even investors desperate for yield and growth after 10 years of ultra-low interest rates are having their doubts.

What is Uber worth?

Uber’s management has suggested that a reasonable valuation for the company would be around $120bn. That’s astonishing for a company has been in operation for ten years and, in that time, has burned through billions of dollars without ever threatening to turn a profit.

Now, I know that many people confidently believe that one day Uber will replace all existing forms of transport – personal cars, trains, buses, bicycles, and walking – and that when that happens, Uber will be disgustingly profitable. There are also many who believe that fully autonomous cars are right around the corner and that when they’re deployed, the company will rake in the cash.

But if the tepid IPO teaches us anything, it’s that not everyone buys this story – and I’m one of those who think it’s mostly smoke and mirrors.

Because here’s the thing: Uber is not a tech company. It’s a cab company with an app.

In most tech businesses, there are two things that work to make them immensely profitable. First, they have very potent economies of scale – once their infrastructure is in place, adding more users and having users use their service more intensively costs almost nothing (think Facebook, Google). Second, they have potent network effects – the more people use them, the more valuable they become to the people who use them (again, think Facebook’s social platform or Google’s learning-based search engine).

Neither of these things applies to Uber. Uber loses money with every ride anyone takes. That’s primarily because car rides do not get cheaper the more of them you take. They cost pretty much the same each time. There’s the cost of the driver, the petrol, the wear-and-tear on the car, and then the special costs that apply to taxi rides (no guarantee that you’ll pick someone up on the way back from wherever you drop your punter off, for example, meaning you only get paid for 50% of the drive you have to take). Uber doesn’t reduce any of these costs. In fact, because each Uber driver runs and maintains their own car, Uber rides actually cost more than a traditional taxi ride.

Think about it. A traditional taxi company has a fleet of cars. It buys them in bulk and gets them maintained in bulk, which saves money. It also runs them pretty much 24/7, getting the maximum bang for its buck.

In contrast, each Uber driver pays for the cost of car maintenance themselves, so it’s more expensive because there’s no economy of scale. That money has to come from somewhere, and for Uber, it mostly comes in the form of higher driver compensation.

Read also: Is Uber finally turning into a real business?

In most jurisdictions, the company has to pay its drivers more per ride than other taxi companies, because the drivers are paying for pricier maintenance. For a while, some drivers are dumb enough to subsidise Uber’s capital costs. But those are mostly casual drivers who do a few rides now and then. Since Uber wants to be always on and ultra-convenient, it needs a lot of drivers. To encourage people to sit around aimlessly waiting for rides and to spend a fortune on car maintenance, it must pay them quite a lot. Uber doesn’t make driving other people around cheaper – it makes it more expensive.

To get around this, Uber has been subsidising rides with investors’ money – that’s what it means when we say Uber loses money with each ride. Uber rides are only able to compete with other forms of transport because private equity investors are paying a big chunk of the costs.

There’s also no network effect at play. It doesn’t matter if my friends also use Uber. The service doesn’t get more valuable to passengers the more people use it – it just gets slower and more crowded. It doesn’t even get more valuable for drivers when more drivers use it. In fact, when too many drivers are working, it actually gets less valuable, because it’s harder for drivers to pick up fares.

The only thing Uber brings to the table is a cool app. And that’s not exactly rocket science. Anyone can, and has, made apps that are just as good. Uber has not made personal transportation cheaper. It’s just added a new way to call a cab.

Beyond the fundamentals of the transport business, another weakness of Uber is that it doesn’t have any moat against competitors. There’s no advantage to using one app over another. That’s why different apps dominate in different countries and cities. They’re all equally good. It’s also why old-fashioned taxi companies were usually based in a single city. There’s no special advantage to operating taxis in multiple cities – no cost-cutting, no network effect.

Now, Uber fans will point out that the company is in other markets, like food delivery. But Uber doesn’t make any profits in those markets either, which is not surprising. While Uber has to split revenue with drivers for passenger transport, it has to split revenue with drivers and restaurants in the food delivery business. Same problem, but more so.

But what about autonomous cars, you may ask. Well, Elon Musk’s compulsive optimism aside, that’s probably not going to happen for a while. Like, 20 years or so. And it’s not as if Uber is the market leader here – that honour goes to Google’s Waymo and a handful of automakers like GM. There’s absolutely no reason those companies couldn’t just put together an app – which will take them about 10 minutes, 5 for Google – and crush Uber once their autonomous cars are good to go.

The bottom line is that this is a loss-making company with no clear plans for profitability. Its unaudited Q1 results showed that it lost between $1 billion and $1.11bn and its quarter-on-quarter revenue growth slowed to 5%. Its best bet was that its “core platform contribution margin” – a made-up number that ignores a bunch of its costs, which Uber says offers a “real” picture of the company – will be between -4% and -7% in the foreseeable future.

There’s a reason Uber won the title of fifth-worst performing IPO in recent US history.