Is Uber Finally Turning The Corner?

Uber held its second-quarter 2021 earnings call last week, and to hear CEO Dara Khosrowshahi’s preternaturally optimistic assessment, some investors may wonder why the company’s stock has been performing so poorly of late. Over the past six months, Uber’s stock price has sagged 20% while the S&P 500 index grew 14%. But given Uber’s woeful track record, the more relevant question investors should be asking is why Uber remains as highly valued as it is, even at its current depressed levels.

For context, it’s important to remember that Uber has lost more money faster than any startup in history, and the company’s Q2 2021 earnings report only added to this dubious distinction. There are three reasons for Uber’s epic and continuing losses, and there’s little Dara Khosrowshahi (DK) can do about two of them.

First urban mobility and delivery are intrinsically tough businesses to be in if your goal is to make money. On the mobility front, ridehail players are competing against public transport providers, who by design lose money in every major metro area in the world. Cities choose to subsidize money-losing operations (e.g. 24-hour transit service in NYC and low-density money-losing bus routes in most urban/suburban areas) because transportation systems serve as the lifeblood of a city’s economy, vitality, and social welfare. As such, governments can tax the positive externalities associated with enhanced mobility (e.g. greater access to high-paying jobs, more revenue for downtown shops and restaurants, etc.) to offset transit subsidies. In contrast, not only can’t Uber or its peers benefit from the positive externalities they create (e.g. the Friday night bar scene), but they are increasingly facing penalties for their negative externalities (e.g. congestion, pollution, accidents). As such, ridehail providers will always be disadvantaged competing against money-losing public transportation and the watchdog governments that operate them.

As for taxis, that business has never been profitable when allowed to operate in largely unregulated markets, because of extremely low barriers to entry and intrinsically undifferentiated service. It is ironic that Uber has consistently opposed legislation that would cap rideshare supply in major cities, when in fact unregulated taxi markets almost guarantee low corporate profitability, skimpy driver compensation, and lax safety oversight.

The second intractable reason for Uber’s riches to rags performance is that the six key assumptions that shaped Uber’s strategy, first advanced by founder Travis Kalanick (and now fully embraced by his successor) have proven to be demonstrably false.

1. Uber’s asset-light business model and strong network effects will yield huge economies of scale and an unassailable first-mover advantage in each of the markets it enters.
2. Uber’s prodigious fundraising will give it ample reserves to drive competition from the market and establish global monopoly control and pricing power
3. Uber’s scale advantage and sophisticated AI algorithms will power a superior service, translating into shorter wait times for passengers and drivers, and improved driver productivity, which in turn will allow Uber to achieve the trifecta of low fares, attractive driver compensation, and corporate profitability.
4. With consumers on its side, municipal governments will be unwilling or unable to restrict its ever-expanding operations, even after recognizing that Uber’s business priorities conflict with public policy goals for sustainable, efficient modes of public transportation and adequate compensation for a large and growing sector of city employment.
5. Product line extensions making Uber “the Amazon of transportation” will provide profitable growth opportunities to offset lingering losses in the core ridesharing business
6. Over the longer term, the combination of available funds from capital markets and retained corporate earnings will fund a seamless transition to autonomous vehicle operations, promising an even more utopian future.

By the time Dara Khosrowshahi succeeded Kalanick in 2017, Uber’s first five strategic assumptions had already proved demonstratively false, while the last remains highly doubtful at anything like Uber’s current valuation. For all his promises of turning over a new leaf for a better performing Uber 2.0, DK continues to embrace the strategy of a company with a cripplingly weak Uber 1.0 economics, burdened by:

• Largely undifferentiated service
• Relatively low customer and driver loyalty
• Limited economies of scale, yielding stubbornly high costs of revenue and marketing
• Much lower gross margins than other tech industry superstars (e.g. Google, Facebook).
• Weak network effects, given highly localized operating territories and extensive multi-homing by both riders and drivers
• Relentless price competition to attract riders and diners
• Perennial need for sizable incentive/bonus payments to recruit and retain drivers, couriers, and merchants, given chronic widespread dissatisfaction with compensation and fees
• Abundant access to capital, sustaining resilient competitors in all of Uber’s major markets for core platform services
• Growing scalability constraints in major metro areas — bounded by limits on road capacity and driver supply
• Growing global regulations targeting Uber’s negative externalities (congestion, emissions, public safety), and improving compensation and benefits for a growing body of city workforces.

Given these structural business weaknesses, it is not surprising that Uber’s search for profitability has proven to be a Sisyphean quest, or that none of the other major ridehail providers has achieved consistent GAAP profitability, including Didi Chuxing who enjoys a 92% share of the largest ridehail market in the world.

Uber’s profit challenge is even greater in last-mile delivery, where all major providers (except Meituan, whose business circumstances in China are unique) remain deeply unprofitable, despite significant industry consolidation and unimaginably favorable if tragic pandemic market conditions. When even Amazon has chosen to shutter its unprofitable restaurant delivery business after four years of futile, money-losing effort, prudent investors should be asking tough questions that Uber has yet to adequately answer.

DK does deserve credit for reining in the company’s reckless past spending and bloated costs — the third factor contributing to Uber’s epic losses. Since taking the helm, DK has sold Uber’s autonomous vehicle research and urban air vehicle businesses, retreated from more than ten hopelessly unprofitable ridehail and delivery markets in Southeast Asia, India, and Europe, and laid off 25% of Uber’s workforce (early-pandemic).

Yet even with long-overdue cost-cutting, Uber’s 1H 2021 operating loss was -$5.6 billion while burning through yet another ~$1 billion in cash. Granted, the pandemic has ravaged Uber’s core ridehail business, but Uber and its peers were deeply unprofitable long before the pandemic.

Uber thus joins other players in the mobility/delivery sector in being unable to create sufficient value to adequately reward all stakeholders: consumers, drivers, merchants, and shareholders, forcing the companies to play one off against another, in what has become a long-running pursuit of profitless growth.

What about Uber’s outlook, which DK heralded four times as “good news” during his Q2 2021 earnings call? Uber’s current stock price should reflect future growth and operating margins, and by this yardstick, Uber is still grossly overvalued as explained in New Constructs’ insightful analysis published in March 2021, when Uber was trading at $53/share (now $44).

The New Constructs analysis demonstrates that to justify its recent stock price by traditional discounted cash flow analysis, Uber would need to immediately improve its profit (NOPAT) margin to +4% (from -34% TTM) while growing its topline by 36% annually over the next ten years.

This achievement would be fantastic, but alas, fantastical, giving Uber 2030 bookings of $1.2 trillion (170% of the projected global bookings for the entire rideshare and food delivery industry in 2030), and revenues of $241 billion, exceeding the 2030 toplines of FedEx, UPS, and the four largest US airlines combined in 2030 (at their historical growth rates).

Uber and Lyft have been steadfastly unwilling to provide guidance on their GAAP financial outlook, but given the market and competitive characteristics of the mobility and delivery markets noted above, neither will come remotely close to the profits and growth required to justify their recent valuations.

During Uber’s Q2 earnings call, DK signaled his recognition that near-term, sustained 4% profit margins are unlikely, so he’s “leaning in” on topline growth: “We see the path of sustainable and improving EBITDA profitability in the next six months, but it’s our growth potential over the next five to 10 years that has me and the team excited and hungry to Uber on.”

But pre-pandemic, Uber’s revenue growth had already been slowing considerably, reflecting maturing markets and increased prices. In preparation for their IPOs, Uber and Lyft aggressively raised US rideshare prices at double-digit rates in 2018 and 2019, which, not surprisingly depressed their trip demand growth. As such, the prospects for future margin and revenue growth from additional price hikes are limited.

Between the hyperbole, Uber’s S-1 IPO prospectus revealed these troubling trends, fueling investor concerns. Uber’s Y-O-Y core revenue growth in Q1 2019 was only 10%, down from 59% the prior year, while quarterly losses more than doubled to over $1 billion, contributing to Uber’s broken IPO. Uber suffered the then biggest ever first-day valuation decline in IPO history and has struggled to recover ever since.

DK has tried valiantly to shift the narrative away from Uber’s chronically poor financial performance in repeatedly making the case that Uber’s success is just around the corner. Before and during the pandemic, he’s tried several themes on for size: 1) “We’re just getting started in serving a $12 trillion TAM; 2) We’re becoming the Amazon of transportation; 3) Look at Uber Eats growth!; 4) We’re ideally hedged to weather the storm; 5) Ridehailing is coming back! (conveniently pegged against the depths of the pandemic); 6) Right now, I dream about pushing a button and getting a piano delivered to your home in an hour and a half… I think that’d be really cool.”

Granted, DK’s last comment was likely a whimsical retort during Maureen Dowd’s recent New York Times puff piece interview. But it fits a pattern of spin, hucksterism, and selective data drips that defines Khosrowshahi’s leadership.

But this faux optimism is wearing thin and belies the elephant in the room. Fundamental flaws in Uber’s business model will continue to keep the company from achieving anywhere near the growth and profits required to justify its current valuation. This leaves Uber in the uncomfortable position as other players in this space: needing to squeeze drivers, merchants (and more recently customers) in vain pursuit of elusive profits and growth.

Inexorably, investors will come to terms with what value to place on what is likely to become a pricey, slow-growing, and barely (at best) profitable taxi and delivery service, reminding us once again that business models matter. Look. Out. Below.