Uber: Value stock or value trap?

Uber Technologies, Inc was once the most anticipated public listing of 2019. But since its initial public offering (IPO) last April, the ride-hailing giant has been a major letdown, with shares trading some 30 per cent below its IPO price.

With that in mind, I decided to do a quick analysis of Uber using my blogging partner Ser Jing's six-point investment framework.

1. IS UBER'S REVENUE SMALL IN RELATION TO A LARGE AND/OR GROWING MARKET, OR IS ITS REVENUE LARGE IN A FAST-GROWING MARKET? 

Uber is a great example of a company that is dominant in its industry but still relatively small compared to its total addressable market. According to Uber's IPO prospectus, the global personal mobility market consists of 11.9 trillion miles per year - or a US$5.7 trillion (S$7.68 trillion) market opportunity in 175 countries. 

Despite Uber's dominance in the ride-sharing space, it "only" recorded US$12 billion in ride gross bookings in the three months ended Sept 2019. That translates to gross bookings of just US$48 billion annually, a drop in the ocean compared to its US$5.7 trillion total addressable market.

Uber also owns minority stakes in affiliates with similar businesses, such as Didi and Grab, which serve markets that have an estimated size of US$0.5 trillion.

Besides personal mobility, Uber is also in the food delivery and freight business. Uber believes its UberEats business addresses a market opportunity of US$795 billion.

The freight trucking market is estimated to be around US$3.8 trillion in 2017, which Uber believes represents its total addressable market as it will address an increasing portion of the freight trucking market.

UberEats and Uber Freight's gross bookings of US$3.6 billion and US$223 million, respectively, are less than 1 per cent of Uber's total addressable opportunity for these markets.

Let's not forget that Uber is also spending heavily on autonomous vehicles and other technologies such as Uber Elevate (aerial ridesharing). These could potentially open other avenues of growth for the company.

2. DOES UBER HAVE A STRONG BALANCE SHEET WITH MINIMAL OR REASONABLE AMOUNT OF DEBT? 

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Uber ticks this box too. It is widely publicised that Uber has been burning cash at an alarming rate. However, the company managed to buy some time by raising US$8.1 billion through its IPO.

As of 30 Sept 2019, Uber had US$12.6 billion in cash and US$5.7 billion in debt, giving it around US$7 billion in net cash.

3. DOES UBER'S MANAGEMENT TEAM HAVE INTEGRITY, CAPABILITY, AND AN INNOVATIVE MINDSET? 

I want the companies that I invest in to be led by capable and honest people.

Uber's CEO Dara Khosrowshahi was appointed to lead the company in April 2017. Before that, he was the CEO of online travel outfit Expedia. Khosrowshahi brings with him a wealth of experience. His track record at Expedia - he quadrupled the company's gross bookings - speaks for itself. 

Khosrowshahi has also been able to clean up Uber's corporate culture, promising to instill integrity and trust among stakeholders. Before he arrived, Uber's corporate culture was said to be hostile and sexist under founder and then-leader Travis Kalanick.

I would also like to point out that a large portion of the compensation of Uber's executives is in the form of stock-related awards. In 2018, 88 per cent of Khosrowshahi's compensation was in stock awards. Khosrowshahi also bought around US$6.7 million in Uber shares in Nov 2019, bringing his total number of shares up to 1.53 million, worth around US$48.9 million. 

His large personal stake in the company, along with his compensation package, should mean that Khosrowshahi's interests are aligned with shareholders.

That said, Khosrowshahi has only been in charge of Uber for slightly over two years, and the company has only been listed for less than a year. As such, I think it is worth keeping an eye on management's decisions and the company's performance over the next few years before we can truly judge the capabilities of Uber's leaders.

4. ARE UBER'S REVENUE STREAMS RECURRING IN NATURE? 

Recurring revenue is a beautiful thing for any company to have. A company that has recurring revenue can spend less effort and money to retain existing customers and focus on expanding its business.

In my view, Uber has recurring revenue due to repetitive customer behaviour. Uber's customers who have experienced the efficacy of ride-sharing end up consistently using the company's services, along with those of other ride-sharing platforms.

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On top of that, Uber has built a large network of drivers and regular clients that is difficult to replicate. More drivers, in turn, leads to faster pickups, better service, and more consumers, creating a virtuous cycle.

Uber has thrown large amounts of cash at drivers to attract them to its platform in a bid to improve its ride-sharing platform and decrease the wait-time for commuters. As the network matures, Uber can theoretically start to profit by raising prices.

That said, Lyft still remains a fierce competitor in the US and has also built its own huge network of riders. While the US market is potentially big enough for two players to co-exist, if Lyft decides to try to eat into Uber's market share, both companies may suffer.

5. DOES UBER HAVE A PROVEN ABILITY TO GROW? 

From Uber's IPO prospectus, we can see that it has indeed been growing at a decent clip. Adjusted net revenue for ride-sharing, which removes excess driver incentives, tripled from US$3 billion in 2016 to US$9 billion to 2018. Uber Eats' adjusted revenue went from just US$17 million in 2016 to US$757 million in 2018.

Uber is still growing fast. Its total revenue for the first nine months of 2019 increased by 21 per cent from a year ago.

6. DOES UBER HAVE A HIGH LIKELIHOOD OF GENERATING A STRONG AND GROWING STREAM OF FREE CASH FLOW IN THE FUTURE? 

So far we have seen that Uber ticks most of the right boxes. However, the last criterion is where Uber fails.

Uber has been unable to record a profit since its founding, and has also been burning cash at an alarming rate.

The company had operating cash outflow of US$2.9 billion, US$1.4 billion, and US$1.5 billion in 2016, 2017 and 2018 respectively. Worryingly, the cash burn has not slowed down. In the first nine months of 2019, Uber had a net cash burn of US$2.5 billion from operations.

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One of the causes of Uber's inability to generate profits or cash from operations is its relatively low gross margin of 50 per cent for a tech service company.

Uber's gross profit margin is low partly due to heavy insurance expenses required to operate its ride-sharing platform. This leaves the company with little room to spend on marketing expenses.

In addition, the potential for price wars could further squeeze Uber's gross margins in the future. It remains to be seen when or if the company can eventually turn a profit and start generating cash consistently.

OTHER RISKS

A discussion on a company will not be complete without assessing the risks. 

Besides the risk of competition driving down its profit margins, Uber also faces regulatory risk. Uber's ride-sharing operations have already been blocked, capped, or suspended in certain jurisdictions, including Argentina, Japan, and London.

These restrictions may prevent Uber from entering and growing into other markets, significantly reducing its total addressable market size.

Uber is also investing heavily in autonomous vehicles and Uber Elevate. Both these initiatives require a lot of money and have widened the company's losses and cash burn rate.

In the first nine months of 2019, Uber spent a whopping US$4.2 billion on research and development, which is more than 40 per cent of its revenue. There is a chance that these investments may not pay off in the end. 

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Uber's cash burn rate of more than US$1 billion a year is also worth watching. At this point in time, Uber's strong balance sheet allows it to spend cash without overstretching its books.

However, if the cash burn rate continues for an extended period, Uber may end up needing to raise more cash through an equity or bond issue that could potentially dilute shareholders.

UberEats also faces competition from startups such as GrubHub, Door Dash and Deliveroo. UberEats has been the biggest drag to the company's profitability in recent quarters and a price war against these other food-delivery competitors could widen its losses.

THE GOOD INVESTORS' CONCLUSION 

There are certainly some reasons to be impressed by Uber. The ride-sharing giant has a long runway ahead of it and has set its sights on autonomous vehicles and air transportation. And with the move towards a car-lite society, ride-sharing will likely become increasingly more prominent.

However, there are also many uncertainties surrounding the company at this time. Ridesharing is effectively a commodity-like service and the presence of other big-name competitors such as Lyft may result in expensive price wars.

Another concern is Uber's alarming cash burn rate and low gross profit margins. 

Valuation-wise, Uber is also not necessarily cheap. At its current market cap of US$57.8 billion, it trades at around four times its annualised adjusted net revenue for 2019.

That's not cheap, especially for a company that has failed to consistently generate positive cash flow from operations and is unlikely to post operating profits anytime soon.

As such, despite Uber's growth potential, the uncertainties surrounding Uber's road to profitability, its ability to generate free cash flow, and the potentially painful price wars, make me think that Uber is still too risky an investment for my liking.

This article was first published in The Good Investors. All content is displayed for general information purposes only and does not constitute professional financial advice.