“It is all about liquidity for Uber and Lyft,” analyst Pierre Ferragu told TheStreet. Ferragu follows Uber for New Street Research and rates its shares a Buy with a $50 price target; he does not formally cover Lyft. Both stocks are currently in the doldrums since they first went public this past spring, with Uber shares down 31% at a recent price of $28.65, and Lyft is down 43% at $44.87.
But Ferragu sees Uber reaching profitability in a couple of years’ time, while continuing to grow revenue at double-digit rates, as it settles into a comfortable duopoly with Lyft that proves difficult for other companies to break into.
Uber’s ability to efficiently make more rides available in the markets it enters is a “game changer,” according to Ferragu. The crux of his argument is the difference between fixed capacity and flexibility capacity in a market.
In 2012, the year Uber started operating, there were 1.5 billion rides annually in the U.S. by taxi services, Ferragu noted, citing data from researchers at the University of Kentucky. That total had only risen about 3% each year over a decade. The reason there wasn’t much growth in taxi rides was because of fixed capacity. As a city added more cabbies to serve more customers, fares for rides had to rise in order to make sure each cabbie still earned enough, since each cabbie was now splitting the market with more competitors.
Rising fares discouraged passengers, so the system reached a kind of equilibrium at some point, with little growth in ridership.
Rather than managing a fixed number of drivers, however, Uber and Lyft can automatically adjust the number of drivers based on demand – i.e., they can manage liquidity. “Liquidity means that at any point in time, at any place in the city, they can influence the number of cars available and riders available,” Ferragu said. By optimizing supply in that way, Uber and Lyft can keep fares competitive and thereby encourage more and more ridership.
The number of paid rides has now risen to 5 billion annually in the U.S, with ride sharing taking over 85% of the market, according to Ferragu. “When you have a new technology that increases the market three-fold in six years, that is technology that is creating a lot of value,” Ferragu said.
That value will endure, Ferragu believes, because new entrants will find it difficult to compete with the Uber-Lyft duopoly. “If you arrive after the number one and number two are established in a market, you cannot achieve the same liquidity as them,” said Ferragu. In other words, the economics of Uber and Lyft become so efficient, given their scale, that any new entrant is at a disadvantage, and so they won’t get startup capital to compete.
The remaining question, however, is whether Uber can make a profit. It is projected to lose $2.85 billion this year on an Ebitda basis (earnings before interest, taxes, depreciation and amortization), on revenue of $14 billion. The company has told Wall Street that it will be profitable for the full year 2021.
“We just still struggle to get comfortable with visibility of the financials,” Tom White of D.A. Davidson, who has a Neutral rating on Uber stock, told TheStreet. The average estimate for Ebitda in 2021 is still negative, he noted, evidence that “the market doesn’t entirely believe” the company’s promise to become profitable at that time.
As for valuation, Uber trades at a multiple of just three times its sales, based on its enterprise value, notes White. “A lot of people would look at that and say, that’s pretty compelling already,” he said. “The only thing that’s different is, the magnitude of the losses they are incurring is so large, in absolute dollar terms, that [it] gives pause.”
Another concern is that to reach profit more quickly, Uber will have to spend less money on investments in its “Uber Eats” initiative for meal delivery, as well as on its development of autonomous vehicle technology and expansion into new global markets.
“To get profitable faster they are going to invest in fewer markets,” said Ferragu. “They are going to exit the markets where they are the less-well-positioned.”
And no one knows exactly what that trade-off of growth for profit will look like. “That accelerated time frame [to get to profitability] raises questions,” White said. “What does it mean for the size of the core business, or the likelihood that some of their longer term bets, like autonomous freight, and such might be starved of capital they could otherwise have used?”
Uber trades at about 0.4 times its projected “bookings” next year of $82 billion, which is the total dollar value of rides it enables. With improving profitability, the stock can see that multiple expand much the way Amazon’s multiple expanded in the 2000s as it became profitable, Ferragu argued.
“If [Uber is] growing bookings, say, 20% per year, and they are becoming profitable, you could see that multiple expand to 0.9,” said Ferragu. “That could more than double the stock.”