This article first appeared in The Edge Malaysia Weekly on April 22, 2019 - April 28, 2019

INVESTORS who found some way to short the stock of Lyft, the No 2 ride-hailing player in the US, have had a great ride since its initial public offering three weeks ago. Lyft’s stock plunged to US$56.11 on April 15, down 22% from its IPO price, or 35% below its first trading day highs.

 There is a sense of déjà vu for tech investors. In May 2012, the much-anticipated IPO of social media giant Facebook opened at US$38, went up to US$43, only to fall below US$18 just four months ­later, or as much as 52% below its IPO price. Facebook at the time was a loss-making firm in search of a business model, much like the ride-hailing companies around the world today.

 Lyft’s poor debut as a listed company is seen as an indication that the public markets may be far less forgiving of Silicon Valley unicorns’ high valuations and non-existent profits than private investors have been so far. Indeed, Lyft’s precipitous slide in its initial weeks of trading is seen as an ­ominous sign for Uber, its larger global rival that is expected to list in early May.

Ride-sharing has not looked as shaky since Uber co-founder Canadian software engineer Garrett Camp and his buddies spent US$800 just to hire a car on New Year’s Eve in Paris. Camp decided that there had to be a better way. Digital hailing of cabs was an idea whose time had come. He roped in his friend Travis Kalanick, a serial entrepreneur, to help launch the world’s first ride-hailing service in 2009, just as economies around the world were recovering in the aftermath of the global financial crisis.

Ride hailing’s moment of truth?

As Uber readies its IPO and its Southeast Asian peer Grab reaches for further cash injection to help keep up with rival Go-Jek, investors are wondering aloud whether this might be ride hailing’s moment of truth. Uber, Lyft, China’s Didi Chuxing, Southeast Asia’s Grab and Go-Jek, India’s Ola, the Middle East’s Careem and Russia’s Yandex have been burning cash at an impressive rate while showing little or even negative operating leverage. Ten years after ride-hailing services were first launched, they make up just 0.4% of total vehicle miles travelled in the US and indeed much lower elsewhere. “Uber almost doesn’t feel like a business, but rather some essential service that investors believe should exist, so they have kept injecting money into it,” The Atlantic magazine noted in a recent opinion piece about ride hailing.

Uber expects to raise up to US$10 billion, giving it a public market valuation of between US$90 billion and US$100 billion — lower than the expected US$120 billion. Even at the low end, it would be the largest IPO in the US this year and the biggest tech listing since Alibaba Group Holding debuted on the New York Stock Exchange five years ago. Uber’s adjustment of its IPO pricing suggests that high-flying unicorns are now clearly heeding public market concerns about their lofty valuations. Veteran tech fund manager Paul Meeks, who runs the Wireless Fund, says while “investors are getting more realistic about ride sharing”, even at a US$90 billion valuation, “Uber will still be significantly overvalued” because its business model is faulty, with no clear network effect that successful internet companies such as Amazon.com, Facebook and ­Google’s parent Alphabet currently enjoy.

Ahead of its IPO, Uber announced that it was buying Careem, the ride-sharing leader in the Middle East, for US$3.1 billion — US$1.4 billion cash and US$1.7 billion to be paid in convertible notes — giving it a dominant position in that market. While Careem’s acquisition helps the narrative about Uber’s overseas expansion, it does not bring it any closer to profitability. Indeed, the purchase pushes Uber’s profitability further into some distant future.

For its part, Uber is pretty upfront about a lack of traction or any clear pathway to profits. “We have incurred significant losses since inception, including in the United States and other major markets,” notes Uber’s S-1 filing to the Securities and Exchange Commission. “We expect our operating expenses to increase significantly in the foreseeable future, and we may not achieve profitability.” Uber lost US$4.1 billion in 2017 and US$2.9 billion last year. Its operating margin was -26.1% last year. Ride-hailing companies’ profitability is not a few quarters away, but rather, at least 5 to 10 years away, with tens of billions of dollars of additional cash required to get them closer to a break-even position.

 Uber’s IPO filing shows that revenue growth is slowing at its core ride-hailing business. Monthly active user growth over the last three quarters was around 30% while revenue grew 42%. That is even slower than Facebook’s growth, and last year was a tumultuous one at the social media giant. The only bright spot: Uber’s sales and marketing expenses have been falling. They were down to 28% of revenue last year from 41% of revenue in 2016. Analysts expect 2019 marketing and promotional expenses to be higher, as Uber ramped up efforts to boost riders ahead of the May IPO.

So, how should investors look at the upcoming Uber IPO as well as its investee companies such as Grab and Didi Chuxing? Avoid both the hammered Lyft and soon-to-be-listed Uber until their stock prices have fallen to more realistic levels. New York University’s Professor Aswath Damodaran, the doyen of tech valuations, says there is more downside for Lyft’s stock and, clearly, a lot of pain for Uber if it indeed lists anywhere near its US$90 billion expected valuation next month.

‘Unsustainable business model’

The way Damodaran sees it, loss-making ride-hailing companies such as Grab and Uber will continue to suck in more capital because they have yet to figure out how to make money. Their current business model, he argues, is just unsustainable. “There is absolutely no stickiness in the ride-hailing business, and they know it,” he says. In the US, riders have both Uber and Lyft apps on their smartphones, and in Southeast Asia, they have both Grab and Go-Jek apps. Moreover, 80% of American drivers use both the apps as they search for nearby riders. “The driver is a free agent and the customer is a free agent,” Damodaran notes.

When you have the same or similar cars and mostly the same drivers, riders will use the service that is the cheapest. As a frequent user of Lyft and Uber services, I can tell you that the difference between the two services in the same North American city for a 5km ride is often less than 50 US cents. Like other riders, I tend to choose the cheapest service because there is no difference in cars, service and drivers, and any brand distinction is irrelevant. And, it is no different between Go-Jek and Grab in Southeast Asia. Things such as red moustache logos or loyalty card points are not enough to differentiate one ride-hailing service from another.

Uber bulls say investors should have faith that the ride-hailing giant will ultimately figure out a way to make money, like Amazon.com, which lost money for years before it carved its own pathway to profits. Yet, any comparison with Amazon.com is misleading because even when it was bleeding, the e-commerce giant was fairly close to break-even, not losing US$3 billion a year like Uber. Initially, Amazon.com lost money as it transformed itself from an online bookstore to an e-commerce behemoth. Over the past decade, it has built what is now a gigantic cloud infrastructure money machine, the Amazon Web Services. Uber’s business model does not remotely look like Amazon.com’s, let alone like anything that might actually make money anytime soon.

How much is Uber worth?

Could Uber be the Facebook of 2019? Not a chance. Even though Facebook’s 2014 IPO was botched and its stock plummeted 50% within weeks, the social network giant’s revenues were actually growing at an annualised 88% at the time. Though Uber’s revenue grew 42% last year, growth in its core ride-hailing segment has been slowing sequentially, with some analysts forecasting revenue growth of under 30% this year. That would put Uber’s revenue growth on a par with Facebook’s, which is incredibly profitable despite the controversy surrounding its data harvesting techniques and privacy.

So, how much is Uber really worth? NYU’s Damodaran values its operating assets at about US$44.4 billion, based on its total addressable market, or a “top-down” view. Adding its stakes in Didi, Grab and Yandex pushes the valuation to US$55.3 billion, he notes. Combining Uber’s cash balance on hand as well as the IPO proceeds and subtracting its debt, he values Uber at around US$61.7 billion, or about US$54 a share. Even a slightly larger IPO size or additional proceeds from a greenshoe allocation — typically 15% of the money raised in an IPO — are unlikely to boost Uber’s valuation beyond US$65 billion. A more conservative “bottom-up” valuation, he notes, shows that Uber is worth US$58.6 billion, or US$51 a share.

Given the hammering Lyft has taken, it is likely that Uber and its investment bankers will aim for the lower end of the originally suggested valuation range. If Uber values itself at US$90 billion — or US$95 a share — in the IPO and a fair value of the company is 35% to 45% lower, Uber shares could fall almost as much as Lyft’s stock has fallen since its IPO. The world’s most-anticipated stock market listing in years might turn out to be quite a ­roller coaster of a ride.

Assif Shameen is a technology writer based in North America

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