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Should You Buy Uber as It Starts Trading on Thursday?

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Ride hailing companies are coming of age. Soon after its younger cousin Lyft filed for an IPO, Uber is slated to do likewise.

One can’t help wondering why the company is choosing to go public at a time when the perceived value of its brand seems to be declining and multiple problems appear to be plaguing it. In fact, the risk section of its prospectus is long enough to arouse fear in most.

The primary issues before the company and those that investors must be concerned about include

1.    Its ability to recruit and retain drivers without increasing costs significantly

2.    Its ability to retain and grow the user base without increasing the fares significantly

3.    Its ability to diversify successfully beyond ride sharing into the chosen areas of food delivery, other mobile (escooters and ebikes), trucking/logistics, autonomous driving, etc.

4.    Its ability to deal with significant and growing competition in each of its served markets

5.    Its ability to generate profits

6.    Its ability to stay out of regulatory trouble with respect to anti-competitive behavior,  user data (privacy and security) and also improper cash usage in certain developing countries

7.    Uber also has the job of undoing its unsafe image and poor corporate culture under former CEO and founder Travis Kalanick who’s still on its board (there is considerable improvement on this front already)

8.    In addition, there’s the concern that some early investors might be looking to cash out since Uber’s valuation seems to be falling (and could fall further if Lyft’s fortunes are any indication)

Drivers

Drivers of several Uber, Lyft and other ride hailing apps in New York, San Francisco, Chicago, Los Angeles, San Diego, Philadelphia and Washington, DC are joining a strike called by the New York Taxi Workers Alliance (NYTWA) for a couple of hours on Wednesday morning. They are seeking job security, living wages and a restriction on the amount ride hailing companies can collect from each fare.

The problem is summed up by an NYTWA member: "Uber claims that we are independent contractors even though they set our rates and control our work day."

Driver dissatisfaction is a big problem that is likely to remain because all employees expect increments even when the value of the services delivered don’t increase. In Uber’s case, some drivers complain that they don’t get paid as much as regular taxicabs, but the law of demand states that this would cause them to quit. In most cases when drivers pull out, it’s because they don’t want to work for incentives. On the other hand, the company needs to lower cost if it is to contain price increases and continue taking share from traditional cabbies.

Dissatisfaction among its 3.9 million drivers is widespread not only in the U.S. but also in other key markets like India.

Lyft reportedly defended its position in an emailed statement: "Over 75% drive less than 10 hours a week to supplement their existing jobs. On average, drivers nationwide earn over $20 per hour." So Lyft’s position seems to be that it doesn’t control the work day as claimed by the NYTWA worker, in which case, fewer drivers will be driven to a strike.

Uber’s S1 indicates that it pays 70-80% of gross bookings to drivers. So unless there’s something seriously wrong with the operating model, drivers shouldn’t be complaining at all.

Users

According to its S1 filing, Uber’s monthly active platform users (MAPC), defined as unique consumers using Ridesharing, New Mobility or Uber Eats services at least once a month averaged quarterly, were 91 million at the end of 2018.

Ridesharing and Uber Eats with 70 million+ and 15 million+ users, respectively, together constitute the “core” platform. User growth continues to grow strongly (at around 34% in 2018, significantly slower than the 51% growth in the prior year).

Users naturally want to pay as little as possible while drivers want to earn as much as possible. This led to the creation/promotion of UberPOOL. Uber started increasing rates on the single passenger rides so more and more people opted for POOL, which was half the cost. Then it started increasing rates on POOL, so they were almost level with normal unshared taxi services.

Getting paid for two or three trips in one (trips grew 37% in 2018 over the 58% increase in the prior year), while not having to figure out where to go since there are now common pick up spots, has been a good deal for drivers, who remain dissatisfied. In the meantime, users are beginning to see that prices go on rising as deliveries drop in value.

UberPOOL still remains a good option for many office goers, so if prices don’t go on increasing, the user base will continue to expand till there is critical mass in many more cities. As Uber says, many of the markets in which it operates are significantly underpenetrated, averaging at around 2%, so there is significant room for growth. Any price hike can only come in areas where it has already attained critical mass.                   

Diversification

Of the $11.3 billion Uber generated in 2018, $9.2 billion (81%, up 33% from 2017) came from ridesharing, less than 7% came from Uber Eats (up 149%), around 1% from Uber Freight and the balance from other areas. So while one diversification idea appears to be working out, the others like freight, ebikes and escooters, and particularly autonomous vehicles are still years in the making.

Even the ridesharing business is far from mature since expanding in underpenetrated markets, which appears to be a key growth strategy will require investment in human resources, local knowledge, advertising and technical support among other things.

The S1 says that Eats will require significant further investment, which can be justified by its high growth rate (nearly 168% increase in gross bookings in 2018 over the 2017 level).

Escooters and things are experiments at best now and the company has made some acquisitions and collaborations in the space the benefits of which aren’t evident as of now.

On the other hand, autonomous vehicles are a market the company has to crack, there’s no choice in this. If it has effective automation in driving, it can keep the driver cost in check.

Second, if it doesn’t do this, others like Alphabet’s (GOOGL - Free Report) Waymo are going to get there. Then there’s nothing to stop them from taking over not only the ride sharing business but also other markets like food delivery, trucking etc, totally devouring Uber’s business. Uber may be able to deploy cars from traditional auto makers that incorporate self-driving technology, but Waymo appears to be in the lead.

Competition

Uber is primarily a logistics business. It has fleet management software and maps that help it determine how to most profitably deploy vehicles for the transport of people, food or other goods. The growing digitization of our lives has led to a healthy volume of startups and others like Lyft (LYFT - Free Report) and GrubHub (GRUB - Free Report) in the space.

Additionally, large technology companies that already possess some of the building blocks like Google’s maps, customer data, and artificial intelligence (AI); and Amazon’s (AMZN - Free Report) logistics, robotics, customer data and AI also pose challenges.  

Profitability

The company had an operating loss of $3 billion for the year, down from $4.1 billion in 2017. But it intends to invest heavily in expansion of the core business as well as its future growth in freight and auton.

omous technology and doesn’t expect to see profits in the foreseeable future. Revenue growth slowed significantly from 106% in 2017 to 42% in 2018. If revenue growth continues to decelerate while costs continue to increase, investors may not get a good return on their investment.

Conclusion

Uber has presented a business proposition with significant growth prospects. The company is also in possession of key technologies and has a broad presence in a large number of markets where its services have achieved a certain level of popularity.

At the same time, its road to profitability lacks clarity. In this situation, and given that the company has been in operation for several years already without anything to show in terms of profit or plans of attaining profitability any time in the near future, there is considerable risk in investing in the shares.

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

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