Not to be outdone by its now-publicly-traded rival Lyft (NASDAQ:LYFT), this past week Uber submitted its initial public offering paperwork to the SEC. The long-awaited and oft-discussed Uber IPO is finally about to happen.
A bunch of traders are buzzing because… well, many traders love cool concepts. At the other end of the spectrum, naysayers can’t get past the line in the official filing that says the company “may not achieve profitability.”
It’s a dire suggestion, but it’s not the red flag many investors are making it out to be.
Most companies that aren’t profitable at the time of their IPO warn in their S1 paperwork they may never turn a profit. Twitter (NYSE:TWTR), for instance, cautioned investors in 2013 in its S1 filing it “may not be able to achieve or subsequently maintain profitability.”
But it’s making money now.
In 2003, salesforce.com (NYSE:CRM) was worried enough to issue this warning to would-be IPO buyers: “If our revenue does not grow to offset these expected increased expenses, we will not continue to be profitable.”
Salesforce has earned $1.11 billion over the course of the past four reported quarters.
It’s boilerplate language.
Still, investors would be wise to be wary of the Uber IPO because it may not actually ever turn a sustained profit, even if the warning in its recent paperwork was just the usual rubber-stamped disclaimer.
The Plan
Whether or not Uber said so, there’s a very real possibility the company may never create sustained profits.
Uber, of course, is a ride-hailing company. Tech-centered and volume-minded, the organization was founded in 2009, with relatively humble beginnings. Travis Kalanick had sold Red Swoosh just a couple years prior, freeing him to partner up with computer programmer Garrett Camp to create what was then called UberCab.
The app itself was and still is the centerpiece of the company’s operation, which has since cultivated an army of roughly 3 million independently-contracted drivers.
It’s clever competition to conventional taxi cab companies. Those 3 million drivers all work remotely, and independently, and are dispatched by the same platform that powers the consumer-facing app. It’s arguably more efficient than traditional taxi companies.
That doesn’t make it profitable, though.
It’s complicated, but the short explanation of the concern is this: Uber spends more on regular, recurring operating costs than it collects in net-revenues.
That may not always be the case. In fact, Uber specifically believes that won’t be the case in the foreseeable future. The plan is to grow ride-hailing revenue to the point where they finally exceed fixed, unavoidable costs. Higher fares aren’t likely to be a component of that improvement, as it faces off with Lyft and other, more localized players. Paying its drivers less isn’t a great option either. The plan is to grow the number of rides it facilitates.
Even that, however, may not get the company over the hump.
Scale Isn’t Necessarily the Key
Many observers have laid out the flawed thinking in Uber’s growth plan. But, giving credit where it’s due, it’s Intelligencer’s Yves Smith that makes the most cogent case against buying into the Uber IPO. He penned the following late last year:
“Uber is a taxi company with an app attached. It bears almost no resemblance to internet superstars it claims to emulate. The app is not technically daunting and does not create a competitive barrier, as witnessed by the fact that many other players have copied it… [apps] do not create network effects. Unlike Facebook or eBay, having more Uber users does not improve the service.”
Smith adds a subtle but important detail the matter, noting “More drivers means more competition for available jobs, which means less utilization per driver. There is a trade-off between capacity and utilization in a transportation system, which you do not see in digital networks.”
In short, an Uber swing to profitability assumes that the ride-hailing market (however they’re hailed) is not yet mature, and further assumes that competitors won’t win any market share if the market does somehow expand.
And the fact that Uber drivers feel they’re being forced to break the law as well as being forced to cancel rides when fares are too low suggests the supply-demand dynamic has already run out of runway.
Bottom Line on Uber IPO
Don’t misread the message: The Uber IPO may prove amazingly fruitful for traders able to actually buy into the initial public offering and offload their Uber stock at a much better price in the open market. Although it didn’t work for Lyft this way, Uber shares may ride the post-IPO buzz higher and higher. Euphoria is a powerful force.
Sooner or later, though, Uber has to realistically prove to investors that it may be able to turn a decent profit at some point in the future. The company’s top brass continue to tacitly hint that it can, but consider the source. The more convinced investors are that Uber will be viable one day, the more money those insiders make on the shares they already own.
Notice, in particular, that Uber has yet to offer any solid growth outlook that’s based on verifiable, validated data that jibes with the market’s growth expectations.
Never say never, but this smells a lot like another Groupon (NASDAQ:GRPN) or Spotify (NYSE:SPOT). Consumers love their products, but the companies aren’t actually “businesses” with a model capable of consistently producing earnings.
To that end, there’s a reason LYFT stock is down 16% from its IPO price in just a few days.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities. You can learn more about James at his site, jamesbrumley.com, or follow him on Twitter, at @jbrumley.
