It’s easy to make the bear case for Uber Technologies Inc (NYSE:UBER). The current UBER stock price — even after a 14% decline over the past two sessions — still suggests a market capitalization near $70 billion. Yet Uber isn’t close to profitable.
In fact, Uber lost a staggering $5 billion in its second quarter, according to last week’s earnings report. To be fair, much of that loss was due to stock-based compensation following the company’s IPO. But even on an Adjusted EBITDA basis, Uber lost some $656 million in the quarter. In that context, $70 billion seems ridiculous.
That said, this is a company with a path to growth. At least some of the current losses are coming from investments in areas like UberEats and Uber Freight. Those investments eventually will generate returns, or so the company hopes. And with a real opportunity in self-driving vehicles, in particular, growth can continue for decades to come — with profitability likely to follow at some point, and possibly some point soon.
But the long-term question remains: how much profitability? While the UBER stock price has fallen off a single earnings report, that’s the question that really matters. And there’s a very real probability that the answer is much worse than Uber shares suggest, even as they trade not far from post-IPO lows.
The CEO’s Case for UBER
On Friday, one day after Uber earnings, CEO Dara Khosrowshahi gave a lengthy interview to CNBC. The appearance certainly seemed like damage control from the notoriously PR-focused company, as the UBER stock price fell despite some good underlying news in the quarter.
There’s one passage from the roughly 20-minute interview worth calling out in the context of understanding the fundamentals behind the UBER stock price. CNBC’s David Faber asked Khosrowshahi if he agreed that it was an “uphill battle” to get the company to cash-flow positive. Here’s how the CEO responded:
This is a 20% revenue margin business at 50, 60 plus percent scale. Every single year we add $15 billion of gross bookings at 20% margin – revenue margin. So that’s essentially $3 billion of revenue that we’re bringing in house. And you know, put that against a $656 million quarterly loss. And you see that with a couple of years of $3 billion-plus revenue coming in, you’re going to be able to cover those losses. I am very, very confident of this.
Can Uber Technologies Inc Hold Pricing?
From a broad standpoint, that’s the right answer. Uber will be able to grow to the point where Adjusted EBITDA is positive.
Growth stocks across the market have soared this decade on the backs of similar models. And companies — including both Uber and rival Lyft (NASDAQ:LYFT) — have taken advantage of that fact to go public earlier than in the past.
It’s worth going through the exact metrics Khosrowshahi cites because they can also highlight the bear case for UBER stock right now. First, he notes that the business is at 20% “revenue margin.” What this means is that Uber has a “take rate” around 20% of bookings, or the price that riders pay. (According to figures from the 10-Q, take rate actually was about 19% in Q2, excluding a one-time driver benefit in conjunction with the IPO.)
That metric alone is a worry for Uber. Per its own filings, Uber’s take rate has steadily declined in recent years. The key factor has been competition from Lyft and China’s Didi Chuxing, who has expanded into Europe and Australia.
And one real concern is that it will keep declining. After all, competition can create a “race to the bottom.” More importantly, drivers may not be able to survive paying Uber 20% of the fare, while also maintaining and fueling their vehicles and being properly compensated for their time.
The argument from Uber bears is that the model doesn’t work. The company is funding its business through incentives to consumers and incentives to drivers. That combination can’t last forever — unless Uber (and its rivals) want to keep burning cash. While those promotional incentives have stabilized across the market, per post-Q2 commentary, that may not hold. The risk here is that there’s always going to be someone out there willing to undercut the incumbent players.
Does Operating Leverage Lead UBER Stock Price Higher?
The CEO then notes that the company is running a quarterly loss (which, to be clear, is Adjusted EBITDA) of $656 million, or about $2.6 billion a year, while growing revenue at a $3 billion clip. In theory, that should narrow losses rather quickly.
After all, this is a platform company, or at least believes that it is. And the reason platform stocks (think Etsy (NASDAQ:ETSY) or Match.com (NASDAQ:MTCH)) generally trade at high valuations is that incremental margins are huge. Once the platform is built, each extra dollar in revenue comes with minimal costs. So raising pricing, as Etsy did, or simply growing usage both lead profitability to move almost exponentially higher in a very short amount of time.
$3 billion in revenue probably can’t cover a $2.6 billion hole. $6 billion probably can — at least if platform economics hold. But here, too, there are questions. New riders on the Uber platform, for the most part, need a corresponding amount of new drivers. (Existing drivers can increase their utilization, but only to a point.) And acquiring new drivers costs money. Either Uber has to market to them, incentivize them, or pay them.
For most digital stocks, incremental margins are huge. For Uber, it’s not clear that they are. The company’s own financials don’t show it: Adjusted EBITDA loss more than doubled year-over-year in Q2.
To be fair, the company has kept up its spending as it has entered new markets, and looked to grow UberEats, in particular. The longer-term risk, however, is that Uber always will have to keep up its spending.
Other Bets
There are real concerns as to whether the core ride-sharing business can ever really be profitable. After earnings, bulls and analysts pointed to a notable improvement in contribution margin from ride-sharing. The figure, according to the earnings slides, jumped to 8% from -4% in the first quarter. Some of the loss, then, is coming from spending on UberEats and autonomous driving, in particular.
Again, this is a company worth $70 billion. GrubHub (NYSE:GRUB) is worth $6 billion. As Ian Bezek pointed out last week, Square (NYSE:SQ) sold Caviar to DoorDash for just $410 million. UberEats is going to have to be absolutely dominant to support even a fraction of the current UBER stock price.
Uber Freight is intriguing, but faces stiff competition in an industry that has huge numbers of incumbent brokers (many of whom have similar technology). And the autonomous efforts don’t necessarily solve Uber’s problems: driverless cars certainly would have lower costs, but they’d also have commodity pricing, as MarketWatch contributor Rich Alton pointed out this week.
The core distribution business has to reach profitability — and likely material profitability — for the UBER stock price to do anything but keep falling. That’s not guaranteed. Khosrowshahi’s math works on paper. The key question for Uber is whether it will work in practice.
As of this writing, Vince Martin has no positions in any securities mentioned.
