How California Is a Big Problem for Lyft

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After a brutal 2019 following its much-hyped IPO, 2020 has been even worse for Lyft (NASDAQ:LYFT) stock investors. I’ve been warning investors about California’s AB-5 for over a year. Unfortunately, those fears are about to become reality for Lyft.

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Uber (NYSE:UBER) has gotten most of the headlines following a recent California court ruling on AB-5. However, Lyft will get hit even harder than Uber will when the law goes into effect as soon as Aug. 21. Barring a successful appeal, the outlook for ridesharing stocks just got a lot uglier in the near term.

Bad News for LYFT Stock

Uber and Lyft have always classified their drivers as independent contractors rather than employees. By doing so, the companies can avoid footing the bill for costly benefits, such as health insurance.

However, ridesharing drivers meet the classification of employees as defined by California’s Assembly Bill 5, which is very bad news for Uber and LYFT stock. The two companies spent massive amounts of money lobbying against AB-5 and fighting it in court. Their primary argument is that AB-5 is unconstitutional. They say it stifles both workers and companies providing jobs in the on-demand economy.

On Aug. 10, a California judge ordered Uber and Lyft to comply with AB-5 and provide all the benefits guaranteed to full-time employees. Uber and Lyft are now on the hook for massive new costs at a time when proving profitable business models is critical for investors. At the same time, the two companies may be forced to temporarily shut down business in California. That move could obviously take a huge bite out of revenue growth.

AB-5 is bad news for Uber stock. It’s much worse news for Lyft stock. California represents roughly 20% of Lyft’s total rides in a normalized environment compared to just 5% for Uber, according to Stifel.

What Happens Next?

Uber and Lyft both filed appeals in California courts in hope of extending the current stay on AB-5 beyond Aug. 20. California voters have the chance to directly override AB-5 by voting for Proposition 22 in November. In the meantime, things could get very messy for Lyft stock.

Uber CEO Dara Khosrowshahi has said the company could be forced to shut down operations in California for several months while it updates its operating model. Stifel analyst Scott Devitt says Lyft will likely do the same.

“The injunction would force Lyft to suspend rideshare operations in California until it can either transform its business model to conform to the regulation or a successful outcome on the Proposition 22 ballot initiative,” Devitt says.

The best possible outcome for Lyft stock investors at this point is for a court to accept its appeal and extend the stay on AB-5 until the election. However, if the law goes into effect on Aug. 21, investors should expect a full shutdown in California.

Uber and Lyft desperately need either a court or California voters to exempt them from AB-5. If the courts won’t do it, it’s in both companies’ best interest to make things as painful as possible for California voters between now and November.

In my mind, that means no jobs for ridesharing drivers in California and no rides for California residents. That decision would likely inflict tremendous pain on Lyft stock in the near-term. However, I bet that approach would significantly improve the chances Proposition 22 passes in November.

A Potential Buying Opportunity

Piper Sandler analyst Alexander Potter says Uber and Lyft will likely shut down operations in California to prove a point.

“We don’t know if this will ultimately happen, but if it does, then Q3 [earnings] guidance will be at risk. Either way, we suspect volatility (mostly to the downside) until this issue is resolved,” Potter said of LYFT stock.

Both Piper Sandler and Stifel have “neutral” ratings on Lyft. I agree that it’s difficult to get too bullish on the stock given all the near-term uncertainty.

But I do believe the chaos in California has created a potential trading opportunity. Expect LYFT stock to sell off if it’s forced to temporarily shut down in California. However, look for a buying opportunity ahead of the November election. If Proposition 22 passes, it will be a huge bullish catalyst for Lyft.

Wayne Duggan has been a U.S. News & World Report Investing contributor since 2016 and is a staff writer at Benzinga, where he has written more than 7,000 articles. Mr. Duggan is the author of the book “Beating Wall Street With Common Sense,” which focuses on investing psychology and practical strategies to outperform the stock market. As of this writing, Wayne Duggan does not hold a position in any of the aforementioned securities.

Wayne Duggan has been a U.S. News & World Report Investing contributor since 2016 and is a staff writer at Benzinga, where he has written more than 7,000 articles. Mr. Duggan is the author of the book “Beating Wall Street With Common Sense,” which focuses on investing psychology and practical strategies to outperform the stock market.


Article printed from InvestorPlace Media, https://investorplace.com/2020/08/how-california-is-a-big-problem-for-lyft/.

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