It is said that Travis Kalanick, who resigned as Uber’s boss last month, has been reading Shakespeare’s Henry V. Prince Hal’s transformation, from wastrel prince to sober monarch, is doubtless one he would like to emulate.
As a guide to the ride-hailing firm’s financial dilemma, however, Macbeth is the best play. This line especially resonates: “I am in blood stepp’d in so far that, should I wade no more, returning were as tedious as go o’er.”
Uber has bled money for years in an attempt to become the absolute ruler of its industry. Once Kalanick’s replacement is found, voices will whisper that the company, like Macbeth, is in too deep to alter course. Nonetheless, the new boss must change Uber from a company that sacrifices anything for its ambitions into one which has a realistic valuation and uses resources efficiently.
Its product is elegantly simple. Uber makes a market between drivers and passengers and takes a cut of about a fifth of the fare. The more people use its service, the better it functions, with lower waiting periods for passengers and better use of drivers’ time. Some 55 million people in 574 cities use it every month. Underlying sales were more than $4 billion in 2016, more than double what they had been the year before, though all figures exclude Uber’s troubled Chinese arm, which it sold to a local rival, Didi Chuxing, last year.
Uber’s main trouble is high expectations. Its supporters think that it will become the next Alphabet or Facebook. At its last funding round in 2016—it is privately held—investors valued it at a whopping $68 billion.
However, the next boss will have to deal with an income statement that is scarier than the Thane of Cawdor. Underlying pre-tax losses were between $3 billion and $3.5 billion last year and about $800 million in the most recent quarter. Between $1 billion and $2 billion of last year’s red ink was because of subsidies that Uber paid to drivers and passengers to draw them to its platform. At least another $1 billion went on overheads and on developing driverless cars, with money also being splashed on a new food-delivery venture and a plan to build flying cars.
To put its 2016 loss in perspective, that number was larger than the cumulative loss made by Silicon Valley’s least profit-conscious big company, Amazon, between 1995 and 2002.
Investors rationalize its valuation by assuming that, in the long run, it will be highly profitable, with a dominant share of a large market. In 2014 Bill Gurley, a well-known tech investor who was then an Uber director, estimated that the pool of consumer spending that it could try to capture might be more than $1 trillion, with ride-hailing and ride-sharing replacing car ownership. Today many Silicon Valley observers think that estimate is too conservative.
However, a discounted-cashflow model gives a sense of the leap of faith that Uber’s valuation requires. After adjusting for its net cash of $5 billion and for its stake in Didi, worth $6 billion, you have to believe that its sales will increase tenfold by 2026. Its operating margins would have to rise to 25%, from about -80% today.
That is a huge stretch. Admittedly, Amazon and Alphabet, two of history’s most successful companies, both raised their sales at least that quickly in the decade after they reached Uber’s level, and Facebook is likely to as well. During the same periods, though, these companies’ operating margins show a total average rise of only one percentage point. Put simply, Uber finds it desperately hard to make money. It is not clear that it breaks even reliably across the group of cities where it has been active for longest.
Thus the new chief executive will have to deliver a bleak message: Ride-hailing is locked in a vicious circle. Low prices and high subsidies lead to losses, so companies must raise capital continually, requiring them to exhibit rising valuations. To justify these they must frequently enter new cities and dream up new products. Even more speculative capital is then drawn in by the paper gains seemingly to be made. In the past year 10 of Uber’s competitors, such as Lyft in America and Grab in southeast Asia, have together raised or are raising, roughly $11 billion. That will be used to finance still more price wars to win market share.
© 2017 Economist Newspaper Ltd., London (July 22). All rights reserved. Reprinted with permission.
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