UBER - Uber: Algo Dominance But Show Me The Money!

2023-03-29 18:59:39 ET

Summary

• Uber has adapted to the increased cost of capital and focused on return on investment, positioning the company favorably in the competitive market.
• The company's Mobility sector and Multi-Product Membership Platform offer potential for long-term growth and increased customer lifetime value.
• Uber's advanced algorithms and global data assets provide a competitive edge, while the company faces challenges in terms of profitability and cash flow.

Uber ( UBER ) shares are down 26% since its IPO in 2019, and despite the challenges faced by its competitor, Lyft ( LYFT ), the company seems to be unable to generate a profit. However, the poor performance of growth and story stocks piqued our interest in Uber. In this article, we analyze Uber's business performance, focusing on profitability, growth in the mobility sector, the potential of its multi-product membership platform, and the company's competitive advantage stemming from its algorithms. We also examine Uber's financials, valuation, risks, and debates surrounding the company's future prospects.

Business Performance Overview

One significant change we've observed is the increased cost of capital across all companies, resulting in everyone pulling back on incremental spend and focusing more on return on investment. We feel that Uber was ahead of the curve in adapting to this change and setting new targets.

For example, Uber's headcount for its core business only increased by 10% from 2019 to 2022, allowing the company to adjust more smoothly compared to its competitor, Lyft, which has struggled with financial performance and whose founders stepped down recently . We believe that being the #1 player in the world, with benefits from both Mobility and Delivery platforms, has positioned Uber favorably in this environment where scale tends to provide more stability. Consequently, Uber gained category positions in the majority of its top 10 markets, while also significantly improving margins.

Regarding profitability, Uber's Delivery business has been a key driver of margin improvements. This is due to a combination of factors, such as a better competitive environment, significant algorithmic advancements that reduced cost per transaction, and the rapid scaling of its Advertising business. On the other hand, the negative performance of Freight and shipping markets has impacted Uber Freight's top-line growth and margins. However, we believe that this challenging environment may ultimately benefit Uber Freight, as it allows companies with superior technology and products to pull ahead, and we see Uber Freight as having that potential.

Mobility

Our research suggests that investors are very much focused on the long-term growth of Uber's Mobility, specifically on supply. The main factors influencing growth over the next five years include the number of drivers on the platform, driver retention, and engagement in terms of supply hours per driver.

Driver supply has seen higher engagement, improved retention due to strong earnings, and increased numbers on the platform. In Q4, global driver numbers were up 35%, and the U.S. saw a 30% increase. This growth is attributed to good earnings, streamlined onboarding processes, and a looser labor environment. About 70% of drivers join the platform to augment their earnings due to inflationary effects.

In terms of growth, the three key metrics we focus on are new customers, frequency, and price. We expect to see growth in all three areas, and we forecast a shift from price to transaction growth in the future. New customer acquisition remains healthy, with significant untapped potential, as less than 30% of adults in developed markets have used Uber. We believe Uber will penetrate the remaining 70% through aggressive marketing and new product launches.

Newer products, such as hailables, Reserve, and rental car services, are helping acquire new customers and opening up new use cases. Additionally, Uber aims to increase pricing through personalization and occasion-based pricing, with a focus on premium products like Uber for Business. Overall, we expect healthy growth rates in the future, but the key factor remains supply, where the company is currently in a strong position.

Multi-Product Membership Platform

We believe what really differentiates Uber is its membership and multiproduct offering across Rides, Eats, Grocery, Last Mile and others. Our analysis indicates that approximately 45% of Uber's gross bookings come from users who engage with multiple products, while about 25% of the overall gross bookings are generated from membership.

Cross-platform or cross-product use is driven by the product offerings and upselling strategies, leveraging machine learning and AI algorithms to present the right products at the right time and price. We believe this approach will increase multi product usage, resulting in higher engagement, frequency, and overall customer lifetime value.

Uber's membership program, which currently boasts over 12 million members, has nearly doubled year-on-year. We believe the combination of the platform and membership will continue driving cross-product usage and higher frequency. However, it is crucial to optimize the upselling process, ensuring it does not interfere with consumer or driver desires while maximizing business goals.

We forecast that the power of Uber's platform, which has been discussed for the past three years, will continue to yield a competitive advantage, demonstrated by the company's ability to deliver both top-line and bottom-line growth and category position. The compounding effect of the platform is expected to maintain this edge over competitors in the long run.

Uber's Algo Advantage

Following our research on Uber, we have found that the company uses algorithms to balance supply and demand in different markets while also considering a capital allocation framework across geographies and products. The primary goal of these algorithms is to balance the market at the lowest possible aggregate cost while maximizing throughput. We believe the company's competitive position is achieved as a result of this process rather than a direct target.

Uber's algorithms can operate at a larger scale and over more extensive data sets than its competitors. One of the recent advancements is the ability to train models on global data assets instead of relying solely on city-by-city data. This approach allows the algorithms to identify patterns and similarities across different customers, occasions, cities, or neighborhoods that would be challenging for humans to detect.

These larger models provide Uber with a more significant advantage over competitors due to the global nature of the data. The company's multi-product and multi-geo approach allows for more data to be used for training, further enhancing its competitive edge.

Regarding the trade-off between growth and margins, Uber follows a capital allocation framework that considers both geography and product mix. If the company has margin flexibility, it will typically overinvest in geographies with lower margins or in certain products to improve its long-term growth rate. The capital allocation framework adapts based on geographic and product mix considerations, allowing Uber to maintain a balance between growth and profitability in various markets.

Financials & Valuation

In 2022, total gross bookings for Uber increased to $115 billion, marking a 33% year-over-year growth. This represents a compound annual growth rate ('CAGR') of 23.6% since 2018 when total gross bookings were $50 million.

Interestingly, Uber's Delivery segment has grown to be larger than its Mobility segment, with $56 billion in bookings in 2022 compared to Mobility's $53 billion. The Delivery segment saw rapid growth, increasing its gross bookings from $8 billion in 2018 to $56 billion in 2022, resulting in a CAGR of 47.3%. Meanwhile, the Mobility segment grew more modestly, with gross bookings rising from $42 billion in 2017 to $53 billion in 2022.

The Mobility take rate improved from 22.1% in 2018 to 26.6% in 2022, while the Delivery take rate jumped from 9.6% in 2018 to 19.5% in 2022. This resulted in a consolidated take rate of 27.6% in 2022, up from 20.7% in 2018, demonstrating Uber's significant ability to monetize its business.

In 2022, Uber's adjusted EBITDA reached $1.7 million, becoming positive for the first time in the company's history. However, the company remains unprofitable on a GAAP basis, with cash flow from operations at a negative $9 billion in 2022, and it is not expected to turn positive within the next three years.

Uber's balance sheet is not in an ideal position, with $4.2 billion in cash and cash equivalents but $9.3 billion in convertible notes and debt. Overall, the company has shown remarkable growth in both its segments, but it continues to face challenges in terms of profitability and cash flow.

In the evaluation of Uber's valuation, it is essential to consider that the company is not profitable. Resorting to adjusted earnings, adjusted EBITDA, and adjusted cash flow may provide an incomplete and potentially misleading picture. Instead, it is preferable to analyze all companies on an equal basis, focusing on standard financial metrics.

Due to Uber's lack of profitability, its valuation can be assessed based on its enterprise value (EV) to forward 12-month sales metric. Currently, the company is trading at an EV-to-sales multiple of 1.8, which is at the lower end of its three-year range. This valuation can be justified, given the growing concerns about the company's lack of profitability and the weakening macroeconomy. As Uber's business is sensitive to discretionary spending, a downturn in the broader economy could negatively impact its financial performance.

Risks

Adoption of ride-hailing: One major debate revolves around the adoption of shared mobility in the coming years. Bears argue that shared mobility will only replace taxi services and account for a small percentage of miles traveled, primarily in urban centers. However, the bullish view is that the convenience and affordability of shared mobility services could lead to greater market adoption than currently anticipated, potentially sustaining Uber's growth in the post-pandemic recovery phase. In this debate, we skew bearish in our views. Although the Uber model will certainly expand the market, it should not dramatically alter the aggregate demand for ride-hailing.

Sustainability of take-rate: Another point of contention concerns the sustainability of profitability in shared mobility and food delivery businesses. While bears worry about rising labor and insurance costs, bulls maintain that driver scale will lead to lower fulfillment costs and profitability at scale. The food delivery sector, in particular, will continue to face debates around unit economics and take rates for restaurants and grocery stores. However, optimists believe that businesses will eventually adapt their operations to leverage the advantages of third-party channels. On this debate, we again skew bearish. We do not believe Uber's scale is large enough to give it significant negotiating power in the vastly larger labor and restaurant market. In the end, we believe Uber to be largely a price taker.

Regulatory risks: The regulatory risk of owning Uber shares primarily revolves around the ongoing debate on driver classification, with recent events such as the reversal of a lower court's ruling on Proposition 22 in California, which allowed gig companies to classify drivers as independent contractors with added benefits. While the decision is likely to be appealed to the California Supreme Court, the outcome remains uncertain and could take a considerable amount of time. If Proposition 22 is repealed, it would be replaced by AB5, requiring gig companies to reclassify drivers as employees with full benefits and a higher minimum wage. This could potentially lead to declining service levels and higher prices, negatively impacting consumers and creating an unintended by-product of legislation. However, it is important to note that US regulatory policy may not always reflect its initial intention and outcomes similar to Proposition 22 in California could be more likely, focusing on driver protections for those pursuing full-time driving, which affects only a minority of drivers.

Conclusion

Uber has shown remarkable growth in its Mobility and Delivery segments, driven by its focus on return on investment and its ability to adapt to market changes. The company's multi-product membership platform and advanced algorithms offer a competitive advantage and potential for long-term growth. However, Uber faces challenges in terms of profitability, cash flow, and regulatory risks, making its future prospects uncertain. Investors should consider these factors and debates surrounding the company's potential for market adoption, the sustainability of its take rate, and regulatory risks before making investment decisions. In our view, we see the risks and rewards of owning Uber as balanced and therefore remain on the sidelines.

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