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Cheaper Doesn’t Mean Cheap for Lyft Stock

Vince Martin

Like so many other IPO stocks, Lyft (NASDAQ:LYFT) keeps falling. The LYFT stock price, just over $38, is barely half its IPO price of $72. The declines have been particularly nasty of late, with LYFT down 42% from highs on Aug. 8, the day after what looked like a solid second quarter earnings report.

Cheaper Doesn't Mean Cheap for the LYFT Stock Price

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Admittedly, LYFT does look intriguing here. It’s easy to forget amid the carnage in recent IPOs that Q2 earnings really were better than expected. The company raised full year guidance for revenue and lowered its outlook for Adjusted EBITDA loss.

Combined with disappointing results from rival Uber (NYSE:UBER), the quarter suggests that Lyft is taking market share. Meanwhile, valuation at least looks more reasonable after the nearly 50% haircut.

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EV/revenue of about 2.4x isn’t quite as cheap as it sounds given lower margins than other tech companies valued on a top-line basis. But using “contribution margin” — basically, adjusted gross profit — LYFT is trading at about 6x gross profit. The combination of a single-digit EV/GP valuation and 72% revenue growth, as Lyft posted in Q2, isn’t found in too many places in this market. The recent (albeit unproven) bottom in the LYFT stock price suggests at least some investors see value here.

But there are problems with assuming that LYFT is a “buy the dip” candidate. I believe it might be at some point. I don’t believe that point has arrived.

LYFT and the Private Market Problem

Many IPO stocks this year have plunged. LYFT is down almost half from its IPO price, and UBER 36%. Chewy (NYSE:CHWY) and Peloton Interactive (NASDAQ:PTON) are underwater. Slack Technologies (NYSE:WORK), until a recent bounce, had traded almost straight down after its direct listing.

The narrative has been that investors suddenly decided to stop buying unprofitable growth stocks. And trading in already-public names like Shopify (NYSE:SHOP) and Roku (NASDAQ:ROKU), plus the carnage among cannabis stocks, does suggest that valuation finally has become a point of focus.

What’s tempting about the narrative is that, presumably, sentiment can reverse. After all, growth has sharply outperformed value in this bull market, and after a pause, may well do so again.

But there’s something else going on with the recent batch of IPOs beyond just a lack of profitability. It seems increasingly clear in retrospect that the private markets that funded those companies before the IPO were in a bit of a bubble. The presence of Softbank (OTCMKTS:SFTBY) alone seems to have boosted valuations, as evidenced by its primary role in the WeWork debacle.

Softbank aside, private markets saw a flood of ‘dumb money’ from pension funds, mutual funds, family offices, and other investors chasing the “unicorn” boom. The flood led to ever-increasing valuations, based often on relatively small equity injections.

Those valuations went too far. And so the problem with a company like Lyft isn’t necessarily that investors decided to knock the valuation down to a current ~$8 billion (excluding net cash). It’s that the $15 billion valuation assigned last year was too high. Those late-stage investors, quite simply, didn’t know what they were doing. They created false expectations that public investors would pay even more. It’s now clear they won’t.

Two Key Questions for the LYFT Stock Price

And so it’s a poor argument to bet on LYFT simply because it’s cheaper than it was. It shouldn’t have had a $20 billion-plus valuation. It’s thus dangerous to hope that the LYFT stock price will follow that of Facebook (NASDAQ:FB) and Snap (NYSE:SNAP). Both of those companies saw steep post-IPO drawdowns — which were followed by multi-bagger rallies. Lyft’s inflated private valuation suggests that path is much less likely.

There are two key fundamental worries. The first, as I noted after the LYFT IPO back in May, is the company’s relatively modest growth in rides per user. The argument for big upside in both LYFT stock and UBER is based on the companies taking an increasing share of overall transportation. Simply splitting the existing taxi market isn’t enough.

Lyft didn’t break out figures after Q2. On the Q2 call, CFO Brian Roberts said that rides did outpace the growth in riders. In other words, rides per user increased. But it’s likely the increase was small — or else Lyft would have been trumpeting the figure, not ignoring it.

Given profitability concerns for both ridesharing companies, the increase almost certainly isn’t enough. Lyft can get to profitability, but that alone doesn’t support a ~$8 billion enterprise value.

Those profitability concerns also go to the question I’ve asked about UBER: is ridesharing really a profitable model? Investors have worries. Uber’s efforts in delivery and freight are one reason why I thought UBER would outperform LYFT — and despite declines in both stocks, it has.

But incremental margins in ridesharing simply may not be as high as hoped — which means profitability may be further off, and the LYFT stock price may well have even further to fall. All told, investors looking to buy the dip need to have faith in both the model and in management.

As of this writing, Vince Martin is long CHWY. He has no positions in any securities mentioned.

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