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Is the Government in Your Portfolio?

Jeff Remsburg

New legislation in California could increase costs for the companies behind two widely held stocks … and it could just be beginning

Today, let’s talk about the government, your investment dollars, and the law of unintended consequences …

To begin, please understand that I’m not writing this Digest advocating a specific political position. In fact, I’d like politics to stay out of it. I write purely from an investment orientation.

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With that established, in the past few days, news has come out of California that state politicians passed a landmark bill that would require “gig economy” employers — notably, ridesharing companies, Uber and Lyft, to reclassify certain workers as employees rather than contractors.

The legislation comes from a noble place — it’s intended to support and protect the individual worker who, historically, has had little power against the corporation.

However, there’s a very real risk that the unintended consequences of such legislation could hurt some of the same workers this law is meant to protect … and it could hurt investors like you and me who might have our dollars invested in gig-economy companies.

Pulling back, we’ve entered a marvelous age of technological advancement. What we’re able to accomplish on our smartphones in just seconds was literally unthinkable just a decade ago. At no other time in human history have our lives been more convenient. And it’s only going to get better.

With all the advancements that are coming, tech investors stand to make massive wealth over the next decade. For example, our own analysts, Matt McCall and Louis Navellier have been writing about huge breakthroughs in 5G, cutting-edge batteries, precision medicine, artificial intelligence, and far more.

But, as the news from California illustrates, investors need to be mindful of the impact the government may have on the growth of specific trends, industries, and companies. Well-intentioned laws may have very real negative, unintended consequences.

So, in today’s Digest, let’s look a bit deeper into the interplay between technological advancements, the government, and your investments.

***”One of the most controversial (bills) of the year”

That’s how the Los Angeles Times describes Assembly Bill 5, which California state senators just passed. If signed into law by Governor Gavin Newsom, it would require “gig economy” workers to be reclassified as employees instead of contractors.

Someone who’s an “employee” as defined by the bill is eligible for benefits, including a minimum hourly wage, workers’ compensation, and protection from discrimination and sexual harassment.

Now, we’re all for additional benefits to employees in the abstract. But the challenge is to analyze the full-spectrum impact of such a decision in detail.

So, what’s the overview from both sides? Well, on one hand, we have the drivers who claim they’re working long hours, and that after doing the math, they’re working for less than minimum wage. And in fact, a recent analysis of Uber drivers’ wages, conducted by the pro-labor think tank Economic Policy Institute, finds that they take home about $9.21 an hour, or less than minimum wage.

Uber’s chief economist, Jonathan Hall, rejects this number, and suggests the per-hour figure after expenses is $13.04.

But if the number is, in fact, $9.21, that would put Uber drivers in the bottom 10% of wage earners. It would also fall below the mandated minimum wage in nine of 20 major markets, including Chicago, Los Angeles, and New York.

On the other hand, Uber’s chief legal officer reports that 45% of Uber’s drivers are on the road less than 10 hours a week, and 92% drive less than 40 hours a week. Working these limited hours points toward their classification as contractors instead of employees. The Fair Labor Standards Act does not apply the minimum wage payment requirement to independent contractors.

***So, what might be the unintended consequence of this bill?

Well, the Los Angeles Times points out that affected businesses say the extra benefits will add as much as 30% to their labor costs. This raises concerns about whether companies will be forced to cut their workforce to handle the higher costs that are a part of legislative compliance.

Stanford Law School Professor Bill Gould recently described it this way:

Uber and Lyft have often spoken about the loss of flexibility in number of hours worked or timing of work in the event that drivers become employees. Though this doesn’t follow as a matter of law that there will be fixed schedules, it is likely that schedules will be set and the number of drivers reduced.

In fact, in a recent blog post, ride-sharing giant, Uber, wrote that the bill could lead to it engaging “far fewer drivers than we currently support.” This would obviously hurt some of the very same drivers the law is intended to help.

I live in Los Angeles and often use Lyft and Uber. I regularly chat with drivers who reveal that they’re aspiring actors, aspiring musicians, retirees, or small business entrepreneurs who like driving because their hours are highly irregular. Driving is just their “side gig” for extra cash because it enables them to drive as little or much as they want as they focus on their primary aspirations.

These are the drivers that could be hurt if this legislation is enacted.

In essence, the law could simply shift work away from these limited-time drivers, while toward those individuals able and wanting to drive more regular, established hours — in many cases, as their full-time job.

So, from this context, is this law really a benefit to all contractor drivers?

***The alternative to reducing the number of paid drivers is companies passing through the added labor costs to the customer

Of course, it’s Econ 101 that if costs rise too much, it would reduce demand for the service, impacting the company’s profitability. That could curtail hiring, as well as negatively affect the stock price for investors like you and me.

It’s unclear exactly where this “pass-through” line is, and we’re not arguing a modest increase in Lyft and Uber prices would have this effect. But it’s a conversation that Uber and Lyft investors need to have … because it’s not at all clear that our politicians are having it.

***For example, Lorena Gonzalez (D-San Diego), the author of the California bill recently tweeted the following about Lyft and Uber, which reflects a serious misunderstanding of the situation

Here’s her tweet, referencing Uber and Lyft and their payment policy:

The problem is Gonzalez is confusing a few “billionaire” individuals with “Uber” and “Lyft” themselves. It’s a critical distinction that must be made, so let’s make sure we’re clear here …

Are some of Uber’s and Lyft’s key executives and principle investors billionaires? Yes.

But the new legislation is not targeting these executives or investors — it’s targeting, in this case, Lyft and Uber, specifically, as companies.

So, are Lyft and Uber, as companies, billionaires? Are they hoarding massive cash profits on their balance sheets that could be used to “pay your damn workers!”?

No — neither company has ever earned a single dollar of profit, nor are they close at the moment. They are burning through a mountain of debt and cash from investors in order to survive. For example, Lyft lost $644 million in the second quarter of 2019. Of course, that was nothing compared to Uber’s loss of $5 billion over the same period.

Despite how Gonzalez’s tweet makes it appear, these are not wildly-profitable businesses, flush with free-cash-flow from healthy operations that are refusing to pay their drivers their fair share. At present, they are money-losing businesses that are hemorrhaging cash, that will face an even steeper uphill climb toward profitability if/when a 30% labor cost increase is tacked onto their P&L statements.

If you’re an investor in either Lyft or Uber, you’re already watching this cash-flow issue. Now that the California government is getting involved (and potentially setting an example for other states), your eyes should be glued to it.

***Another recent comment from Gonzalez reflects an even greater lack of understanding

She recently said:

We will not in good conscience allow free-riding businesses to continue to pass their own business costs on to taxpayers and workers. It’s our job to look out for working men and women, not Wall Street and their get-rich-quick IPOs.

First, have Uber and Lyft created “get-rich-quick” IPO profits for Wall Street investors?

Well, Lyft investors who got in at the IPO are currently down 35% …

Meanwhile, Uber investors who got in at the IPO are down nearly 24% as I write …

The reality is Uber has destroyed more than $12 billion of investment wealth since its stock began trading. I would say that doesn’t qualify as a get-rich-scheme.

Second, we’ve been seeing a shift in the IPO market in recent years in which companies have been staying private longer than ever. So, not only is the “rich” in Gonzalez’s alleged “get rich quick IPO” accusation debatable, so is the “quick” part as well.

The reality is because private companies — most notably Uber — spent far longer in the private market before going public, it has resulted in more riches funneling toward a select few private investors in Silicon Valley … rather than public investors on Wall Street.

But don’t take my word for it. It was famed private venture investor Marc Andreessen who called “the effective death of the IPO” in 2014, saying that tech companies that stay private for longer periods of time mean “gains from the growth accrue to the private investor, not the public investor.”

With all this in mind, it’s hard to take Gonzalez’s “get-rich-quick IPO” jab as anything other than political pandering. But pandering or not, it could affect the business climate for Lyft and Uber … and by extension, their investors.

***This entire issue points us toward a critical question we each must answer as investors …

How vulnerable are our portfolios to government regulation — whether that regulation has wonderful or less-than-wonderful consequences?

Over recent months, it’s become fashionable for politicians to cry “foul play” and call for greater regulation of Big Tech. We’re not making the case for or against such regulation — rather, we’re simply asking, “are you exposed to it if/when it happens? Are you aware of how it could affect your portfolio? And are you comfortable with that?”

In all likelihood, this is just the beginning. Think about the advances we’re going to see in the coming decade — from greater internet connectivity, to delivery drones zooming through air, to renewable energy, to self-driving cars, and far more. Do you believe the tendency will be for the government to engage in greater or lesser regulation of these technologies?

Taken a step further, do you believe we’ll have greater or fewer politicians like Lorena Gonzalez who publish tweets that reflect confusion as to how businesses and our investment markets actually work?

Bottom line, as we continue into this great age of technology, perhaps one of our new checklist questions before buying any investment should be “how exposed to government regulation is this company, and are we comfortable with that?”

As to the Lyft/Uber driver situation, it’s a thorny issue. It seems fair that individuals who drive full-time should earn at least a minimum wage. Yet a huge percentage of drivers aren’t working full-time. How do you account for these different groups with one policy? Regardless of what you believe is the answer, as an investor, this is something to keep on your radar as we go forward.

Have a good evening,

Jeff Remsburg

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