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Swelling Insurance Costs and More Red Flags in Lyft’s IPO

John Jannarone

 

Ridesharing Company Expected to Price IPO Later This Week

By John Jannarone

Netflix, Snapchat, Grubhub – technology companies with blistering growth but little to no profit can be tempting investments. In the case of number-two ridesharing operator Lyft, investors should be careful before stepping aboard.

Lyft, which is expected to price its IPO this week, will command a hefty $22 billion market capitalization assuming the shares price at $65 each. The attraction for most investors is the company’s surging revenue: Sales doubled in 2018 and analysts at Renaissance Capital expect 47% growth this year.

But questions remain about when – or even if – the company will achieve profitability. Lyft posted a negative Ebitda margin of 43.7% on sales of $2.16 billion last year. Even bullish analysts such as D.A. Davidson, which initiated the stock as a “buy”, expect negative Ebitda till at least 2022 due to obvious factors such as competitiveness both among drivers and customers.

Another little-noticed fact in the company’s 990-page S-1 registration statement: Lyft may be just as much in the insurance business as it is in the ridesharing technology business. The company must spend heavily to insure against accidents, and while disclosures are minimal, it’s easy to see that such expenses will likely keep rising.

Consider the company’s cost of revenue, which jumped 89% to $1.2 billion in 2018 from $660 million in 2017. Some $319 million, or more than half of that rise, was due to higher insurance costs.

Significantly, Lyft made the decision to manage that risk under its own roof. In the S-1, Lyft says “we have elected to reinsure substantially all of our financial risk with respect to auto-related incidents in the United States using our wholly-owned insurance subsidiary.” In other words, the company insures some through third-party insurers, but the vast majority of the responsibility is on Lyft itself.

That requires Lyft to analyze insurance risks and keep reserves on hand for possible claims, which may not be its strong suit. “We establish insurance reserves for claims incurred and related estimable expenses, which we evaluate for appropriateness with insurance claim reserve valuations provided by an independent third-party actuary, but making such determinations is inherently difficult and our actual insurance-related costs may deviate from our insurance reserves,” the S-1 filing says.

As Lyft grows, it looks likely to need to set aside more cash for its insurance subsidiary. The amount in the subsidiary’s trust has ballooned to $864 million at the end of 2018 from $118.3 million at the end of 2016.

And insurance costs could rise further if Lyft’s relationship with its drivers changes. At the moment, Lyft generally treats drivers as contractors rather than employees. But that legal definition has been hotly contested. If Lyft were forced to classify drivers as employees, a host of costs may rise and it may also create greater potential liability the company level.

Of course, Lyft has other growth initiatives that could someday deliver a profit windfall. Take its electronic scooter rentals. Lyft touts the potential of scooters in its investor roadshow presentation and mentions “scooter” no less than 159 times in its registration statement, according to Sentieo.

But the scooter landscape is crowded with rivals including Bird and Lime that have a first-mover advantage in many locations. Some regulators have placed bans on scooters after deadly accidents. That also raises questions about how much insurance will be needed for scooters over time, potentially inflating costs further.

Governance at Lyft could also prove problematic. Co-founders Logan Green and John Zimmer own super-voting shares with 20 votes per share, giving them a combined 49% voting control of the company. As a result, even a large shareholder may struggle to effect board changes in the event Lyft becomes a disappointment to investors. Lyft didn’t respond to multiple requests for comment from IPO Edge.

The big hope for Lyft investors is that a major shift occurs among car owners who give up their vehicles in exchange for ridesharing. But it’s still hard to imagine people doing so outside of densely-populated areas. In many cases, it would be far cheaper to make a car payment than to hail a Lyft for regular trips like work commutes.

Indeed, while there has been a gradual shift to large, crowded cities, it is likely to creep on over decades rather than years. The United Nations predicts 68% of the world population will be in urban areas by 2050, versus 55% today. Even then, there are competitors in addition to Uber that have already become well known locally, such as Juno or Via in New York City.

In the meantime, investors who buy Lyft at the expected IPO price will pay an enterprise value of 5.6 times 2019 estimated sales, according to Renaissance Capital. Several other fast-growing technology service companies with positive Ebitda are already cheaper, with Grubhub at less than 5 times, Spotify at 3.3 times, and Zillow at 3.4 times.

With profits so far away and minimal disclosure about Lyft’s plans to get there, investors should think twice about hailing this ride.

 

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John Jannarone, Editor-in-Chief

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