Uber Technologies Inc. (NYSE:UBER) has had a rough go of things since going public in May. Since its initial public offering, Uber's shares have fallen sharply; at $29.60 per share at the close on Nov. 29, the stock is down 30% from its market debut.
Yet for all its difficulties, Uber continues to enjoy strong support from a number of Wall Street analysts.While it may be true that hope springs eternal in the human breast, Uber's path to profitability is far less sure.
True believers keep the faith
Uber's boosters on Wall Street have not lost hope yet. They appear to believe that the company, despite its rocky start as a public entity, will prove the naysayers wrong by turning profitable within just a couple years. Benjamin Black of Evercore ISI is one such true believer. In an October update, the analyst argued that a pre-profit Uber represented an opportunity akin to those proferred by Amazon.com Inc. (NASDAQ:AMZN) and Netflix Inc. (NASDAQ:NFLX) during their early years of growing pains:
"If you look at the likes of Amazon or Netflix, if you had waited for profitability, you would have left a lot of money on the table."
Black has forecasted Uber to turn profitable in 2022, as will Lyft Inc. (NASDAQ:LYFT), the next-largest U.S. ride-hailing company. That is certainly more positive than the average Wall Street analyst; the current consensus estimate calls for Lyft to become profitable in 2023, while Uber is expected to take until 2025 to do the same.
Pricing power proving ephemeral
A key conceit of the Uber bull thesis is that, given sufficient scale and market share, the company will be able to increase prices and flip its staggering losses into big profits.
While this notion makes sense in theory, it is far from clear how this will play out in practice. The key problem facing Uber is that it is not a monopoly. It has a number of competitors, most notably Lyft. Both companies rely on drivers (employed as independent contractors in most jurisdictions) for their businesses to work. Competition for drivers thus creates a fundamental limiting factor for pricing power, as billionaire investor John Malone observed earlier this month:
"The problem is Uber's asset is the drivers and if the drivers work for two or three digital players it's not really your asset. They really need to capture those drivers even if it costs them something so they are not moving around & scale really means something. If I have 70% of cars in an area, customers are going to want to use me. Drivers will like that they'll make more money. Right now, where you have three or four competitors in a metro with drivers working for them all, I don't see where scale changes the economics."
Grubhub delivers a bitter lesson
To understand the scale of Uber's competitive problem, we can turn to another tech company operating in a similar sphere: Grubhub Inc. (NYSE:GRUB). Grubhub had hoped that scale in its food delivery business would eventually translate into pricing power. However, as CEO Matt Maloney pointed out during the third-quarter earnings call in October, this has simply not occurred:
"If you think about the industry historically, third-party delivery unlocked new pockets of growth over the past few years. But with all the major players, at least, expanded across the whole US delivery coverage has now been commoditized...we all have roughly the same algorithm, same driver interactions, the same ETAs, five minute difference in delivery time is negotiable for diners, effectively delivery as a function is commoditized and now with non-partnered restaurant inventory becoming more prevalent, supply side is soon going to be commoditized as well."
Uber faces essentially the same painful economic reality. It does not own the market thanks to existing and nascent competition. Thus, investor confidence in the company's imagined future pricing power, which has underpinned its premium valuation, appears wholly unfounded.
Major losses for minor growth
The bottom line is that Uber is playing in an industry rapidly approaching price commoditization. The company lacks control over the marketplace, as both consumers and drivers enjoy the capacity to engage in arbitrage between the various ride-sharing platforms. Raising prices or cutting driver pay will only serve to push users and drivers to rival services.
It is actually rather remarkable that Uber has managed to continually raise capital through equity and debt sales, even as the harsher economic reality has begun to set in.
In August, Jay Van Sciver of Hedgeye Research offered a somewhat prophetic take on Uber's plight:
"I think that when people look back at this particular market, what's the anomaly they're going to focus on? I think it's going to be the ability of these companies to do capital raise after capital raise in order to generate results that look pretty disappointing. I think what's going to come out is that the market opportunity is much smaller than people expected."
Uber is valued as if it will be the future of human transport with phenomenal pricing power and profits expected just around the proverbial corner. Investors would be wise to discount these rosy projections. The iron laws of economics cannot be overcome, no matter how much venture capital money gets thrown at them.
Disclosure: Author is short Uber.
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This article first appeared on GuruFocus.