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Uber and Lyft: Dependence on Contractors Puts Rideshare Industry's Future in Doubt

Market enthusiasm for the disruptive potential of the rideshare industry remains high, as evidenced by the eye-watering market capitalizations of the two leading companies, Uber Technologies Inc. (NYSE:UBER) and Lyft Inc. (NASDAQ:LYFT).

Despite their attempts to diversify their value propositions through the addition of new services, such as food delivery and freight, Uber and Lyft share the same core business model: passenger ride-hailing. That is their bread and butter, and is likely to remain so for the foreseeable future.

The rideshare business model is highly reliant on a particular type of relationship with drivers. Drivers for Uber and Lyft are not employees. Rather, they are independent contractors. This distinction is critically important. Were Uber and Lyft required to treat their drivers as employees, they would be responsible for significant additional obligations and costs. Those higher cost would almost certainly end up driving both companies out of business.

No contractors, no business

Uber and Lyft have been big money losers since their inception. In the first quarter of 2019, Uber and Lyft posted net losses of $1.01 billion and $1.14 billion, respectively. Both companies said that these losses will diminish over time, with Lyft promising an inflection point from next year.

Yet, many analysts and commentators have questioned this rosy outlook, with some questioning whether they will ever make a profit. We have addressed this issue previously, but it bears repeating. In essence, Uber and Lyft have shown only limited ability to increase revenue per trip, while expenses such as advertising have continued to balloon.

Fundamentally, competition for riders and drivers has limited the power of rideshare businesses to extract significant economic value for themselves. If forced to treat drivers as employees, a challenging path to profitability would likely become an impossible one. Barclays has calculated that, in California alone, reclassification of drivers of employees would increase Uber's annual operating loss by more than $500 million, while Lyft would be out $290 million.

Politicians tightening the screws

Barclays' analysis of California was no mere thought experiment. Rather, it came in direct response to a bill making its way through the state's General Assembly that would set new limits on independent contracting. If enacted into law, Uber and Lyft drivers would be reclassified as employees. The bill was passed by the California State Assembly in May. After receiving overwhelming support from the lower house, it is easy to conclude that the bill will find a warm welcome when it reaches the floor of the state senate later this month.

Unsurprisingly, Uber and Lyft are deeply troubled by what is happening in California and have been fighting back hard in an effort to secure exemptions. They have ramped up their lobbying activities behind the scenes and have tried to push their drivers to voice opposition to the bill. Thus far, Uber and Lyft have seen little good come from these efforts. Public backlash from both drivers and labor groups has certainly not helped their cause.

The fight in California represents an existential threat to Uber and Lyft. If the bill passes into law, it will undoubtedly spark similar efforts in other states, as well as in major cities. Meanwhile, challenges in international jurisdictions, such as the class-action suit brought against Uber by a group of Australian drivers, will further threaten the rideshare industry.

Verdict

Thus far, investors have failed to acknowledge (or have simply discounted) the very serious challenges to the rideshare contractor model in jurisdictions across the country. That is wishful thinking.

Uber and Lyft face a clear and present danger from the litany of legislative, regulatory and legal challenges to their contractor-dependent business model. Investors ignore this threat at their peril.

Disclosure: Author is short Uber.

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This article first appeared on GuruFocus.