Uber Disrupted An Industry, But Can It Make A Profit?

| About: Uber (UBER)

Summary

It is unclear whether Uber is a sustainable long-term business that justifies its current valuation.

Ride services are fungible and thus competition will drive down prices to the point of marginal supply.

Both drivers and consumers have no brand loyalty and thus the only incentives are convenience and price.

The result is that the long-term valuations of Uber is not justified by the long-term prospects for the company.

Loose capital markets will allow competitors to continue to challenge Uber.

Uber (Private:UBER) is at the very least, a complicated investment. It has done what many had hoped it would and disrupted the taxi industry. UBER caused entire industries to fight for survival, enter large legal battles, and lower the of cost transportation in many of the world's major cities. However, while it has evidently changed the way people think about taxis, it is less clear whether the business is a good long-term investment.

Competitive Advantage or Commodity?

At face value, Uber has no clear moat and has no unique technological advancement. Uber has the benefit of being first, and currently being the largest. Whether things will stay that way is another question. Companies like Uber are initially dependent on a critical mass - both of customers and drivers. Vast sums of money are spent subsidizing drivers to utilize the app. It is not surprising then that competitors offer similar discounts to encourage the same behavior. The result is that drivers just take advantage of the best deal available, a clear result of human behavior in response to incentives.

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Incentivizing Drivers

People respond to incentives. The issue that develops when a company offers something that is fungible, and in abundant supply, is that the product should drop to the marginal cost of supply (often overshooting the market and falling below the marginal cost of supply). With taxis, this was traditionally controlled via taxi medallions and regulation to prevent boom and bust, but also to protect private interests. With Uber, Lyft (Private:LYFT), Didi (Private:DIDI) and the like, they are all offering fundamentally the same thing to consumers. Therefore, where several companies offer sufficient supply of drivers, the price will be the primary driver of consumer behavior. On the driver side, the same behavior drives experiences. In fact, some drivers operate for both Lyft and Uber simultaneously, taking advantage of benefits on a day to day basis.

Low Capital Investment

One of the hallmarks of Uber is the capital-light model. They don't need to purchase cars, factories and other assets. Conversely, they have spent huge amounts of money subsidizing drivers, fighting lawsuits and encouraging regulation. It is not hard to imagine a situation where this could be worse. Rather than spending a lump of capital today, and receiving its spoils over the next few decades, Uber is left continually spending operational money with no certainty of future cash flows. Uber may have the largest market share today, but it lost in China to Didi and is likely to lose in other jurisdictions going forward. It is simply too easy for a company to develop competing technology. Competitors will continue to grow, and the margins of these companies will continue to fall.

Torching Piles Of Cash

Uber is self-reportedly burning through cash. Bloomberg quoted the Chief Product Officer saying "the cash-torching habits of the ride-hailing industry would change when the money train stops." And it is not surprising that this is the case. When you can only compete on cost and mass of drivers, the price is going to be driven down. With most if not all companies running loss-making operations, the price war will stop when capital markets say so. For now, Uber has been able to raise more money despite making a monumental $1.2-$1.7 bn loss in the first nine months of 2015. Furthermore, Uber has been able to borrow money at a low-risk rate of 4.5%.

Conclusions

Does it sound reasonable to expect a loss-making company with no technological moat and a fungible product, to borrow money and raise funds with little difficulty? Many would disagree, but this author does not think so. If Uber is successful in beating Lyft and other competitors, if it kills the taxi industry and grows the pie for all ride services, even then it is not safe. It may be able to raise prices for a while, but it becomes a matter of time before new competition comes. Perhaps in the form of independently run shuttle vans that exist in some U.S. states, or Jeepneys utilized in the Philippines. Tesla (NASDAQ:TSLA), Google (NASDAQ:GOOG) (NASDAQ:GOOGL), Ford (NYSE:F), Toyota (NYSE:TM) and a bevy of other companies are likely competitors in the future.

For now, I'm happy I can get an Uber where it's possible. It's convenient, relatively cheap, and easy to use. But, I have no brand loyalty and no reason to utilize them unless the convenience and cost justify it. If a new company opened up tomorrow offering the same service for less, I would quickly change ships. Herein lies the crux of Uber.

A Note On Self-Driving Cars

Self-driving cars are another focus of the company and worth a mention, with the idea to remove the human driver, and provide a service that costs a fraction of the one utilized today. Uber has teamed up with Volvo to develop the self-driving service. This again is a space in which they are far from the only competitor, fighting very large companies with driven leadership. For all these companies, the long-term result will be commoditization. Ride sharing or ride services are going to be fungible to consumers, and thus a moat cannot be developed. It does not mean that the industry won't exist, it simply means that the valuations of companies need to reflect this reality.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.