Investing in growth companies can be a tricky task, especially when a company is not yet profitable but growing. Uber Technologies (NYSE:UBER) is one of the most-followed growth companies today, and the company is trying to tap into profitability.
Uber's fate so far has been similar to that of many Unicorns listed this year, except Beyond Meat (BYND).
There is virtually no doubt that the company is operating in industries that are expected to grow exponentially in the future. This alone is not an indication of whether Uber is undervalued or overvalued at today's market price of around $32. Therefore, it's important to determine when Uber would be able to become profitable.
According to my estimates, Uber will turn an operating profit in 2027. Due to the significant uncertainty in the cash flows of the company, it's virtually impossible to determine the intrinsic value of shares with a discounted cash flow model. A peer comparison approach was used for this purpose, and the results indicate that UBER is trading at a discount to its fair value. However, shares are only suitable for growth-oriented, risk-seeking investors.
Uber provides a platform that allows users to access transportation and food ordering services online and operates under two business segments; Core Platform and Other Bets.
New Mobility platforms
Source: Company filings
The ridesharing platform and Uber Eats are the two primary services from which the company derives the majority of its revenue. The lesser-known Uber Freight segment creates an on-demand marketplace that connects shippers and carriers. The New Mobility platform, on the other hand, provides alternative access to rides through e-bikes and e-scooters.
The automotive industry is changing, once again. Since the invention of the wheel, private transportation has gone through a few eras of rapid changes, and the industry is poised to take another sharp turn in the next few years. IHS Markit says that selling miles traveled instead of cars will bring about the greatest transformation of the mobility industry since the dawn of the automotive age.
In a report titled Reinventing the Wheel, in which IHS Markit discusses the personal mobility industry in the U.S., Europe, China, and India, the research company projects exponential growth for miles traveled through 2040. However, the most notable development would be the growth of the mobility-as-a-service market (MaaS), which is expected to grow at a much higher rate than miles traveled on personal vehicles.
Source: IHS Markit
In addition to the billions of miles traveled on personal vehicles, ridesharing companies are targeting public transport miles as well. For instance, in its Prospectus, Uber revealed that the total addressable market opportunity for the company is 11.9 trillion miles traveled by individuals on a global basis, which is a combination of miles traveled from private vehicles and public transportation. The value of this market is $5.7 trillion, as per company filings.
Even though Uber, as the leader of the ridesharing industry, has a presence in 63 countries, the company is still addressing less than 1% of this market opportunity, which indicates the significant growth opportunities available in the industry.
Taking these into consideration, Mordor Intelligence projects that the ridesharing industry will grow at a compounded annual growth rate (CAGR) of 19.2% between 2018 and 2024. The increase in demand for cost-saving personal transportation options and the appeal of time-saving transport are expected to keep the demand heading in the right direction for many years to come.
The technological advancements related to the automotive industry are expected to result in higher demand for ridesharing companies as well. For instance, the invention of autonomous vehicles will likely make ridesharing an even easier task.
The prospects of the online food delivery industry should also be taken into consideration to conduct a thorough top-down analysis of Uber.
In a research report prepared in 2018, Frost & Sullivan estimated the value of the online food delivery industry at $82 billion in terms of gross revenue, and they project the industry to more than double by 2025, growing at a CAGR of 14%.
As of 2018, restaurant-to-consumer was by far the largest food delivery category and accounted for 81% of total revenue. However, the platform-to-consumer segment is expected to grow at a faster clip in the next decade.
Multiple tailwinds are driving the industry forward.
First, the growth of data-related concepts such as the Internet of Things (IoT) is prompting dynamic changes across many industries, including the food delivery industry. Customers prefer convenience and personalization capabilities more than ever, and online food delivery platforms are catering to this demand. With the expected technological advancements, including the rollout of 5G, the world would be a more connected place than ever and the demand for online delivery platforms will soar.
Second, the economic growth in developing countries will create demand for the industry, under the assumption that the percentage of the population with access to the internet will grow with economic growth.
The internet penetration in developed regions such as North America and Europe are high. However, the global average penetration is still 53%, mainly due to the less than 50% internet penetration in densely populated regions such as India and China. Not to forget, the economic growth in these regions is consistently higher than that of developed countries, and billions of dollars are invested in improving technological infrastructure.
GDP growth comparison (India, China, and the U.S.)
As per-capita income grows in emerging countries, access to internet will naturally increase. This will create demand for online food delivery companies, and many of the major players have completed several acquisitions to grab a piece of this growing market.
Third, restaurants are increasingly realizing the value of platform-to-consumer delivery services. The benefits include access to new markets and customers, zero investments required to set up and develop online ordering platforms, fewer mistakes on orders as these are handled by trained professionals, and zero maintenance expenses such as developing and training costs. Besides, partnering with a third-party delivery service ensures that restaurants do not have to invest in vehicles as well. All these benefits will create a robust demand for third-party delivery service companies in the future.
Overall, both the ridesharing and online food delivery industries are poised to grow exponentially in the next decade. However, this doesn't guarantee higher earnings for all companies representing these markets.
Adjusted net revenue has grown consistently since the second quarter of 2017, except for Q4 2018, in which a marginal decline was reported. The growth rates have declined, but Uber is still growing at double-digit rates.
Adjusted net revenue (millions)
Despite revenue growth, Uber is still failing to generate positive EBITDA from its business operations. The lowest EBITDA loss was reported in the first quarter of 2018. However, since then, the loss has widened.
Adjusted EBITDA (millions)
Source: Second-quarter earnings presentation
There were multiple reasons behind this deterioration of the EBITDA margin. The rise in the cost of revenue and sales & marketing expenses stand out as the two primary reasons behind the margin compression.
Source: Company filings
At the end of the second quarter, Uber had 99 million active users on its platforms, in comparison to 57 million in the second quarter of 2017. In fact, monthly active users have grown in each of the last 9 quarters, indicating the ability of Uber to acquire new customers regularly.
From a rideshare perspective, what is more interesting is the number of trips taken by an active user. Two years ago, users took, on average, 5.2 trips per month. However, this has grown to 5.6 trips at the end of the second quarter. The expected growth of active users and the results of the survey conducted by McKinsey (more on this in the next segment) paints a positive outlook for Uber in the future.
Uber does not make profits, still. However, this is not an uncommon characteristic of growth companies. Initially, a disruptive company with a unique business idea will post massive losses before reaching profitability. Nonetheless, not all growth companies turn out to be good investments as well since there's always the possibility of competition heating up and eating a significant market share before a company reaches profitability. This will eventually wipe billions of dollars' worth investments off the table.
There are many reasons to believe that Uber will eventually become profitable within the next decade.
First, the company is slowly but surely building competitive advantages around its business operations, mainly due to its network effect. The massive growth of active users on the platform has a snowball effect, and the company would eventually have millions, if not billions of users, to market their products and services to. Uber's massive scale is indicative of the current market dominance, which can be expected to grow in the future.
Second, the number of trips taken by a customer can be expected to increase in the future. A survey by McKinsey revealed that the majority of existing users of ride-hailing and car-sharing services are likely to increase the usage of such services in the next couple of years.
Uber's efforts to win market share in key target locations will pay off in the next decade as users take multiple rides per day and ridesharing becomes the preferred mode of transportation over personal vehicles.
Uber Eats will turn out to be a value driver as well, even though this business segment is making losses, which is the same across all the major online food delivery companies. The primary reason behind this unprofitable nature of the industry is predatory pricing. There is intense competition, and leading players including Uber Eats use pricing strategies in a bid to enhance their market share, resulting from losses. The high cash burn rates are also a concern as companies shell billions of dollars to expand into new markets or acquire smaller companies. Despite these worries, the food delivery industry will turn around and be profitable as leading players emerge as winners, and the market structure shows oligopolistic characteristics. Competition beyond the major players (Uber Eats, GrubHub, Door Dash, Just Eat, and Takeaway.com) will be fragmented.
An interesting development is an attempt by food delivery companies to integrate into the supply chain operations of restaurants. For example, Zomato, the leading player of the industry in India, has set up gigantic warehouses across the country to store fresh produce and other raw materials. The company is trying to be the only intermediary in the whole business chain and is reducing the cost of customers by significant margins. Uber Eats will likely adopt this strategy as well, in the future. Soon, Uber Eats will be a major player in the entire restaurant industry on a global scale.
As of the second quarter, Uber had partnerships with 315,000 global restaurants. The partners of the program will only increase in the future as restaurants try to maximize the benefits of partnering with a third-party delivery provider. The massive scale and brand value of Uber will also come into play when onboarding new clients.
Uber's primary strategy is to dominate the industry first and then raise the take rate. The company management and many analysts are bullish on the ability of Uber to generate a liquidity network effect where the value of the company and the platform increases with the growth of users.
Another growth strategy rolled out by Uber is the rewards program in the United States. As rewards and benefits accrue, users are likely to stick to Uber to fulfill ridesharing and food delivery requirements.
There are exciting developments that are yet to see global adoption as well. For instance, Uber Health is making rapid advances and the segment revenue grew 400% year-over-year in the second quarter. The company will likely roll out this platform on a global basis in the coming years, which should help address the opportunities in the billion-dollar healthcare industry in Asia and Europe.
Valuating an unprofitable business is a tricky task, but not impossible. I believe the best way to value Uber is to project the growth of the two major industries the company operates in (ridesharing and food delivery) and estimate the market share of Uber to derive revenue.
Research & development costs and general administration costs have a high proportion of fixed costs. Therefore, when revenue grows, operating costs should ideally decline as a percentage of revenue. The below target ratios were used to determine when Uber would be profitable.
Cost of revenue/revenue
Operations and support costs/revenue
Sales and marketing costs/revenue
Research and development costs/revenue
General and administration costs/revenue
Source: Company filings and author's estimates
According to data from Frost & Sullivan and Goldman Sachs, Uber's market share in the food delivery industry and ridesharing industry is 10% and 50-70%, respectively. In my valuation model, I assumed that these take rates would be maintained in the future, which is a conservative assumption as Uber will likely grow its market share in both these industries.
The two industries are expected to grow exponentially in the next decade, and below values were used to determine the total revenue of Uber.
Food delivery industry
Frost & Sullivan projects the industry to grow from $82 billion in 2018 to $365 billion in 2030.
Goldman Sachs projects the industry to grow from $73 billion in 2018 to $285 billion in 2030.
Source: Goldman Sachs and Frost & Sullivan
The below snapshot from my model reveals that Uber will generate an operating profit in 2027.
Source: Author's estimates and calculations
According to data from DBS Group Research, ride-hailing companies that were financed recently (IPOs, debt issuance, or venture capital) had an enterprise value to revenue ratio of 8. This includes data from transactions completed by Uber, Lyft, and Grab. Reuters projects Uber to report $12.2 billion in revenue for the current financial year. Accordingly, Uber's enterprise value based on peer multiples is $97.6 billion.
The below table depicts the equity value of Uber.
Source: Company filings and author's calculations
With 1.11 billion shares outstanding, the fair value per share comes to $94.07, which represents an upside of 193% from the current market price of around $32.
Despite this significant upside, investors need to factor in a few other important points as well. Uber is still an unprofitable company, and it would take nearly 8 years according to my model for Uber to generate an operating profit. During this extensive period, things might change drastically, and Uber could face headwinds that are not known today.
Next, the derived fair value is reliant on many assumptions. The probability of one of these assumptions turning out to be inaccurate is high.
Finally, the enterprise value to revenue ratio at which the recent funding rounds were completed may be expensive. A small change in this ratio leads to massive changes in the fair value estimate.
Investing in the stock market has inherent risks, but picking a growth company that does not make profits to invest in has the added disadvantage of relying on numbers and not on historical performance. Uber falls into this category. However, the attractive growth prospects of Uber need some attention.
I find Uber shares undervalued at these prices but wary about the risks attached to the company as well. Growth investors with an extensive investment time horizon should see Uber as an attractive long-term play, but the position should not give headaches to the investor. Well and truly, Uber is a high risk-high reward investment opportunity.
If you enjoyed this article and wish to receive updates on my latest research, click "Follow" next to my name at the top of this article.
We provide portfolio strategies and investment ideas to investors interested in generating portfolio income. Our asset allocation strategies guide investors on where to find the best income-generating ideas and we provide individual security coverage on REITs, Dividend Stocks, MLPs, Preferred Equity, ETFs, Closed-End Funds, and Bonds.
Get access to our 5 Income Portfolios and research including
This article was written by
I am an investment analyst with 7 years of experience in financial markets. I specialize in U.S. equities and incorporate a top-down approach to identify developing macro-level trends and the companies that would benefit from such trends. I am a strong believer that the best investment opportunities could be found in under-covered equities. Please click the "Follow" button to get timely updates on new articles.
I am the founder of Leads From Gurus, a Marketplace service on Seeking Alpha that focuses on uncovering alpha-generating opportunities.
I currently work with leading financial publications including Refinitiv, Seeking Alpha, ValueWalk, and GuruFocus.
I'm a CFA level 3 candidate, an Associate Member of the Chartered Institute for Securities and Investment (CISI, UK), and a candidate in the Chartered Wealth Manager program.
During my free time, I enjoy reading.
Disclosure: I am/we are long UBER. 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.