Summary

Lyft has filed paperwork for an imminent IPO.

The ride-hailing business disclosed big losses in 2018, but laid out metrics it hopes will show a path to future profitability.

A close look at Lyft’s financials show little room for further margin expansion; without this growth, the valuation narrative collapses.

Lyft may never be profitable, thanks to the economics of the industry and the highly competitive landscape.

After the initial enthusiasm subsides post-IPO, Lyft should present a strong shorting opportunity similar to Uber.

2019 is shaping up to be a big year for tech IPOs. On March 1st, Lyft (LYFT) joined the fray, officially filing its paperwork with the SEC in preparation of an imminent public offering. This came as a surprise to no one, since the ride-hailing startup has been gunning for months to beat its larger rival, Uber Technologies (UBER), to the public market.

Lyft’s timing makes sense, and the market looks set to welcome it with enthusiasm. Yet, investors would be wise to steer clear of the stock when it begins trading. Hefty losses in 2018 look set to be repeated in 2019, with little indication of profitability anytime soon.

While active price support by the underwriters combined with significant investor enthusiasm could well see the stock lift off from its opening price, it is unlikely to last. Lyft appears poised to disappoint in the quarters ahead, which could present a shorting opportunity once the initial enthusiasm and lockup-induced volatility have subsided.

Valuation is a Heavy Lift

A quick look at Lyft’s S-1 reveals the key financial highlights. In 2018, Lyft brought in $2.16 billion in revenue from 1.9 million drivers around the world. Unfortunately, that big top line failed to translate to the bottom line. The company reported negative cash flow from operations of $280.7 million and a net loss of $911.3 million. A loss of nearly $1 billion is obviously unsustainable. Hence, the IPO is first and foremost a method of pulling in much needed cash.

As with any other security, valuation is key to understanding the attractiveness of an IPO. Lyft has been guiding for an initial valuation range of $20 billion to $25 billion. That is a significant range, but such is to be expected when dealing with the inherent volatility of an IPO. However, even taking the lower bound of the valuation, Lyft looks extremely pricey.

The company has attempted to justify its valuation by citing a number of key metrics. Revenue as a percentage of bookings – or “take rate” – has been climbing sequentially for some time. In Q4 2018, it hit a whopping 28.7%.

Lyft also points to rider growth. Dividing them by annual cohort, Lyft highlights two factors critical to its growth narrative:

  • Cohort size has grown every year
  • Rides per cohort have grown over time

Another key metric is profit margin. When looking at a company that is posting big losses, the justification must be built around eventual margin expansion. Lyft shares margin data on what it calls “contribution margin”, which appears to simply be gross margin. According to the S-1, this margin hit an all-time high of 48.5% in Q4 2018.

While these elements all appear positive at first glance, taking a closer look reveals a more complex story. Starting with the take rate, it appears that the growth may be approaching a ceiling. This is due to what appears to be limited leverage. Operational leverage looks limited, perhaps even tapped out. This issue translates to margins, which likewise look difficult to expand much further. Lyft reports only limited leverage improvement to the Selling and Marketing (“S&M”) and General and Administrative (“G&A”) line items. That bodes ill for future margin expansion, throwing the prospect of future profitability into considerable doubt.

These issues are compounded by a closer look at the cohorts. Annual cohort sizes have been rising, as has overall usage, yet Lyft’s own numbers seem to suggest that the newer cohorts are growing more slowly than their predecessors. Moreover, there appears to be increasing slippage, with lower retention each year.

Furthermore, this first offering is unlikely to be Lyft’s last. In its filing, it claims to have sufficient cash for 12 months, but will have to tap capital markets once again in order to sustain operations beyond that point. While Lyft says it could turn to debt markets, it is quite likely that it will engage in further dilutive stock offerings to fund its growth.

Investor’s Eye View

Overall, Lyft’s valuation looks too rich and its growth story looks very shaky under the surface. The company’s underlying economic fundamentals, as revealed in its S-1 filing, do not merit the $20 billion-plus valuation currently assigned. Indeed, we are dubious about Lyft’s ability to ever successfully turn the corner into lasting profitability.

Even if Lyft was the only significant player in the ride-hailing market, the valuation and growth narrative look dubious. But, as it so happens, Lyft is far from alone in the marketplace. Numerous regional and global rivals are competing in the same space. Uber, which plans to go public later this year as well, remains the biggest fish in the ride-hailing pond. Uber is aiming for a much larger $120 billion valuation. This makes sense in the context of the market, since Uber saw higher revenues in Q4 2018 than Lyft did for the whole year.

Yet, as we have discussed in a previous research note, Uber’s valuation cannot be justified. With slowing revenue growth and massive quarterly losses, we pegged Uber as a clear shorting opportunity in the months after its IPO. With similar economics, little prospect for profit anytime soon (if ever), and an intense competitive landscape, Lyft should also end up being a solid short.

~source