Summary

UBER was a great idea to modernize the centuries-old taxi and delivery businesses. These are, however, low-to-no margin opportunities.

Fundamentals have peaked.

Cash burn is very large relative to the balance sheet and the business opportunity; Over the next few years, UBER will need to raise significantly more cash to remain liquid.

$54.6BN enterprise value is not supported by the business opportunity and is based on the belief of multi-billions of EBITDA right around the corner. That’s not the reality.

There is no catalyst to change profitability or cash burn. A significant price reckoning is coming.

The Trade

Short UBER common stock outright.

  1. UBER’s corporate strategy keeps changing.
  2. The businesses are struggling: Revenue growth is slowing. Operating Margins are shrinking. Losses are growing. Cash is burning. The balance sheet is levering dangerously, as cash balances have been depleted and UBER is forced to raise more junk debt.
  3. Regulators are cracking down on abuse: California and New York, just to start.

In summary, this fact pattern indicates that UBER is less likely the next Amazon and more likely the next WeWork or Pets.com.

Discussion

  1. UBER’s corporate strategy keeps changing. UBER was originally a “mobility” company, providing a platform to connect independent drivers who needed cash with passengers who needed a ride. UBER planned to establish a foothold by giving away rides at a significant loss. They were able to build a customer base. The plan was to then raise prices, but as localities saw them underpricing and destroying the highly regulated local taxi business, local governments began to regulate UBER, and costs went up faster than revenues. So while revenues have grown rapidly, expenses keep growing even faster. UBER and its investors began to realize that there were no magic elixirs to make money in the centuries-old taxi business. It is not an economy-of-scale business – unless they can enjoy monopoly pricing. So they set out to exit markets in which they could not gain monopoly pricing, which led them to become equity investors in various places around the world. (So far, most of these don’t make money either, but enjoy the capital markets boost that comes with today’s liquidity environment.) Since predatory monopolies are generally out of favor in the United States, UBER was forced to look at new business propositions. They would exit the US mobility business if they could. However, they can not because that is the core of the business and was the basis on which they raised tens of billions of dollars at valuations as high as $72BN!!! They raised this money on promises to replace individual car ownership with UBER for all. This hasn’t happened.UBER then talked about being a data collection company, that was going to track people’s movements, and monetize the data. That went nowhere.Then, UBER added UBER Eats, a delivery business, both from restaurants and grocery stores. The delivery business is, at best, a low margin business. This business can make a tiny amount of money, but only at the expense of a predatory relationship with desperate restaurants. The best case comes only when restaurants are forced out of desperation to give away 20% or even 30% of sales. It is also surprising that even in the era of COVID-19, with tens of millions of new customers, UBER Eats still can not make money. That failure is also evidenced by the current effort to create monopoly pricing power with GRUB. This deal is unlikely to make it through the anti-trust process.UBER also continues to pursue R&D, with hopes of developing autonomous vehicles. This business makes no money, and while quite interesting, autonomous vehicles are not a money making proposition for the period of the model.

2. The business is struggling, and there is no catalyst for change:

(A) Revenue is slowing.

Let’s start with a look at revenues and gross margins.

Exhibit: Revenues and Margins

a

The revenue growth over the last 5 years has gone from 100% to 40% to 25% to 11.1% expected CAGR (skipping over the COVID-19 impacted 2020, and looking at 2019 through 2021). Certainly solid. But not special, and not supportive of infinite cash flow multiples. The top line growth is simply no longer there. Note, that even prior to COVID-19 growth expectations had dropped by more than half, to 22%. (But that world no longer exists.)

At the same time, gross margins have settled in around 50%. However, gross margins do not communicate much information other than they tell us how UBER has chosen to allocate certain costs. These costs are inseparable from the product, and gross margin is indicative of nothing without including SGA. It’s not as if UBER can hive off the mobility business and keep the bulk of SG&A with the remaining business. These are one and the same.

Exhibit: Illustrative 2 year growth rates, with and without COVID-19. Even prior to COVID, growth has been cut in half from the previous period:

b

(B) Operating Margins are shrinking. Losses are growing.

The data suggest that the more revenues grow, the more money is lost.

Exhibit: Revenues and Operating Expenses

c

Operating expenses have been trending from north of 100% of sales to 74% then back over 100% – and this is pre-COVID-19. Even in 2 years the consensus still expects more than $2 billion of operating losses. See the Cumulative line which indicates cumulative operating losses since 2015 accruing to nearly $25 billion by 2021. At this stage of maturity, operating expenses should be showing the benefits of scale. However, here we see the opposite. The more UBER grows, the more money it loses.

(C) Cash is burning and the balance sheet is levering.

Exhibit: Cash Burn and Net Debt.

In the 1Q of 2020 alone, UBER burned $3.7BN of cash. This is why they chose to raise $900MM of junk debt at a 7.5% interest rate during the middle of a pandemic this month– they had to. No issuer would raise in this environment unless they were concerned about future liquidity. During the quarter, UBER went from a net cash position of $5.6BN to a net cash position of only $1.9BN. This could be considered an alarming rate of cash burn, and indicates UBER will turn into a net debtor at the end of the 2Q 2020.

d

While there are numerous items that impact cash, it is important to highlight that this $3.6BN cash burn came in spite of a $531MM cash infusion from selling down accounts receivable from $1.2BN to $683MM.

3. Regulators are cracking down. The State of California has recently sued UBER, accusing them of classifying their drivers improperly as independent contractors instead of employees, evading workplace protections and withholding worker benefits. This lawsuit has the capacity to severely impair UBER’s business model. The concept is that UBER pays below minimum wage and no benefits, forcing taxpayers to subsidize its workers.The City of New York recently enacted a new anti-predatory pricing law that limits delivery pricing. Numerous other municipalities are considering similar lawsuits and regulations on both fronts.

Valuation

UBER’s 1.7 billion shares currently trade around $32 for a market capitalization of $56.5BN. Net debt is actually a net cash position of $1.9BN, including the April 1 payment of $891MM to Careem, and the $463MM incremental convertible note also payable to Careem. Enterprise value is $54.6BN.

This business just doesn’t make money, and will not make money for the foreseeable future. Net losses are massive; cash burn is massive; drivers barely make a living; and restaurants have been giving away most of their profit margin. None of these are sustainable.

In a best case scenario, UBER continues to grow in the high single digits, achieves a few hundred million of free cash flow, and may be worth about $5 – $10BN, or around $2 – $5 per share on a speculative basis.

In a base case, UBER runs out of cash within 3 or 4 years, is forced to raise capital at distressed prices, and ultimately turns into a zero.

Worst case, the base case happens more quickly as a result of the loss of 50% or more of its revenues from COVID-19.

It is worth noting that AirBnB, a still-private and once promising company, has recently seen its valuation cut in half. It is likely that UBER has enjoyed significant benefit from the trillions of recently unleashed money printing that has found its way into publicly traded equities. AirBnb shows us what values look like with true price discovery, and probably offer a more accurate picture of UBER’s current prospects.

Forward Looking Performance

In the short term, UBER has lost more than 50% of its Rides business. The rides business will take years to recover to its previous money-losing volume from 2019, as millions of previous customers will never return to an employed status, and many who do will work from home for the remainder of their careers. Thus, COVID has caused a permanent impairment of the Rides business. The food delivery business, after enjoying a boost from COVID-19, will witness many of its restaurant partners going out of business, while many customers will realize they can no longer afford to order expensive restaurant meals, as their jobs and/or salaries are not coming back. Thus, the food delivery business will remain unprofitable.

Finally, UBER’s growing junk debt pile will eat away at equity value.

Key Risks to Short Trade

Near term volatility, short squeezes, and the NASDAQ rally may drive UBER higher in the near term. That is why put options are less desirable. Position sizing needs to be such that a doubling of the stock can be endured, and in such a case, a short position should be added to.

UBER is an unlikely acquisition target, and as for further industry consolidation, headline risk does exist for hoped-for accretive (in the form of losing less money) mergers, such as GRUB. However, in the unlikely event this combination passes through anti-trust regulators, the combination of 2 money losing businesses will lead only to a larger money losing business, particularly as municipalities set limits on predatory pricing to help out small restaurant businesses.

*via Seeking Alpha*