Economics » Investment » Uber’s uncertain road ahead

Uber's uncertain road ahead

On the eve of its expected IPO, Hargreaves Lansdown senior analyst Laith Khalaf says there are inherent dangers in the ride hailing firm's business model.

Uber is set to go public on the 9 May this year, with full trading beginning on the 10th of the month. The transportation network company is looking to achieve a valuation of between $80.5bn and $91.5bn while raising around $9bn, which would make it one of the biggest IPOs ever.

So far Uber’s demonstrated exceptional revenue growth from $95 million in 2014 to $11.27bn in 2018. The bulk of this comes from the core ridesharing business, which accounts for 84% of the group’s turnover.

Uber has achieved this primarily by leveraging the rise of smartphone technology, allowing riders to simply “tap a button and get a ride”. This allows Uber to use algorithms to match riders to drivers, instead of relying on more traditional dispatch centres. This creates a smoother experience for the passenger, and allows Uber to efficiently allocate drivers.

The other innovation is more controversial. Instead of employing taxi drivers directly, Uber simply connects independent drivers to people looking for a ride. This saves Uber a significant amount of money as it isn’t on the hook for the other associated costs of traditional employment, such as holiday and sick pay.

The other primary source of business is Uber Eats, and again the growth story is outstanding. In 2016 Uber Eats brought in $103m in revenue, which is up more than fourteen times to $1,46bn in 2018. Uber says that consumers spent $795 billion on meals for home delivery, takeaway and drive through worldwide in 2018. Yet Uber Eats has just 1% market penetration, so there’s still room for further growth.

Risky ride

You can’t knock what Uber’s achieved in such a short space of time, but it still looks like a risky ride for investors. Despite meteoric revenue growth the company is really yet to turn an actual profit.

Operating losses stood at over $3bn in 2018, although this is down from $4bn in 2017. Companies which are yet to break even always sit towards the speculative end of the investment spectrum, and for Uber the risk is amplified by the regulatory backlash it’s facing.

The chief concern is the potential for drivers to be classed as employees in some jurisdictions, including the UK and the US, which would incur significant additional costs for the business. Uber is also subject to US and international investigations into a number of issues, including the 2016 data breach, which may mean the tech giant has to stump up further cash.

The competitive landscape is also busy. Uber has first mover advantage in ridesharing, but it’s now being challenged by newer disruptors such as Lyft and Ola, while UberEats faces stiff competition from the likes of Just Eat and Deliveroo.

The cost to consumers of switching from one service to another is virtually nil, so they will go wherever they see the keenest prices, and the best choice and service. Uber’s scale affords it an advantage on this front, but it says it’s willing to spend heavily to beat off the competition. That makes sense because size is so critical to success, but it does mean profits could be a long way off, and that makes them more uncertain.

Ultimately the business model depends on a network effect. More riders using Uber means more business for drivers, so more drivers join providing greater availability and shorter waiting times. This lowers costs and results in a better experience for riders, so more join.

This positive feedback loop is the moat that can protect Uber from the ravages of competition providing it maintains scale in its markets, but requires sustaining losses as the network is built.

Once the network takes effect profits should flow, at least in theory. But if the network isn’t strong enough to alleviate competitive pressure, or Uber can’t sustain the losses required to build it, profits may never arise in a sustainable manner.

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