The VC-funded companies

There’s a view out there that the venture capital-funded companies are simply wasting all that capital they’re swallowing. They’ll never break through into profit and the entire game is just a waste of resources. There are parts of the Financial Times that seem to run with this view, for example.

I’m one of those who think this is true of WeWork. It would, almost but not quite, have been better off sinking $10 billion into actual ownership of office buildings in major cities and almost being a REIT off the back of that. But it is not a listed company and so is of limited interest to us here. It is just an example of how sure, it’s true, some of the VC bets aren’t going to make it and they really are vast waste of capital.

The question is, is this true of Uber (NYSE)? And I would argue not. As a result of something we’re told in its Q3 results this year.

Uber

(Uber stock price from Google)

Uber’s stock price since the IPO has been, how to put this politely, less than stellar in its performance.

It’s also difficult for us to provide any of the usual metrics as it is still massively loss-making as it always has been. So P/E ratios, yields and all that don’t make any sense.

The only thing we can use as a valuation metric – the only thing that makes any sense – is whether it is going to break out into profit at any future date. As and when it does, if it does, how large is it going to be? If it ends up just being a large taxi cab company, then it is going to be worth less than it is now in all probability. If it manages to establish a firm grip on a significant portion of urban transport, then it will be worth more than it is now.

Hey, your guess is as good as anyone else’s here.

Profits

Of course, what we want is a company that makes profits which can be paid back to us as the stockholders. That’s still a long way off with Uber, obviously enough. But the value of the company is the net present value of a future profit stream, multiplied by the probability that one ever appears. That’s the standard financial economics explanation at least.

That general – and to my mind wrong – assumption out there is that Uber doesn’t make profits. As a company, as a whole, sure, it doesn’t. But that’s not the important thing at this stage.

Rather, does the business activity itself cover, or more than cover, its operating costs? That’s what we really want to know. For we also know that the company is continuing to invest in two different ways.

Investment

Uber is still rolling out the core ride-hailing service into new markets. Why not, after all? The core costs of developing the software, developing the business model, have already been spent. They’re sunk costs; that is, why not leverage them over more custom by being in more markets? The costs of that new revenue are the start-up costs in that specific market only.

Uber is also rolling out new services, new areas of business. Eats, freight and so on with investment into such new areas of business; well, everything makes a loss when it first starts up.

There’s also that technology development into truly driverless cars and so on.

But profit

The thing is, we want to know whether there’s any stage at which actual profit is being made. We’re fine with something like the Amazon (NASDAQ:AMZN) model that Jeff Bezos has used. Invest every penny of cash flow, and then some, in expanding the business. That might mean no recorded accounting profits, sure. But there’s economic profit there, it’s just that the profit being made by one sector of the business is being spent on subsidising the start-up losses in another.

That is, really, what we want to know is, does the ride-hailing business make a profit? If it does, then there’s at least something of value there. Not just in the sense that there’s a profit-making business, but we’ve also proven the basic concept – the software-driven gig economy can be profitable for the organising company.

Which is the Q3 thing we find out

This is, to me, quite the most important thing about Uber. And it’s captured in this little phrase:

Record Rides Adjusted EBITDA of $631 million, fully covering our Corporate G&A and Platform R&D”

Yes, adjusted and all that. But the core message here is that if the company stopped trying to expand, then it’d not be losing money anymore. That core business does indeed pay its own way – before we consider the cost of capital at least, but that’s a sunk cost.

Uber (Uber earnings by sector from Uber Q3 report)

Note that within the rides section, there is still the costs of whatever expansion it is doing there. And corporate expenses would be rather lower if it wasn’t also covering those new areas of business it is still rolling out.

My view

The big Uber question for me has long been whether the business itself, ride-hailing, will make money. Not how much of a loss does the company make by investing in new areas. Not what’s the upfront cost of expanding the geographic areas of ride-hailing even. Rather, once set up, does ride-hailing in, say, NYC, or LA, or Denver, London, whatever, make an operating profit?

If it doesn’t, then the company as a whole is a very fragile bet on driverless cars becoming viable sometime soon. But if it does, if the losses are start-up costs, not operating losses, then the company could survive for the long term.

I maintain that this one little piece of information in the Q3 report tells us that it’s the second which is true. As with Amazon, anytime Uber wants to show us a profit it can just stop spending upon expansion. Not that we want it to, of course, but it does mean that there’s a viable business there.

The investor view

I expect the general analyst view of Uber to improve as a result of this one factor. Yes, it’s still a bet on that middle distance future but the company doesn’t have to be swallowing ever more capital to survive to get there. I would expect a rerating of the stock as a result.

Worth a modest purchase for the medium term I would say.

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.

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2019-11-10