(As this article relates to an impending NYSE listing, please note the disclaimer at the foot of this article.)
In one of financial journalism’s most memorably descriptive pieces, Rolling Stone Magazine’s Matt Taibbi described Wall Street investment bank Goldman Sachs in these less-than-flattering terms…
The world’s most powerful investment bank is a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money.Matt Tiabbi – Rolling Stone Magazine
I have no particular views on Goldman Sachs…then or now…but if ever I thought any business deserved to be described as a “great vampire quid”, it’s Uber, whose business practices appear to plumb the depths of an uniquely deep pool of poor conduct in the technology sector..
They’re not right at the bottom, admittedly. Facebook deserves that accolade all on its own, but Uber are certainly giving Menlo Park’s finest privacy invaders a run for their money.
And, of course, money is what it’s all about.
Stock Market listing ahead…
Uber have announced plans for a stock market listing which would value the business at $100 billion or more. However the “price” for this influx of cash from new investors is that the law says Uber now has to tell people at least a little bit about their business as a condition of being allowed to invite members of the public to buy their shares.
Everyone who’s anyone in the field of banking and finance is buzzing around the most eagerly-awaited flotation for years…including, it has to be said, the aforementioned Goldman Sachs, alongside another 28 banks and financial institutions.
Now, I’ve no problem with the basic concept behind Uber’s business.
Like a lot of traditional businesses at the dawn of the digital era, some long-established cab companies were not as responsive and customer-friendly as they might have been. In some cases, service was variable and passenger safety was not always guaranteed.
Even for those business which were at the upper end of the service and reliability spectrum, like London’s Black Cabs, for example, their initial reluctance to embrace new technology left the door open just far enough for an upstart like Uber to gain a foothold.
I also have no problem with people earning a bit of extra cash using their own vehicle to ferry people around outside their normal working hours, provided they are properly insured, trained and regulated.
So far, so good. Up to this point there was the potential that Uber might have become a service- and safety-focused personal transportation business which would provide a much-needed, safe, reliable service to a great many people, while providing an opportunity for part-time drivers to earn a bit more cash in their spare time.
There is a good business idea at the heart of this ‘great vampire squid’ of an organisation.
But it didn’t take long for Uber to show its true colours.
Away from the PR, reality bites…
Uber’s clashes with transportation regulators around the world became the stuff of legend…specifically, the legends that had law firms around the world salivating and rubbing their hands with glee.
Taking on City Hall, with their effectively unlimited legal resources, in a case funded by the deep pockets of venture capital investors with an eye on an eventual multi-billion dollar payout, is the stuff of dreams for the managing partners of sizeable law firms in every major city around the world.
And the personal conduct of Uber’s founder, Travis Kalanick, was less-than-commendable, leading to his ousting from his own business by a group of investors who felt his behaviour was in danger of getting in the way of their own financial returns.
For a short while after Kalanick’s departure, there was an air of optimism that some of Uber’s more questionable management practices would be reined in by their newly-appointed CEO, Dara Khosrowshahi.
It’s certainly fair to say that many of the personal excesses of the Kalanick era have been addressed and having the much more investable Khosrowshahi as the public face of a business heading for one of Wall Street’s biggest IPOs of the 2010s is almost certainly a plus for investors.
So everything is OK, right?
Well, not from where I’m standing.
Uber’s business model is no great shakes…I wonder if it even has a model…
Concerning though the behaviour of one of Uber’s co-founders might be, there’s worse to come. For that, you need to take a look at Uber’s business model.
All you need to do is read Uber’s Securities and Exchange Commission (SEC) Form S-1…the preliminary prospectus businesses are required to issue in advance of listing their shares on the New York Stock Exchange (NYSE).
The prospectus doesn’t start well. The very first page is proudly emblazoned with Uber’s mission statement – “We ignite opportunity by setting the world in motion”.
No doubt some swanky ad agency or strategy consulting boutique came up with this, but the only question that should be in your mind when you read statements like this is “whose benefit is this opportunity for?”.
It feels a bit like Alibaba Co-Founder Jack Ma’s description of his staff’s 996 workweek (9am to 9pm, 6 days a week) as a “blessing”. We can be fairly sure that most of the blessing from making his staff work those hours flows into Jack Ma’s bank account, rather than his employees’.
The “opportunity” that Uber claims to “ignite” is almost certainly less an opportunity for its staff and customers and more an opportunity for its early investors, the management team lucky enough to have picked up plenty of share options along the way, and the Wall Street investment banks, who have large fees riding on a successful NYSE listing.
As part of their S-1, Uber is legally required to disclose who owns 5% or more of its shares and there are some interesting names on that list who will do very well out of a successful IPO…
- First and foremost, Travis Kalanick…remember him?…who remains Uber’s largest individual shareholder with 8.6% of the business, worth a potential $7 billion
- Garrett Camp…not a name you’re likely to have heard, but the original Uber app developer…has 6% of the business, worth just under $5 billion
- Investment firm Softbank owns 222 million shares, worth potentially $13 billion on flotation
- Ryan Graves, Uber’s first CEO but long-since departed from the business, has shares worth just shy of $2 billion
- Benchmark Capital, who led the Series A funding round and participated in later rounds as well, has 150 million shares worth around $9 billion
And, of course, there are many other canny investors who kept their shareholding below the 5% level at which their interest has to be publicly disclosed. Even 5% of a $100 billion business is worth $5 billion, after all…that’s a pretty decent chunk of change.
What’s extraordinary though, at least since the go-go days of the 1999 dot-com boom, is that Uber has never made a penny from operating its business.
The business lost $3 billion in 2018 alone, and $10 billion in the last three years. The only reason it still exists in the face of operating losses of that scale is because its financial backers keep giving Uber cash to grow.
But don’t worry…there is a plan…(on second thoughts, start worrying – I’ve seen the plan…)
The basic plan is that Uber crowd out smaller, more local, operators in their chosen markets…at which point Uber can raise their rates and, having eliminated their competition through a combination of predatory pricing and slick marketing, make back the losses they incurred building the business many times over.
That’s for the long-term, though. There’s clearly still plenty of work to be done crowding existing operators out of their traditional markets first, as Uber’s prospectus makes clear… “We anticipate that we will continue to incur losses in the near term as a result of expected substantial increases in our operating expenses”.
Let that sink in for a moment. Not only has Uber lost $10 billion at the operating level in the last three years, losses, presumably the multi-billion dollar level as a result of Uber’s “substantial increase in operating costs”, will continue into the indefinite future.
Of course, fast-growing businesses with great potential can sell while still loss-making and do very well out of it. But in the long run a business valuation can only be sustained by the level of profits it makes…or, if you’re taking a purist approach to company valuation, the operating cash flow it generates.
If the future flow of profits is a number less than zero, no matter what discount factor you apply, the overall valuation of the business cannot be a number greater than zero…it’s mathematically impossible.
The only way you can sell a business which anticipates making losses into the indefinite future at a number greater than zero is by being fortunate enough to find another group of people who are prepared to keep funding the loss-making business instead of you.
Usually they do that because you…or your investment bankers or PR consultants… manage to convince those investors that immense riches will somehow be magically unlocked for the lucky people who take the shares off the early investors in the IPO. because the business will do so much better in the future than it has in the past.
In essence, that’s what Uber’s IPO is all about. We’ll return to the consequences of this in a moment…
The people who really know what’s going on are the debt-holders
Before we consider what’s in Uber’s plans for shareholders, first we need to consider the role of debt in the business.
Uber hasn’t just been bankrolled by over-excited venture capitalists. It’s been bankrolled to the tune of $7.5 billion in debt as well. And the SEC Form S-1 rightly makes potential investors aware that interest payments and capital returns to its lenders would have priority ahead of any payments to shareholders, and could take up a substantial portion of Uber’s future operating cash flow.
What’s worse, from Uber’s point of view…although undoubtedly better from their bankers’ perspective…the S-1 indicates that terms on which the $7.5 billion in debt has been provided largely prevent Uber from raising additional debt from other sources.
If you wondered why Uber are heading for an IPO right now, your answer is there.
And if you wondered why you should be concerned about Uber’s IPO, your answer is there too.
Uber’s providers of debt finance have been supporting that business, one way or another, for several years now. They have a level of access to the business’s financial information that no outside stock market investor will ever have.
Here’s why that matters…
If the people who know more about Uber’s finances than anyone else have capped their risk so tightly at $7.5 billion…an almost minuscule level of debt exposure in a business allegedly worth $100 billion, you can bet your bottom dollar that they are a whole lot less convinced about the soundness of Uber’s business model than the army of investment bankers and PR consultants walking the floors of the NYSE at the moment.
For any other business with a stock market valuation of $100 billion, a debt exposure of several times $7.5 billion wouldn’t be much of a problem.
But the providers of debt finance have not only capped their own risk, they’ve made sure that other providers don’t increase their risk through the back door by adding more debt on top of the debt the early financiers have already extended to Uber.
It’s quite normal for holders of senior debt to require that their approval is sought before, for example, additional security is lodged against assets over which the senior debt holders already have security.
But Uber’s S-1 says something subtly different to that… “Our existing debt instruments contain significant restrictions on our ability to incur additional secured indebtedness. We may not be able to obtain additional financing on favorable terms, if at all.”
That’s another way of saying that Uber’s debt financiers have wrapped their loans up in conditions so tight that using more debt to grow isn’t a practical option.
Which is odd…
There’s plenty of cash sloshing around the world’s banking system at the moment looking for a home. There’s a good economic argument that suggests loading some more debt into the business would increase returns to ordinary shareholders. And banks, usually, are generally prepared to finance…at the right rate, of course…rapid growth in a successful business with a good business model.
Yet Uber’s debt-holders seem to have lent almost inconsequential amounts of money for a $100 billion business, and done so on terms which prevent Uber raising other external debt either. It hardly speaks of confidence in the business model from a group of insiders with unparalleled access to Uber’s financial records.
Which brings us back to the IPO as a way of finding a group of people who can be hyped-up to such an extent that they’ll buy a story of the sunlit uplands of a few years into the future when Uber will be the dominant transportation business in the world and able to garner excess profits through its pre-eminent market position.
Uber’s own providers of debt finance don’t appear to believe this, and neither do I.
How big do you have to get before you work out how you’re going to make any money?
For a business going for a stock market listing, Uber doesn’t seem to have much of a business model.
In their prospectus, Uber talk a good game, but it remains murky how they ever expect to generate a level of revenue which would cover their operating costs and leave a profit for shareholders.
In my opinion, if you haven’t worked out a way of billing revenues higher than the costs of running your business by the time you’re trying to convince potential investors that business is worth $100 billion, you’ll probably never work out how to do it.
Another astounding feature of the Uber listing is that they’re not even making a secret of any of this. It’s all there in the S-1 Form.
Uber, and their investment bankers and PR consultants, are just presumably hoping nobody reads much past the first few pages full of shiny happy people and vacuous corporate mission statements.
One of the great weaknesses of Uber’s business model is that pretty much anyone can compete with it. In fact, it’s hard to imagine a business with fewer barriers to entry, which is also why it’s hard to imagine profitability is anywhere on the near-term horizon for Uber.
In highly competitive markets, like the ones Uber operates in, if a business increases its prices to cover their operating costs…as Uber desperately needs to do to achieve economic stability…other providers with lower operating costs simply undercut the “market leader” and steal their business away.
That’s why Warren Buffet talks about the “moat” he likes to see round businesses he owns, where the barriers for entry are so high that competitors flooding the markets he owns businesses in are a very unlikely prospect.
Here’s what Uber’s own S-1 says about their “moat”…
The personal mobility, meal delivery, and logistics industries are highly competitive, with well-established and low-cost alternatives that have been available for decades, low barriers to entry, low switching costs, and well-capitalized competitors in nearly every major geographic region. If we are unable to compete effectively in these industries, our business and financial prospects would be adversely impacted.Uber Technologies Inc, SEC Form S-1
Low barriers to entry and low switching costs aren’t the sort of things that would make Warren Buffet feel very comfortable, and it shouldn’t make potential investors in Uber feel very comfortable either.
Realistically, sooner or later Uber need to increase their rates to generate profits, and positive cash flow. But the moment they do, according to Uber’s own prospectus, existing “well-established, low-cost alternatives” are likely to hoover up their business..
We can’t raise our prices, so how do we make a profit?
If you’re unlikely to be able to raise your prices, the only other lever you can pull to generate a profit…and don’t worry, Uber, being a potential ‘great vampire squid’ of a business, has already thought of this…is for Uber to take a greater share of the revenue currently earned by their drivers.
That way, they don’t need to charge customers any extra, so there’s limited risk a competitor will move in and take Uber’s business away. Instead the increased share of their drivers’ earnings can be deployed to plug any gaps in the balance sheet.
You might think this was a particularly scuzzy thing to do…and I wouldn’t disagree with you…it’s not as if driving for Uber is an already-lucrative profession.
In London, a recent Oxford University report found that Uber drivers earned around £11 per hour on average, or only slightly above the London Living Wage.
Around the word, the reaction from Uber drivers to the company’s attempts to take a greater share out of an already small pot is fairly predictable. For example, Uber drivers in Los Angeles have recently voiced their fury about a 25% reduction in their per-mile rates in an attempt to put Uber on a sounder financial footing.
No wonder Uber’s S-1 says this…
…we continue to experience dissatisfaction with our platform from a significant number of Drivers. In particular, as we aim to reduce Driver incentives to improve our financial performance, we expect Driver dissatisfaction will generally increase.Uber Technologies Inc, SEC Form S-1
So Uber’s business model is one where it can’t raise the prices it charges to customers due to the wide availability of competitors who will undercut any rate rises. And it can’t cut driver rates much more and still find people prepared to drive for them.
And all that is glossing over the continuing legal and regulatory disputes about whether Uber drivers are really independent contractors, as Uber claims, or employees who would be entitled to a much higher, legally-mandated, level of pay and benefits.
Were that to happen, Uber’s S-1 acknowledges their business model…such as it is…would suffer a severe and negative impact.
The ‘great vampire squid’ makes its move…
It doesn’t take a sophisticated financial analysis to see that a loss-making business, which can’t raise it’s prices or cut its costs…and which carries substantial risks that its costs will increase dramatically if various legal challenges go against Uber and lower-cost competitors step up the fight against them…isn’t a business model which inspires a huge amount of confidence.
As a CFO, if someone proposed that model to me in a business case, I’d be telling them to go away until they’d found an economic model that actually worked properly. I certainly wouldn’t be giving that business plan a penny.
With the cream of Wall Street financiers on their payroll, I’m sure Uber’s offering will get away in the markets. People will buy, the early shareholders will cash out and retreat to their idyllic Pacific islands without a care in the world.
Things might even appear fine on the surface for some time thereafter. The black arts of public relations can, in fact, defy gravity for quite a while.
But the laws of fundamental economics always wins in the end.
If a year or two from now Uber is still losing $3 billion a year, even as the business grows larger, investors might start to wonder if profitability was ever going to come to Uber.
At first nobody might sell, but people would stop buying.
Brokers would start having to mark the share price down to a level which attracted some buying interest.
As the share price fell, the more risk-averse investors would start selling their shares to make sure they don’t suffer an even greater loss.
Then short-sellers, who will be sniffing around Uber already as they can spot a shaky business case from several miles away, even in the dark, will load up on their positions.
In the history of the financial markets, we all know what’s going to happen next…even if the precise timing of the big swing downwards is harder to predict…days…weeks…months… a year or two…
The timing is uncertain. The direction isn’t.
Once a selling momentum gets behind a business which looks like it’s running out of cash due to its inability to generate a profit, the end is predictable…and usually not pretty.
Of course, even as the ship goes down, its cheerleaders will insist that everything is fine and investors’ money is safe.
But it won’t be.
It wasn’t in the sub-prime mortgage collapse of 2007 which led to the global financial crisis.
It wasn’t in the collapse of Long Term Credit Management in the late 1990s, which went belly-up despite having two Nobel Prize-winning economists on its board after it ran out of cash.
And it won’t be if Uber doesn’t convince ordinary investors that it’s got a business model from which investors can expect a solid financial return anytime in the near future.
As always, the people who suffer if Uber goes belly-up will be the small investors who buy now, not the early-stage funders who are cashing out in the IPO…and the drivers, given that Uber’s S-1 already makes clear that reducing payments to drivers will be one of the ways it’s going to balance the books in the future.
That’s why Uber might be Wall Street’s new ‘great vampire squid’…sucking the life savings out of legions of small investors, and sucking the hours out of their drivers’ lives in return for less and less cash per mile.
It might take a while for the markets to catch on. The IPO hullabaloo will carry Uber for a bit. And once the shareholders switch from well-connected insiders to ordinary members of the public, the likelihood is Uber will get a bit of breathing space while the new shareholders settle in (after all, the prospectus tells them it will be a long haul, so nobody’s expecting magic to happen overnight).
But in John Maynard Keynes’ immortal words. “the markets can remain irrational for longer than you can remain solvent”. Unless you’re a short-seller of unique bravery and deep pockets, now is almost certainly not the time to call Uber’s bluff.
But there are only two possible scenarios from here on in.
There are only two ways forward…neither of them good for Uber investors…
Either Uber will lose the confidence of its investors and fail.
Or it will change its business practices to be fairer to both investors and drivers.
The problem is, the way Uber is set up, either eventuality will be seriously prejudicial to its share price. Uber’s own SEC filing says so, which means thousands of small investors could lose out.
Until one or other of those events takes place, Uber’s continuing pressure to reduce payments to drivers might result in drivers sticking with the platform regardless in the short term, as they need to generate at least some cash to cover their car payments and running costs.
However, in the long run the many thousands of drivers working for Uber will have less money to spend on themselves and their families.
Their car leases will…for now…trap drivers into working for Uber, but ultimately thousands of private individuals are not going to keep subsidising the lifestyles of Silicon Valley billionaires by working for a level of economic return that doesn’t fully reflect the effort they put into the business. They’re all independent contractors. They can leave at a moment’s notice.
I don’t know if it was fair of Matt Taibbi to describe Goldman Sachs as as a ‘great vampire squid’ in his Rolling Stone article.
But I do believe that any business which is trying to unload itself onto an army small investors when it’s not in a position to say when, how or whether it will ever make a profit…
…while at the same time squeezing the payments to its drivers close to, if not below, Living Wage levels and planning to continue to squeeze them down still further after it’s “played nice” during the PR campaign in support of its NYSE listing…
…and indulging in predatory behaviour with the explicit intent of driving ‘mom and pop’ operators out of the towns and cities where they’ve made a decent, if unremarkable, living for many years…
…has the potential to directly affect the lives and financial futures of millions of ordinary people.
Maybe Uber will turn it all around and surprise us all.
But if they don’t, Uber has the potential to become Wall Street’s next ‘great vampire squid’, sucking the life out of millions of people even as they suck the cash out of their bank accounts.
Thankfully, Wall Street investment banks don’t spend their time making pitches to people like me. But if one of them brought along Uber’s prospectus and asked me in invest, I’d be laughing from now till Christmas.
Investing in Uber is one opportunity I certainly wouldn’t want igniting.
(Disclaimer: Just in case you’re stupid enough to act based on a blog post from someone you’ve never met, and wealthy enough to be able to afford a team of swanky lawyers, the foregoing is a personal opinion. I am not a regulated investment adviser in any jurisdiction and before making major investment decisions, you should consult someone who is. Unless they’re dumb enough to fall for Uber’s PR campaign, in which case you might want to reconsider your choice of investment advisor. And yes, that’s a personal opinion too, covered by the rights of free speech in every major jurisdiction.)