Investment Insight |
Uber’s potential remains underappreciated
NZ Funds has had a positive view of Uber for a number of years and we have held an investment position in it since the company listed in mid-2019. The COVID-19 pandemic created a number of challenges for Uber’s business model and has delayed our initial investment thesis. However, the pandemic also created new opportunities which, in aggregate, have made our conviction regarding the upside to Uber’s share price even stronger. This week’s Investment Insight details our view of Uber and why we consider it to be an attractive investment with significant upside.
Attractive business model
One question we ask when we invest in growth companies like Uber is “would our daily lives be inconvenienced without this company?" For many of the best and most valuable companies in the world, the answer to this question is usually ‘yes’. For Uber, most people living in larger cities would also answer yes to that question.
When Uber entered the urban transportation business, it significantly changed the way people went about commuting and travel within cities. While taxis have often been considered a ‘last resort’ transportation method, Uber came into the market offering taxi-style transportation for a third of the cost. In addition to its rideshare business, the COVID lockdowns highlighted another valuable service from Uber. Operating under the brand name ‘Uber Eats’, the food delivery business specialises in delivering restaurant food to homes and workplaces. In just over a decade from its 2009 launch, Uber has changed transportation infrastructure in cities where they operate and is now changing the way consumers access restaurant food.
Uber has been able to make these changes because the technology platform it built has enabled growth in an incredibly capital-efficient manner. Most transportation infrastructure businesses are very capital-heavy and require significant upfront capital expenditure to fund growth (e.g. railways, highways, airlines). Using technology to connect commuters directly to drivers means Uber has been able to forego the need to purchase fleet vehicles; instead, the drivers themselves provide most of the capital required. This has allowed Uber to expand at an incredible speed and obtain a significant market share of the urban daily travel market.
The key costs for Uber that have kept it largely unprofitable to date have been expenditure on marketing and payments to drivers to continue to attract them to their platform. The focus has now turned to profitability as Uber has reached an appropriate scale and market share.
While it is facing competition from challengers replicating their business model (e.g. Lyft, Didi), we consider Uber has a significant first-mover advantage that has allowed it to scale quickly, enabling it to generally price out competitors and defend market share through its reputation with clients.
COVID has accelerated Uber’s development
COVID has had two key impacts on Uber’s business. The first is a negative impact on Uber’s rideshare business which saw its bookings volume reduce during the peak of lockdowns to 25% of pre-COVID levels. This has now returned to 65% of pre-COVID levels and continues to recover as restaurants re-open, commuters return to work and airline travel resumes. What is interesting to us, however, is that analyst consensus forecasts for Uber’s rideshare business in longer-dated years from 2023 to 2025 are approximately 25% below where they were pre-COVID. In other words, the market is assuming that the rideshare business has been permanently damaged and will not fully recover post-COVID. We find this surprising as forecasts in other transportation industries, such as airlines, assume a full recovery to pre-COVID volumes as the world returns to normal following uptake of vaccinations. Further, we actually see potential upside to Uber’s rideshare business as travellers have shown increased willingness to pay for Uber travel compared to other public forms of transport.
The second impact is a significant acceleration in the development of Uber’s food delivery business, which has grown from $14 billion of bookings in 2019 to $50 billion of bookings expected in 2021 to date. This has been transformational to the penetration of Uber Eats as a part of people’s weekly consumption habits and has brought new customers onboard who may otherwise have taken years to use the service. Prior to COVID, consensus expectations were that the food delivery business would not surpass $50 billion of bookings until 2024, meaning the business is now three years ahead of projections.
Where do we stand on valuation?
Prior to COVID, Uber had a share price of $40 and a market capitalisation of US$70 billion. It currently has a share price of $49 and a market capitalisation of $91 billion. Uber’s share price is up 21% over its pre-COVID price and, while this is a good return, this actually represents an underperformance against the wider S&P 500 index which is up 29%. Given that many businesses are trading relatively higher post-COVID due to factors such as lower interest rates and monetary policy, we consider this to be a significant underperformance from Uber and believe it should outperform going forward as the market begins to fully appreciate the extent to which the business has grown in the past 12 months.
We use multiple approaches when valuing Uber, including valuing its cash flows, its relative valuation compared to similar companies (as well as other technology businesses), and also relative to how Uber was valued pre-COVID. On all three of these metrics, we consider Uber to be undervalued, meaning we see fundamental upside to the share price.
It helps to look at Uber’s two key divisions separately. Comparing Uber’s rideshare business to its nearest competitors, this division alone is valued at around $70 billion. Using a similar approach, applying food delivery competitor valuations to Uber’s food delivery business, this division would be worth around $60 billion. Including the value of a number of Uber’s direct investments gives a total group valuation of approximately $150 billion, or 70% upside from today’s market capitalisation.
Additionally, Uber’s valuation relative to the wider technology sector looks cheap compared to the scale of the addressable market in its business divisions and, therefore, its growth potential.
What is holding Uber’s share back?
We believe Uber’s share price performance is being held back primarily due to investor concerns over the speed of recovery in the rideshare business and regulatory risk concerning the way Uber classifies drivers in the US as contractors rather than full-time employees. Regarding recovery of the rideshare business, the data we track is showing very positive signs on the uptick in activity and we consider the next six to 12 months will show a near full recovery in this business. In turn, Uber will not only become profitable but also rapidly grow its earnings. Regarding regulation, we consider it unlikely for there to be any material negative consequences for Uber in the next five years given this would require legal framework changes at the Federal level which will be difficult to enact with the current structure of the US Senate.
With Uber’s underlying strong fundamentals, we maintain our conviction in the investment and expect the market to begin to appreciate this as we move through 2021 and into next year.
Attractive business model
One question we ask when we invest in growth companies like Uber is “would our daily lives be inconvenienced without this company?" For many of the best and most valuable companies in the world, the answer to this question is usually ‘yes’. For Uber, most people living in larger cities would also answer yes to that question.
When Uber entered the urban transportation business, it significantly changed the way people went about commuting and travel within cities. While taxis have often been considered a ‘last resort’ transportation method, Uber came into the market offering taxi-style transportation for a third of the cost. In addition to its rideshare business, the COVID lockdowns highlighted another valuable service from Uber. Operating under the brand name ‘Uber Eats’, the food delivery business specialises in delivering restaurant food to homes and workplaces. In just over a decade from its 2009 launch, Uber has changed transportation infrastructure in cities where they operate and is now changing the way consumers access restaurant food.
Uber has been able to make these changes because the technology platform it built has enabled growth in an incredibly capital-efficient manner. Most transportation infrastructure businesses are very capital-heavy and require significant upfront capital expenditure to fund growth (e.g. railways, highways, airlines). Using technology to connect commuters directly to drivers means Uber has been able to forego the need to purchase fleet vehicles; instead, the drivers themselves provide most of the capital required. This has allowed Uber to expand at an incredible speed and obtain a significant market share of the urban daily travel market.
The key costs for Uber that have kept it largely unprofitable to date have been expenditure on marketing and payments to drivers to continue to attract them to their platform. The focus has now turned to profitability as Uber has reached an appropriate scale and market share.
While it is facing competition from challengers replicating their business model (e.g. Lyft, Didi), we consider Uber has a significant first-mover advantage that has allowed it to scale quickly, enabling it to generally price out competitors and defend market share through its reputation with clients.
COVID has accelerated Uber’s development
COVID has had two key impacts on Uber’s business. The first is a negative impact on Uber’s rideshare business which saw its bookings volume reduce during the peak of lockdowns to 25% of pre-COVID levels. This has now returned to 65% of pre-COVID levels and continues to recover as restaurants re-open, commuters return to work and airline travel resumes. What is interesting to us, however, is that analyst consensus forecasts for Uber’s rideshare business in longer-dated years from 2023 to 2025 are approximately 25% below where they were pre-COVID. In other words, the market is assuming that the rideshare business has been permanently damaged and will not fully recover post-COVID. We find this surprising as forecasts in other transportation industries, such as airlines, assume a full recovery to pre-COVID volumes as the world returns to normal following uptake of vaccinations. Further, we actually see potential upside to Uber’s rideshare business as travellers have shown increased willingness to pay for Uber travel compared to other public forms of transport.
The second impact is a significant acceleration in the development of Uber’s food delivery business, which has grown from $14 billion of bookings in 2019 to $50 billion of bookings expected in 2021 to date. This has been transformational to the penetration of Uber Eats as a part of people’s weekly consumption habits and has brought new customers onboard who may otherwise have taken years to use the service. Prior to COVID, consensus expectations were that the food delivery business would not surpass $50 billion of bookings until 2024, meaning the business is now three years ahead of projections.
Where do we stand on valuation?
Prior to COVID, Uber had a share price of $40 and a market capitalisation of US$70 billion. It currently has a share price of $49 and a market capitalisation of $91 billion. Uber’s share price is up 21% over its pre-COVID price and, while this is a good return, this actually represents an underperformance against the wider S&P 500 index which is up 29%. Given that many businesses are trading relatively higher post-COVID due to factors such as lower interest rates and monetary policy, we consider this to be a significant underperformance from Uber and believe it should outperform going forward as the market begins to fully appreciate the extent to which the business has grown in the past 12 months.
We use multiple approaches when valuing Uber, including valuing its cash flows, its relative valuation compared to similar companies (as well as other technology businesses), and also relative to how Uber was valued pre-COVID. On all three of these metrics, we consider Uber to be undervalued, meaning we see fundamental upside to the share price.
It helps to look at Uber’s two key divisions separately. Comparing Uber’s rideshare business to its nearest competitors, this division alone is valued at around $70 billion. Using a similar approach, applying food delivery competitor valuations to Uber’s food delivery business, this division would be worth around $60 billion. Including the value of a number of Uber’s direct investments gives a total group valuation of approximately $150 billion, or 70% upside from today’s market capitalisation.
Additionally, Uber’s valuation relative to the wider technology sector looks cheap compared to the scale of the addressable market in its business divisions and, therefore, its growth potential.
What is holding Uber’s share back?
We believe Uber’s share price performance is being held back primarily due to investor concerns over the speed of recovery in the rideshare business and regulatory risk concerning the way Uber classifies drivers in the US as contractors rather than full-time employees. Regarding recovery of the rideshare business, the data we track is showing very positive signs on the uptick in activity and we consider the next six to 12 months will show a near full recovery in this business. In turn, Uber will not only become profitable but also rapidly grow its earnings. Regarding regulation, we consider it unlikely for there to be any material negative consequences for Uber in the next five years given this would require legal framework changes at the Federal level which will be difficult to enact with the current structure of the US Senate.
With Uber’s underlying strong fundamentals, we maintain our conviction in the investment and expect the market to begin to appreciate this as we move through 2021 and into next year.
Source: Bloomberg.
Source: Visible Alpha.
Source: Visible Alpha.For more information please contact NZ Funds.
This document has been provided for information purposes only. The content of this document is not intended as a substitute for specific professional advice on investments, financial planning or any other matter.
While the information provided in this document is stated accurately to the best of our knowledge and belief, New Zealand Funds Management Limited, its directors, employees and related parties accept no liability or responsibility for any loss, damage, claim or expense suffered or incurred by any party as a result of reliance on the information provided and opinions expressed except as required by law.
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Andrew Curtayne is Portfolio Manager for New Zealand Funds Management Limited (NZ Funds) and a member of the NZ Funds KiwiSaver Scheme. Andrew's comments are of a general nature, and he is not responsible for any loss that any reader may suffer from following it.
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