Broken Growth Stocks: Uber

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This is the third article in our Broken Growth series where we started writing about companies that have seen a precipitous decline in their stocks from speculative heights but the company’s future prospects look encouraging. Our last two broken growth stocks were Twitter (TWTR) and Coursera (COUR).

Difficult Decade

Uber (NYSE:UBER) has had a difficult decade as it battled local, state and national governments to carve out a new business model and dealt with internal company issues that lead to the ouster of its founder. The gory details have been captured in books like Super Pumped: The Battle for Uber and a TV series based on the book.

Despite all the trials and tribulations, the company managed to grow from 8 cities in 2011 to over 10,000 cities in 72 countries by 2021. It also expanded its business model by including delivery of restaurant meals and groceries through Uber Eats, matching carriers to shippers with Uber Freight and expanding its core mobility business by expanding into car rentals, incorporating healthcare related travel and adding other modes of transport like taxis, autos (tuk-tuks) and moto (motorcycles).

Uber Growth 2011-2021 (Company investor presentation)

Network Effects

The appeal with Uber has always been that the network and software they built could be expanded to other verticals and we saw this play out in delivery with restaurants first and then with groceries. The company recently expanded its partnership with Albertsons (ACI) and its various brands including Safeway, Randalls, etc. to over 2,000 stores. This shift to delivery helped the company in a material way during the early phases of the pandemic when their mobility division took a big hit.

The new vertical with a lot of potential for Uber is freight, where they connect shippers like Costco, CVS, Walgreens, Home Depot, H.E.B, Colgate-Palmolive, P&G and Abbott with carriers. While freight represented less than 7% of Uber’s gross bookings of $26.45 billion in Q1 2022, the division is growing rapidly.

Uber Freight (Company investor presentation)

The company has also done a great job of optimizing its market presence through a series of acquisitions, divestures and exiting sub-scale delivery markets. Just like Uber gave up its mobility division in China for a stake in Didi, it did the same with its delivery division in India for a stake in Zomato. At the same time Uber acquired Careem in the Middle East and Postmates in the U.S. The divestures and operating initiatives like exiting markets or reducing headcount has helped the company reduce $1 billion in fixed costs.

Improving Bottom Line

Unlike a lot of technology companies that were showing net losses but were free cash flow positive, Uber was burning cash on a consistent basis until Q3 2021. While the company reported a huge $5.9 billion net loss for Q1 2022, $5.6 billion of that loss came from a drop in value of its equity investments like Didi. Adjusted EBITDA was positive at $168 million but as investors are well aware, companies adjust all kinds of things and investors need to take “adjusted” numbers with a pinch of salt. It was however encouraging to see that cash from operations in Q1 2022 was positive. The company even managed to generate more than half a billion dollars of free cash flow in Q3 2021.

With the write-down of equity investments in Q1 2022 and a natural decline in stock-based compensation because Uber’s stock is down nearly 40% since the start of this year, things should start looking better on the bottom line in the coming months and quarters.

Outlook

When the company reported Q1 2022 results it guided towards gross bookings of $28.5 billion to $29.5 billion and adjusted EBITDA of $240 million to $270 million. At the mid-point of the range, gross bookings are expected to grow nearly 10% on a sequential quarter basis and 24.5% year-over-year.

As I watch the transformation of Uber, it is clear that Dara Khosrowshahi’s strategic vision for Uber, since he joined the company in September 2017 is finally being realized. Prior to joining Uber, he ran Expedia (EXPE) for over 12 years and the stock outperformed the S&P 500 by more than 400% during his tenure. The outperformance however did not start until about five years into his tenure. He faced the Great Recession shortly after he took over Expedia in August 2005 and ran into a global pandemic after he took over Uber.

Warren Buffett used to love buying regional newspapers back when folks used to still read newspapers. Most cities had two dominant newspapers and they worked almost like a duopoly, generating good returns for their investors. The current situation with Uber and Lyft remind me of similar dynamics. By either acquiring competitors or exiting certain markets, Uber has attempted to create similar dynamics across multiple global markets.

Valuation and Risks

While the stock is starting to look attractive at two times forward sales, I do have some concerns. A 2023 EV/Sales metric of 2.14 is cheap for a software business but Uber doesn’t exactly sport software margins. TTM Gross margin of 35.67% is about half what I would expect from a pure-play software business and the company’s long-term guidance points to “adjusted” EBITDA margin of 10%, which is not very exciting.

Uber Next 3 Years (Company investor presentation)

Most of the EBITDA in Q1 2022 was from the mobility division and delivery barely broke even. A friend of mine mentioned how Uber Eats constantly gives him 20% to 25% discounts on delivery and it is clear that the model in the U.S. is not much of a win for either restaurants or the delivery driver.

Current market weakness could translate to further markdowns of its equity investments in Q2 2022. While this will not impact cash flow, the headline earnings number might look ugly.

There are also some concerns that Lyft’s recent disappointing results and subsequent large drop in the stock might motivate the company to spend even more to acquire market share.

Conclusion

Uber has managed to execute on a very complex business across dozens of geographical regions. Besides a temporary setback early in the pandemic, the company has managed to grow both within its verticals as well as expand to new verticals. The company’s expansion into a subscription offering called Uber One, peer-to-peer car rental through a partnership with Getaround, products specifically tailored for businesses, and innovation within the mobility business by including autos, motorcycles, public transportation and taxis shows that it views itself as a network that can benefit from connecting people across multiple verticals.

The road is likely to remain bumpy but I am feeling optimistic about Uber’s long-term prospects. The stock is likely to remain under pressure on account of market conditions and could afford an opportunity to build a position over time.