Friday, May 22, 2015

Is Uber Overvalued?

In a commentary on venture capital which I wrote as an Editor of the Schulze School of Entrepreneurship's EIX Exchange (University of St. Thomas), I made a reference to a yawning gap in valuations in the following paragraph:
"Uber is the example of a disruptive service that turns a large, existing market of cars-for-hire upside down.  Professor Aswath Damodoran of the Stern School of Business has estimated Uber's global TAM for taxi and car service at $100 billion.  Venture capitalist Bill Gurley of Benchmark Capital, an A Round investor in Uber, argues that over time network effects will expand the TAM to some 25 times Damodaran's estimate.  I inject this real-life example because it is the one I always have in mind when analysts talk about a "disruptive" service or product."
I studied Professor Damodoran's course material on valuation during some work at NYU and through the CFA review course books: he is unquestionably good at what he does, has applied his methods to hundreds of different kinds of companies, and has also consulted with number of big companies on the same issues.  I read his full analysis of Uber, and it is, as all his work, eminently reasonable.

Bill Gurley is a very smart investor and a very wealthy man, but he clearly has a promotional axe to grind with his valuation, since Benchmark is sitting pretty as an early investor in Uber.  "Network effects" are certainly real in particular cases, but they are widely used in this kind of patter as another form of hand waving.   Reading his article, Uber will eventually convince rational economic actors that it doesn't pay to own a car and the roads will be clogged with black Camrys providing transportation services to consumers like kids going to soccer games and grannies going to their medical appointment, even venture capitalists going up to their ski lodges.  Furthermore, it will do this in every country.  Take this fully network effected addressable market, give Uber a huge capture ratio, and you get this kind of 25x difference in valuation.   As the VCs like to say, it all scales.

But, like in every economic problem, there is at least one fixed factor, and that is time.  There are only 24 hours in a day.  Drivers can't drive 24 hours a day, and even the Uber drivers doing 8 hours a night for 5-7 days can't keep it up too long.  As Uber tweaks its model with fees and hurdles for drivers to achieve different payouts, it will run into the issue that drivers making $50,000 or so a year, probably not making their social security contributions and taking all the maintenance, debt service and insurance risk on their vehicles eventually will conclude that it's a great model for a company which is a piece of software, but not for them.  That labor force will churn, and no there's no more disruption: it's a rather typical management problem in lots of businesses.

As for taking over the world, Uber is having trouble in India, and it is using its cash hoard to take over competitors.  However, so are the local competitors doing the same things.  Software is ultimately a commodity, and Indian entrepreneurs are devising their own systems for fleet management and payments.  With all the traffic congestion in cities, owners, chauffeurs, auto rickshaws and Uber taxis are all limited in their ability to turn around rides.  No amount of cash in Uber's coffers can make this problem go away.

More up rounds have, are and will be done, but as Chuck Prince said, "As long as the music is playing, you better be dancing."


Cabily said...

If the "leaked" financials are true, it is not overvalued. Clearly people far smarter than me are tossing a few billion their way based on the numbers.

Eapen Chacko said...

Do you have a link to the "leaked" financials? I would love to read. Too early to see who is smarter. Thanks for the comment.