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Uber: From Charity to Cash Machine
[Free] Deep Dive
Edited by Brian Birnbaum.
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What follows is a summary of the deep dive and beneath it, the full deep dive.
Deep Dive Summary
Uber has gone from being a transportation charity to a lean mean cash machine.
In Section 1.0 I explain how the collapse of the mobility business in Q2 2020 precipitated this shift, forcing Uber to learn how to operate multiple verticals at once–the key source of its newly gained operating leverage.
In Section 2.0 I explain how Uber is now in a position to deliver outsized cash flows as it deploys new verticals.
In Section 3.0 I dissect the evolution of the mobility and delivery business take rates, which teach us that, although Uber wields the ability to deploy new verticals, it’s not immune to hyper-local disruption.
In Section 4.0 I analyze Uber’s new flywheel–the ads and freight businesses–which promise to drive additional cash flow production.
In Section 5.0 I explain how a disciplined approach to capital allocation, together with its budding structural advantage versus pure-play competitors, may turn Uber into a long term compounder.
In Section 6.0 I analyze the financials, with particular emphasis on the balance sheet, which is relatively weak.
In Section 7.0 my conclusion illustrates that, at a P/S ratio of over 10, the market is not exactly unaware of Uber´s recent fundamental advancements.
Full Deep Dive
1.0 Presenting Uber 2.0
In Q2 2020, Uber’s mobility business collapsed. In hindsight, this is just what the company needed to unlock systematic increases in demand-side frequency and evolve into a profitable endeavor.
Since 2020, Uber has developed startling operating leverage with regard to both revenue generation and cost structure, allowing the company to evolve from a chronic subsidizer to a profitable enterprise. This transformation is best depicted by contrasting the evolution of SG&A and R&D expenses as a % of revenue, versus that of gross bookings.
From Q1 2020 to Q3 2023, SG&A and R&D expenses have gone from 53.98% to 17.08% and from 17.74% to 8.58% of revenues, respectively. More broadly, OpEx as a % of revenue is down from 79.02% to 27.86% during the same interval. Meanwhile, gross bookings are up from $2.9B to $9.2B, an increase of 317%. The numbers point to a fundamental metamorphosis of the business.
Most notably, SG&A expenses are down 68% and R&D down 51%. Within limit, with platforms like Uber, higher R&D spend tends to a drive higher volume of business by improving the user experience. Rising gross bookings coupled with declining R&D spend is quite appealing.
However, the relatively larger decline of SG&A, which includes marketing, suggests that Uber has found a way to do more business with the average customer. This is a far more preferable source of operating leverage than simply cutting costs.
As you can see below, MAPC (monthly active platform consumers) came in at 142M in Q3 2023, 56% higher than the pre-pandemic peak in Q4 2019 of 111M. In turn, gross bookings are up from $18.1B in Q4 2019 to $35.2B in Q3 2023, implying an increase of 94.5% and thus outpacing MAPC growth.
As you can see in the two graphs above, in Q2 2020 Uber´s gross bookings collapsed, brought down by the halt of the mobility operation as the pandemic spread across the world. Upon reviewing this quarter carefully, I found data points illustrating Uber´s inherent anti-fragility.
In Q2 2020, two thirds of Uber´s cost structure was variable, which enabled the mobility business to deliver $50M in adjusted EBITDAr. In turn, Delivery gross bookings grew 122% YoY, keeping the supply side of Uber´s marketplace engaged, allowing for an inevitable recovery.
Q2 2020 was a nightmare scenario for Uber, but it actually planted the seeds for the top-line operating leverage outlined above. As the world normalized post Q2 and the mobility business recovered, Uber eventually discovered that, by operating two segments at once, it increased the network’s frequency, which disproportionately increased gross bookings.
Interestingly, mobility and delivery have different peak hours. This allows the two verticals to co-exist in a highly accretive manner.
In the Q3 2023 conference call, Uber management reiterates that multi-product riders spend three times more and stay on the platform longer than single product riders. As you can see below, Uber already disclosed this metric in February 2022 during the Analyst Day presentation. This is the key source of operating leverage in Uber’s new chapter.
In essence, Uber´s business consists of acquiring audience members, connecting them with earners, and taking a fee for the intermediation services. For the business to be profitable, the CAC (customer acquisition cost) must be far smaller than the LTV (lifetime value) of the average user. The bigger the difference between LTV and CAC gets, the more profitable the company is.
Every additional vertical deployed both reduces CAC and increases LTV:
CAC reductions: each new vertical brings in a new audience that other verticals could not previously access, which then funnels new customers to subsequent verticals. For instance, someone might sign up for Uber to use Uber Eats primarily, because he/she is set with transport but not with food. Eventually and through cross-promotion, this person is likely to end up using UberX (mobility).
LTV increase: as mentioned, with every additional vertical that a customer engages with, spend rises disproportionately, thus driving LTV.
In turn, the health of the Uber network increases non-linearly with that of demand side frequency. A driver has a much higher chance of staying on the platform if he/she receives more jobs. With every additional vertical, Uber exponentially increases the liquidity of the network.
Higher liquidity drives ETAs down (estimated times of arrival) and reduces price surges. Both drive increased customer satisfaction, which drive frequency, liquidity (via higher retention) and so forth. With every additional vertical deployed, Uber makes the platform much stronger financially as a result of enhanced network effects.
2.0 Uber the Cash Printer
MAPCs have only just surpassed pre-pandemic levels. As Uber continues to deploy further verticals and MAPCs continue to trend up, the company is set to print cash. Eventually, the network´s frequency and liquidity increase enough for Uber to become a logistics company.
Currently, Uber’s overall penetration is still low. In major markets like New York and London, for instance, less than 10% of customers over the age of eighteen use the platform weekly. In turn, globally, only one third of customers engage with Uber monthly.
Uber’s best bet to increase penetration is to add new verticals and become more relevant in customers’ lives.
As you can see below, cash from operations has turned positive in the TTM for the first time since Uber´s IPO and, likely, its entire history. Additionally, Uber is adding new Uber Eats verticals like groceries, alcohol, and convenience, along with novel mobility verticals like hailables, taxis and motorbikes (Uber Moto).
These new verticals will accelerate both MAPC growth and penetration, which should translate into outsized cash production. In FY2022, cash from operations came in at $642M and, in the TTM (twelve trailing months), it came in at a face-ripping $2.5B.
As of Q3 2023, new verticals are at a run rate of $9B, growing 80% YoY. Each one of these verticals introduces Uber to new audiences and funnels them into subsequent verticals, lowering CAC and increasing LTV.
For instance, in Q2 2023 riders of Uber Moto in Argentina had a 1.8X greater engagement rate than the average in Argentina. As of Q3 2023, 13% of Delivery users are ordering new verticals, up 300 basis points YoY, showing that additional verticals drive higher frequency.
Same thing in Moto. These are two-wheelers in Latin America, and again, newer lower income audience that previously could afford Uber, now can afford Uber as well. So, all of these either drive audience or frequency or both. And obviously, they're strategic in terms of our long-term growth formula.
-Dara Khosrowshahi, Uber CEO, during the Q3 2023 conference call.
As the frequency and liquidity continues to increase, I believe Uber´s ability to cater to last mile logistics via its driver network will increase exponentially–particularly after once it breaks above a critical level. The non-linear relationship between frequency and liquidity increases is likely to bring this scenario to life.
Beyond this critical level, Uber effectively becomes a competitor in hyper-local commerce logistics, rivaling Amazon and other legacy players like FedEx. Uber´s move into groceries, alcohol, and convenience is a small preview. In the case of success, Uber would turn into a cash printer over the long run.
The nature of the supply side is evolving as I write this. Autonomous vehicles are on the rise and promise to disrupt transportation and logistics. Thus, the value of networks like Uber will mostly accrue from robust mind-share on the demand side.
Regardless of how your groceries get delivered, you are likely to default to the platform/network that you trust most. Since Q2 2020, Uber has demonstrated that they know how to stay relevant with demand-side customers. It thus presents itself as the demand-side funnel to bet on as we move towards autonomy.
Similarly, Uber has an opportunity to move into travel. Approximately 10% of global trips are travel-related. In 2022, for instance, nearly 700 million trips globally (out of a total of 7.6B trips) were taken by riders outside of their primary city.
The travel opportunity is two-fold: first, delivering customers to their destination by offering, for example, cheaper plane tickets; and, most notably, making customers feel at home once they arrive. The latter is where Uber has a distinct competitive advantage, since it is getting to know its customers better by operating a broadening range of verticals.
Uber knows what Uber Eats customers like to eat and drink, on what day of the week, and at what price range. Uber can use these insights to drive additional frequency at the customer´s new destination. The company can thus use travel as a vector for additional liquidity, with the potential to magnify cash flow going forward.
3.0 Dissecting Take Rates
The evolution of mobility and delivery take rates suggest that Uber is capable of deploying new verticals, but the company´s history reveals caveats.
Uber makes money by taking a percentage of the transactions between the demand and supply sides of its network. Lowering the take rate provides an incentive for the supply side and raising it does the opposite, but increases Uber´s net revenue.
Understanding this metric in depth is vital for investors, because it can be used by management to artificially inflate profits. With Uber´s shifting towards profitability and healthier cash flows, it is paramount to ensure that said financial evolution is driven by healthy fundamental improvements.
From 2017 to late 2019, the evolution of Uber´s Delivery vertical participated in a race to the bottom in a highly competitive environment. Delivery players were lowering take rates in an effort to maximize scale, by providing increased incentives to both drivers and restaurants. In Q4 2019, Uber decided to exit the Indian market and the move teaches us some valuable lessons.
Uber sold its delivery business in India to Zomato, a local competitor, in exchange for a 9.99% stake in the Indian start-up. At the time, the Indian delivery market was dominated by two major players: Swiggy and Zomato. These two companies were heavily funded by venture capitalists and were able to offer aggressive discounts and promotions, making it difficult for Uber Eats to compete effectively.
By January 2020, Swiggy had raised a total of $1.7 billion across 19 funding rounds, while Zomato had raised a total of $2.2 billion across 22 rounds. To put this into context, Uber exited FY2020 with $6.8B cash in hand, proving that hyper-local competition is hard to offset with global network effects (I will review this in depth in the next section).
Meanwhile, in Q4 2019, the US Delivery take rate rose 500 basis points YoY with a rather convoluted competitive environment, as depicted below. Further, the delivery take rate began to tick up when Uber acquired Postmates on July 5 2020 in an all stock deal valued at $2.65B.
Per the above data, the deal set Uber Eats´ market share at approximately 30%. Roughly on par with Grubhub and DoorDash, the former´s market share was declining rapidly. From this point on, it appears, rising Delivery take rates have become a function of softer competitive pressures brought about by the Postmates acquisition.
Note: adjusted EBITDA consists in adding stock-based compensation, non-recurring expenses and interest expenses back to EBITDA.
In hindsight, the Q4 2019 to Q1 2020 period suggests that Uber CEO Dara Khosrowshahi is an excellent capital allocator. The inflection point of the Delivery business’ adjusted EBITDA can be traced back to exiting India and acquiring Postmates.
The situation also teaches us that Uber can indeed deploy new verticals, increasing cash flow production capacity, as I hypothesize in Section 2.0. However, as mentioned, we also learn that Uber´s global network effects are not immune to disruption by hyper-local ones.
Thus, the extent to which Uber´s new verticals will equate to increased cash flows depends on how it manages local competition.
In fact, in Q3 2023 we see Uber Eats exit eight markets.
Some of you will recall my commitment on our Q3 2019 call to invest aggressively only in markets where we are confident we can establish or defend a number one or number two position.
Consistent with that strategy, on Monday we announced Eats will exit eight countries.
-Dara Khosrowshahi, Uber CEO during the Q3 2023 conference call.
In the graph above (which I include again for your benefit), you can also see how Mobility take rates took a dip during the pandemic and have now arched upward once more. At first glance, it would seem that management is opportunistically raising the take rate. However, the UK accounting change makes mobility take rates look higher than they are.
Without this accounting modification, the take rate would be 21%, which is a considerable increase since Q1 2021, but largely in line with historical levels. Meanwhile, despite the normalized increase in Mobility take rates, we see the volume of total trips continue to grow.
From the Q4 2019 peak to Q3 2023, total trips have grown from 1.91B to 2.44B, implying an increase of 27%. As mentioned in Section 1.0, MAPCs (monthly active platform consumers) are up 56%. The relative softness in trip growth is food for thought, especially when considering the previously mentioned dynamics between global and hyper-local network effects.
4.0 The Emerging Freight<>Advertising Flywheel
The two operations are growing fast and are set to create a flywheel, which enables Uber to compound goodwill with corporations. The long term result of this flywheel is likely to be fairly accretive to the bottom line.
At the end of Q2 2023, Uber’s advertising business was at a run rate of $650M and according to Dara, as of Q3 2023 is on its way to hit the $1B run rate milestone. This makes it one of the fastest-growing advertising businesses in the world.
The advertising operation enables Uber to compound goodwill with corporations. Over time, building up trust will enable Uber to lower CAC and increase LTV for the freight business.
Once a corporation has a recurrently great advertising experience with Uber, sending goods around via the platform is a natural step forward and vice versa.
The return on ad sales are excellent. Return on ad sales are on average, anywhere from 7x to 10x your spend. So, this is a very profitable endeavor for our product for our partners, which is great.
-Dara Khosrowshahi, Uber CEO, during the Q3 2023 conference call.
Uber did not formally launch a dedicated advertising business unit until 2022. However, the company experimented with advertising and monetization programs as early as 2016. In 2017, it introduced display ads on Uber Eats and followed up by launching cartop ads in 2020.
Uber then started testing in-app video ads for its ride-hailing service in 2021. As part of the testing phase, it launched its inaugural Journey Ads program in October 2021. These efforts paved the way for the creation of Uber's advertising business, which formally commenced in 2022.
The majority of Uber´s ad revenue comes from small and medium sized organizations. But Uber is building out an ad-tech stack to enable more granular attribution. Over time, this should draw in larger organizations, which will then be funneled into freight, which the company is doing across mobility and delivery.
According to management, the freight business is seeing “category-wide headwinds,” with weak industry spot rates. Although this trend is expected to continue in the near term, you can see in the graph above how freight gross bookings have been growing quite rapidly since 2017.
Simultaneously, the freight business saw a $9M QoQ improvement in adjusted EBITDA. Below you can see how the metric has been converging as quickly as gross bookings have been rising. According to management, convergence is due to cost discipline for the most part.
Overall, Uber is gradually positioning itself for cashing in when the headwinds dissipate.
The US freight industry is one of the largest and most competitive in the world, with a total market size of over $700 billion in 2023. The industry is fragmented, with thousands of trucking companies of all sizes operating across the country, giving Uber´s aggregating platform technology a potentially fitting role in the industry.
Uber Freight is a subsidiary of Uber that operates as an independent business unit. Still, it’s closely integrated with Uber's other businesses.
For example, Uber Freight uses Uber's technology platform to connect shippers with carriers and leverages Uber's brand and reputation to attract customers. Additionally, Uber Freight shares some resources with Uber's other businesses, such as its marketing and engineering teams.
5.0 Competitive Landscape
Uber´s exposure to hyper-local network effects is a threat to the long term thesis. However, as the company deploys further verticals, it gains a structural advantage over pure-play competitors. Uber One is enhancing said advantage.
My main concern with Uber is that its data moat might not be that effective if its attention is spread out too thin, with an ever growing list of highly focused local competitors. When asked about Uber´s compounding operational advantages in Q3 2023, Dara replied the following:
So in terms of the compounding advantages, I'll go back to what I was talking about in terms of machine learning, which is becoming a much more important part of the business. So we're just -- we have more data points in terms of opportunities to match riders to drivers or eaters to restaurants to couriers.
As mentioned, Uber Eats exited eight markets in Q3 2023. In the various quarterly conference call transcripts that I have read, there is no particular mention of how Uber´s global network effects are structurally set to compete with local competitors that are evidently causing trouble.
Management is evidently accustomed to pruning operations in markets in which Uber cannot achieve a number one position. Perhaps that is enough in the long run for the company to continue growing well, but I would like to see management give more insights into how global network effects feed into hyper-local ones.
In the graph below, you can appreciate how most of the revenue growth stems from the US and the UK, while revenue growth from other countries is not as impressive.
On the other hand, as Uber deploys more verticals it gains a structural advantage over its pure-play competitors. This is best evidenced by the Q2 2020 collapse of the Mobility business, with the simultaneous rise of the Delivery operation. Certainly, the growth in US revenue reflects said advantage.
More verticals gives Uber more touch-points with the demand and supply sides. Over time and through the inevitable ups and downs, this equates to better marketplace health versus competitors that have a lesser ability to retain the attention of their networks´participants.
In turn, this puts more capital into Uber´s hands which, together with good capital allocation, then yields more touch-points and so forth. This is best evidenced by the acquisition of Postmates, which set the Delivery business on a much more profitable orbit. Uber couldn’t have acquired Postmates without its superlative scale.
As a consumer, it makes more sense to be loyal to the company that most aggressively lowers the cost for a growing number of services (transport, takeaway, groceries, alcohol, travel etc). The more scale Uber achieves, the more it can lower costs, which drives more loyalty.
Uber One promises to serve as a loyalty catalyst for Uber, in the markets in which the company manages to deploy multiple verticals successfully. Uber One is a membership program that offers a variety of benefits to Uber and Uber Eats customers, including:
Unlimited free delivery on Uber Eats orders over $25.
5% discount on Uber rides.
Exclusive member perks and benefits.
Uber One members spend four times more than the average customer and according to Dara in Q3 2023, have a 15% higher retention too. As of Q2 2023, Uber One was generating 27% of total gross bookings, up from 23% in Q2 2022. That is a 17% YoY growth and unfortunately, management has not updated the metric for Q3 2023.
Uber One essentially consists in giving discounts to the more loyal customers. Although this decreases the nominal spend per purchase, it increases frequency. As I have previously explained, every increase in frequency drives a non-linear increase in liquidity, thus driving the top-line disproportionately over the long run.
The membership is available in 18 countries as of Q3 2023. During the quarter, Uber One launched in Colombia, Peru and Portugal.
The network´s advancements are translating into a beautifully converging bottom line. However, investors may be wary of what may be artificially constricted levels of OpEx and CapEx. Further, the balance sheet is not overly strong.
The evolution of Uber´s income statement is characterized by a fast growing top line and a shrinking cost structure, driven by the network´s advancements analyzed in Section 1.0 and 2.0. From Q1 2021 to Q3 2023, total revenue is up 320%, while OpEx is only up 12%.
As a result, operating income is converging upwards. I expect the trend to be durable, as Uber deploys additional verticals and increases penetration, by permeating its customers´ lives further.
Gross margin is relatively flat since FY2017. This supports the idea that management is playing the long game, by not jacking up take rates. For instance, gross margin was 30.48% in FY2017 and in the TTM (twelve trailing months), it sits at 32.41%.
A potential headwind to the progression of the income statement is the aforementioned hyper-local pressures that Uber recurrently experiences overseas. However, with continued discipline, Uber should continue being able to double down on attractive markets and cut off the less attractive ones.
Cash Flow Statement
Cash from operation is tracking operating income, as it pivots to the green. In FY2022, cash from operations came it at $642M and in the TTM (twelve trailing months), it came in at a whopping $2.5B.
As analyzed in Section 2.0, the deployment of additional verticals promises to be highly accretive to cash flows going forward. In the chart below, you can see how free cash flow levels are rising in sync.
The rising free cash flow is aided by rapidly decreasing levels of CapEx, which is currently $227M in the TTM. In the graph below, CapEx is represented as negative because in the cash flow statement it is a detractor. Regarding this decline, the same potential concern arises as with a quickly tightening OpEx: it may be artificial.
Free cash flow (FCF) is the money a company has left over after paying its operating expenses (OpEx) and capital expenditures (CapEx).
When a company commits to cutting costs, an improving bottom line is the positive aspect. The negative aspect is that the people within the company are working under tighter conditions. Similarly, a lower CapEx implies that the business is reinvesting less. Investors must closely observe this trend, in order to discern whether it is sustainable going forward.
Uber ended the quarter with $5.2B in cash, $9.2B in long term debt and $1.57B in capital leases. The balance sheet is therefore not very strong. Uber has to meaningfully increase its cash flow for the balance sheet to give investors peace of mind. So far, it is on the right path.
At a P/S ratio of just over 10, the market is not amiss of Uber´s evolution into a structurally better business. Although the prospects are enticing, the relatively weak balance sheet and the hyper-local pressures discourage me from labeling Uber as a highly asymmetric pick.
Having said that, long term returns can be excellent if Uber indeed increases the network´s frequency enough to become a logistics player. However, in that realm of operations it will encounter rivals of a much higher level of competence, like Amazon.
Although Uber is a fantastic innovation, it doesn’t have a track record of fending off bigger and meaner players, like Spotify does, for example.
Further, Uber is a wonderful example of how quickly a platform can evolve financially speaking when it manages to successfully deploy additional verticals. New verticals have simply increased ARPU (average revenue per user) and this is rapidly transforming Uber´s income and cash flow statements.
Lastly, Dara owns 0.05% of all shares. Given the nature of the challenge ahead and, especially as Uber moves into the logistics domain, I really wonder whether this is enough.
Until next time!
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