Leading ride-share companies Lyft and Uber are set to IPO in the next month. Lyft goes first this Friday, while Uber follows in April. Investors that hitch a ride with these domestic-transportation-disruptors may be looking at a half-trillion-dollar market by 2023, according to Morningstar analysts Ali Mogharabi and Julie Bhusal Sharma.
But what are some of the key success factors that drive the success of the industry?
The network effect – a value engine
When you have an app that delivers value on both the demand and supply side, you have a self-fulfilling and self-replicating business model that grows exponentially. The more drivers, the better experience for riders. The more riders, the greater financial incentive for drivers.
With every iteration of this ‘network effect’, the appeal for new clients and suppliers grows. And this leads to a competitive advantage, according to Mogharabi and Sharma, who assign the company a narrow economic moat.
The other benefit of this network effect is the growth in valuable data. As the network expands, so does Lyft’s intangible assets associated with rider, rides and mapping information, which Mogharabi and Sharma believe can help drive Lyft’s profitability and excess returns on invested capital in the future.
Promising, but not yet profitable
Lyft is not yet profitable, and Mogharabi doesn’t expect the company to starting making money until 2022. That being said, he sees top-line growth of 36% compounded annually through 2028 with the increased adoption of ride-sharing globally.
Lyft has so far raised about $5 billion in capital, according to Morningstar Pitch Book Data. Its 11th and last round of funding in June 2018 was for $600 million, which implied a valuation of $15 billion. “We believe the intrinsic value of Lyft is probably over $24 billion,” says Mogharabi, adding that the IPO is likely to reflect an $18 billion to $30 billion company.
Mogharabi and Sharma also mention key metrics around Lyft’s foray into the bike- and scooter- sharing markets, which they think is worth over $9 billion, and set to grow 9% annually through 2028.
The risks – regulation and competition
“Many risks remain around legal and regulatory matters in the rapidly growing ride-sharing space,” say Mogharabi and Sharma. “Regulatory issues today involve how the company runs its everyday business, from employee type recognition to a minimum pay requirement. Various other requirements such as background checks and driver classification are also being enforced. In our view, pressure from such legal matters will persist.”
Before addressing Lyft’s most direct competitor (Uber), it’s worth looking at competition from the taxi industry – mainly due to the relation to legal and regulatory reviews that followed their demands for market fairness.
In Canada, ride-sharing has been available for some time, but consultations, and tensions, with the taxi industry persist. The fairly nascent industry has taken an ‘act and ask for forgiveness’ approach that at one point spurred taxi services to protests in Toronto.
The risks are around new requirements for licensing, training and safety standards – all with the potential to drive up costs and reduce the value of ride-share services relative to the taxi industry.Toronto is now entering a second round of consultations around its vehicle-for-hire industry bylaws. Topics will include safety training requirements first visited in 2016 amidst heated regulatory discussions, and a report of recommendations is expected to be tabled in June.
Meanwhile, the B.C. government has only just come around to making ride-sharing (legally) available by the end of 2019. Last month the federal Competition Bureau released a report which urged the B.C. government to revisit provincial taxi regulations with a focus on market competitiveness and the sustainability of the taxi industry. B.C. will require all ridesharing drivers to get a Class 4 passenger license and undergo regular criminal checks.
However, for all the noise and heated discussions, both the ride-sharing and taxi industry are likely to adapt to compromise and the risk of competition will likely be contained.
“We think it is less likely for taxis to retake some of the market in the future, says Mogharabi who points out that he does not anticipate taxis to go away. “Taxis could also choose to operate on the Lyft or Uber platform as those two have been successful in creating the network effect,” he says.
How about fuel costs?
“Fuel cost risks are borne mainly by the drivers,” notes Mogharabi. Passengers might not immediately feel the pain of fuel prices, and before that happens it’s likely it will push private car owners over to become car-sharing passengers instead.
“Fuel cost risks could also force car owners and others that haven’t used Lyft, Uber, or other ride-sharing providers to begin using those services as while they may be more expensive than public transportation, their on-demand services would attract more commuters and other users. Plus, depending on average commute or travel distance, using Lyft or Uber could be cheaper than using one’s owned vehicle.”
Uber – in the lead, for now
Finally, investors may be wondering which company to go with. Will Lyft eventually overtake Uber?
Uber has an edge on Lyft in terms of an earlier start, higher market share, and a stronger network effect around its service, says Mogharabi and Sharma. But Uber’s efforts are diluted with a business model that includes food transportation (Uber Eats) and logistics. Mogharabi and Sharma like Lyft’s relatively narrower business focused on consumer transportation and point to Lyft’s innovations in the targeted space.
Lyft’s pricing may also give it a competitive advantage. Based on samples collected in February, Mogharabi and Sharma say Uber charges between 11-20% more for trips in 10 major U.S. cities. Based on data from Second Measure, as of January 2019, Uber’s market share in the U.S. was 68.5% versus Lyft’s 28.9%. Yet in its recent SEC filing, Lyft stated that it had 39% market share in the U.S. by the end of 2018, based on estimates from Rakuten Intelligence.
Early access – private opportunities through public products
Most interested investors may be waiting for the IPO to hitch a ride on this opportunity, but there is another way to invest before a company’s IPO actually hits the market – a private placement.
Private placements are available to accredited, large-sum investors – including institutions. One-way mainstream investors can get a piece of the action is to piggyback on the research capabilities and access of a fund company, and invest in a mutual fund that buys private placements.
In Canada, some of Fidelity Investments’ funds have secured private stakes in Lyft. These funds include Fidelity Insights Class, Fidelity Founders Class, and Fidelity American Balanced Fund.
Mark Schmehl, portfolio manager with Fidelity Investments Canada, believes that Lyft has a great product. Post the IPO, he sees the ride-share market getting more crowded with more regional dominance paying a critical role in the competitive landscape.
Schmehl was a pioneer in the private space here in Canada. “I go for privates because of a lack of growth stocks within Canada,” he says, explaining that when he started investing in privates seven years ago, he found few opportunities in Canada as there is a lack of capital to support the growth of the companies. This pushed him to Silicon Valley. He found the same businesses far exceeding the growth of identical businesses in Canada, citing one company that eventually raised $3bn, while the Canadian counterpart only raised $100m. “That gives you can idea of the climate here for private investments”.
When starting out, he emphasized the importance of having boots on the ground, getting your name out there and setting up meetings for the most direct investment insights.
Schmehl’s secured 22 private placements to date, and now works with a team of portfolio managers to travel – often to Silicon Valley – to scope out the next businesses on the frontiers of new markets.
“Generally it takes about six months from start to finish to secure a private placement,” said Schmehl. This includes research, due diligence and personal meetings which Schmehl considers very valuable. “These businesses have a long road ahead of them and it might be 10 years before you see a company go private.” However, Schmehl emphasizes the value of the dialogue and information flow while waiting. Ground-level, personal, fundamental insights into entire industries blossoming helps inform the investments in the rest of his portfolio.
