Kicking the Tires on Uber’s $17 Billion Valuation: Is It Worth That Much?

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In June, five-year-old San Francisco-based startup Uber raised $1.2 billion in a round of funding — but it also raised quite a few eyebrows with a valuation of at least $17 billion.

Based on the funding total from Fidelity Investments and other investors, some analysts say the firm is now worth $18.2 billion. At that price, Uber would be more valuable than companies such as Whole Foods, United Airlines and Alcoa, the largest aluminum producer in the world. According to James Ball’s analysis in The Guardian, the firm’s current valuation is a sign of “tech insanity” and “just another fantasy marketed by Silicon Valley.” He writes: “Not only has the last sane person in the Valley left and switched out the lights, but someone probably paid him at least a billion dollars to do it.” However, Wharton experts such as finance professor Jeremy Siegel note that the technology sector as a whole is not overvalued (as he explains later in this article).

Uber provides its customers private car service through a smartphone app. For its premier service, it uses higher-end vehicles — such as sleek Lincoln town cars — operated by freelance drivers. Based on the investments it has attracted, the firm is estimated to be worth more than Hertz and is nearly triple the value of Avis — all without owning a fleet of vehicles or other physical assets such as rental car locations and their adjacent parking lots.

Founded in 2009, Uber was launched to address certain inefficiencies in the taxi and limousine market: People have to flag down or call cabs, and then they fumble with cash and credit card payments. Consumers use Uber’s smartphone app to summon a ride and pay the fare with their phones in a cashless system. The app lets them track their drivers as they approach; they can even see driver identification photos and ratings. But unlike public transportation, Uber employs “surge pricing,” where rates can rise exponentially in periods of peak demand, including during rush hour, holidays and bad weather.

Uber offers a range of vehicles at different prices: UberX service is the cheapest and uses lower-end cars such as the Ford Fusion; Uber Taxi, Black and SUV deploy middle-of-the-road to higher-end vehicles, while Uber Lux hires out premium cars like BMWs. But it does not operate commercial vehicles, thereby avoiding high capital expenditures. Instead, it contracts with other drivers in exchange for a 20% cut of the gross proceeds.

“Regulations could kill them…. Everyone wants Uber to be gone.” –David Wessels

The set-up seems to work for both sides. According to Uber, its drivers’ median income exceeds $90,000 a year in New York City and $74,000 in San Francisco. In contrast, the average U.S. cab driver makes a median income of nearly $27,000, according to the Bureau of Labor Statistics. The higher income potential attracts many drivers, and the service’s convenience brings in passengers. At last count, Uber operates in 149 cities and 41 countries.

“Their business model is fantastic,” says David Wessels, Wharton adjunct finance professor. “It’s a real business, with real tangible cash flow.” However, even promising new companies can be overvalued. If Uber sticks to the $10 billion taxi market, its $17 billion valuation would be tough to justify, he notes. The upside is the service’s potential to replace private vehicles, which is a far bigger market, Wessels adds. Urban residents who only drive once or twice a week could opt to get rid of their cars and take Uber instead.

Wharton finance professor Luke Taylor agrees that Uber’s market would have to expand beyond car service to command such a lofty valuation. He notes that Uber has been dipping its toes in the logistics business, and he sees potential growth there. In April, Uber introduced UberRUSH, a messenger service being tested in Manhattan. Last December, Uber partnered with Home Depot to deliver live Christmas trees to residents in 10 cities willing to pay $135 for a 7- to 8-foot Fraser or Noble fir with a stand. That puts Uber squarely in competition with UPS and FedEx. “This is much bigger than the taxi business,” he notes.

The company’s focus is “not about the market that exists; it’s about the market we’re creating,” Uber CEO Travis Kalanick said in a June 6 story in The Wall Street Journal. He added that the company’s vision is to “make car ownership a thing of the past.” In San Francisco alone, the size of the ground transportation market is $22 billion, Kalanick noted.

Seeing Possibilities

Scott Kupor, managing partner at venture capital firm Andreessen Horowitz, says that his firm often bases its investment decisions on a start-up’s potential market rather than merely the size of an existing industry. “Our view about how big the ultimate market can get [often] drives a lot of those decisions,” Kupor notes. Some of the firm’s early stage, high-profile bets include Facebook, Twitter, Foursquare, Pinterest, Skype, Zynga and Groupon.

According to Kupor, most analyses of tech valuations tend to be short-sighted because they extrapolate projections based on existing markets. As such, they miss the boat by underestimating the start-up’s true potential. For example, Airbnb, a service that matches people who have vacant rooms or beds in their homes with travelers in need of lodging, was gauged by the traditional metric of hotel stays.

But what many people failed to realize, Kupor says, was that Airbnb — which Andreessen Horowitz is backing — has created a much bigger market: People who never would have thought to enter the hospitality business began renting out rooms in their private homes. “You can dramatically change the market size opportunity by enabling a use case that didn’t exist before,” Kupor notes.

The same opportunity exists in the so-called “sharing economy” for car services, he adds. His firm is an investor in Lyft, an Uber rival. The potential Andreessen Horowitz sees in Lyft is its ability to energize private car owners to give passengers a ride for a reasonable fee. As in Airbnb, these drivers would not have thought to enter the taxi and limousine market themselves. Their entry makes the market bigger overall and swells the revenue of Lyft, he points out.

“The taxi industry is close to a monopoly, and it’s ripe for disruption — and Uber is going to do it.” –Luke Taylor

Kupor believes that firms like Lyft and Airbnb arguably should be worth more than their traditional rivals in the car rental and hotel businesses. Since they do not have to build hotels or buy a fleet of cars, their profits per unit should be “significantly higher. They ought to be way more valuable than their physical counterparts because they are operating at scale and with a margin structure that looks unlike what we’ve seen in any physical capital businesses.”

Regulatory and Other Headaches

At present, Uber’s main hurdle is the stiff opposition coming from regulators and taxi associations in many cities. City and state officials are concerned about keeping passengers safe and monitoring individuals who can become Uber drivers at any time. “You have a guy showing up in an old Chevy with flames on the side of his car, without a shirt,” scoffed Evgeny Freidman, a top taxi fleet operator in New York, according to a July 7 article in The New York Times.

In June, protests from London to Madrid have popped up as taxi drivers have fought Uber’s entry into their markets, especially since the firm’s drivers do not undergo the same rigorous licensing and testing process required in some countries. In France, new laws reportedly are being proposed to manage mobile taxi apps, including one that only lets licensed taxis show on an app created by the government. Brussels has banned Uber. In Germany, the Berlin Taxi Association won an injunction to bar Uber in the city. Uber is appealing that decision.

Uber’s “surge pricing” policy has resulted in rates skyrocketing when demand is high, such as during natural disasters, triggering anti-price-gouging laws. In New York, Uber recently reached an agreement with the state to cap prices for UberX and Uber Black during emergencies. It expects to roll out the price-cap policy nationwide. Meanwhile, New Orleans, Portland, Ore., and Miami have blocked Uber. Other cities are pondering similar regulations. Lyft faces similar roadblocks, with New York filing a lawsuit to block the start-up.

“Regulations could kill them…. Everyone wants Uber to be gone,” Wessels notes.

According to Kupor, Andreessen Horowitz invested in Lyft despite these obstacles because of the “dispersion of regulation.” While medical device or drug companies live or die by U.S. Food and Drug Administration approval, Lyft has a fighting chance because it gets to make its case city by city. “You don’t have a single governing body that can keep you out of a very large market, and for us, that de-risks the regulatory problem,” he notes.Kupor adds that some cities want to be frontrunners in the “sharing economy” and welcome these tech start-ups. As car-sharing services prove their worth to the community, he predicts that regulators will have a change of heart and slowly embrace new technologies. But in the meantime, companies have to brace themselves for costly trench warfare. “It’s a city-by-city education process.”

“Certainly, there occasionally are firms that might be overvalued, especially for IPOs, but the tech sector as a whole is definitely not overvalued.” –Jeremy Siegel

Taylor is betting that Uber will survive. “I think it has staying power,” he says. “The taxi industry is close to a monopoly, and it’s ripe for disruption — and Uber is going to do it.”

A Bigger Question

Meanwhile, as venture capitalists, mutual funds and private equity firms feverishly flood Uber with money — the start-up was worth $3.5 billion only a year ago — its valuation brings to mind the spectacular boom and bust of Internet stocks from 1999 to 2000. The aftermath of the dot-com crash wiped out $5 trillion in paper wealth and destroyed former highfliers such as eToys.

Is the market in a similarly frothy state today?

“We are not in a tech bubble,” Wharton’s Siegel says. “Things are dramatically different than they were in 2000.” At the height of the Internet boom, he notes, the average price-earnings ratio of tech-sector companies in the S&P 500 was 90. Now, it is 15. “Certainly, there occasionally are firms that might be overvalued, especially for IPOs, but the tech sector as a whole is definitely not overvalued,” Siegel states.

In the first quarter, venture capital investments totaled $9.5 billion on nearly 1,000 deals — the highest since 2001, according to the National Venture Capital Association. But from 2010 to 2013, investments stayed within a range of $23 billion to $29 billion on 3,600 to 4,100 deals on an annual basis. During the dot-com boom, VCs had deployed a lot more capital: $55 billion flowed into 5,600 deals in 1999 and $105 billion into 8,000 transactions in 2000.

Moreover, “Uber is a well-established company” which is making profits, Siegel points out. “It’s not like the Internet companies in 2000 — very few of them were making profits. Probably the only one at that time making profits was AOL.” The dot-com crash has made tech investors more sober. “People learned a lesson from that. There was nothing in history for people to judge [such] valuations back then…. I think people will be far more disciplined.”

According to Siegel, while the Dow Jones Industrial Average recently closed above a record high of 17,000, the market is rising because of solid market fundamentals instead of speculation. “Earnings are at all-time highs, so stocks should also be at all-time highs.” He predicts that the Dow will hit 18,000 by the end of the year. Low interest rates and moderate earnings growth should continue to support the market’s valuation, he adds. Still, investor caution will persist because of the “terrible bear market” of five years ago, which was the worst in 75 years, he says.

Meanwhile, there are pockets of standout valuations, especially among fast-growing tech companies such as Uber. According to Siegel, investors are chasing higher returns in an environment of low interest rates, so they are eyeing even risky IPOs. But it is a calculated bet. “Don’t forget, you only have to hit one IPO that goes up 10 times,” he says. “You can have nine others that flop, and you’ll still do extremely well.”

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