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Stock Strategist

Uber May Pick Up Investors in Its IPO

The ridesharing pioneer is likely to maintain its competitive advantage via its network effect.

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We've taken a deeper look at privately held Uber, the ridesharing service provider that sits at the number-two spot in the world (based on rides hailed) and is attempting to gain traction in what we estimate to be a $630 billion market by 2022. In our view, Uber's core business, the ridesharing platform, would warrant a narrow economic moat rating as it has displayed some moat sources such as network effects and intangible assets, which could position the company to become profitable and generate excess returns on invested capital in the future.

Based on our analysis and using publicly available data on Uber's financials from The Wall Street Journal as a starting point, we value Uber at a $110 billion market capitalization, ahead of the company's last valuation round of nearly $62 billion in May, according to PitchBook. We project that Uber's net revenue will grow at a 27% average annual pace over the next 10 years to $82.4 billion. We foresee Uber continuing to spend on expansion and research and development but think it will become profitable by 2022. The company is likely to go public during the second half of 2019, and considering its success at raising capital, we expect the initial public offering price to value Uber between $100 billion and $110 billion.

Looking ahead, Uber may leverage its moaty ridesharing business and tap into other growth opportunities, including bikesharing, meal takeout and delivery, freight brokerage, and ridesharing via autonomous vehicles. In our view, autonomy is the most transformative technology set to affect the world of ridesharing; we see powerful economic forces driving autonomous vehicle adoption in the ridesharing industry, from which Uber may benefit. On the other hand, risks remain, such as increased competition and the company's legal issues.

How Big Are Uber and Its Market?
As of June, an Uber ride can be ordered in 65 countries and over 700 cities. Based on data from Uber and eMarketer as quoted in Reuters, Uber has U.S. ridership of over 40 million people (defined as those who use Uber at least once per year) and global ridership of 75 million. EMarketer projects U.S. ridership to increase to 64 million by 2022. Riders depend on approximately 3 million active drivers globally, with "drivers" defined as those providing more than four rides per month. Uber says it completed 4 billion trips in 2017, resulting in $36.2 billion in gross bookings and $7.8 billion in net revenue. Its largest territory is North America, while the company is also present in Central and South America, with the ridesharing app available in over 300 and 175 cities, respectively.

Uber's scale is not derived only from ridesharing, however. According to Eater and Uber, Uber Eats has 8 million monthly active users in over 250 cities globally, with over 60,000 participating restaurants. This compares with current market leader Grubhub's (GRUB) 15 million users and over 80,000 restaurants. Uber Eats has expanded rapidly, with the number of drivers growing 24% between March 2016 and March 2017, according to The New York Times. Although its drivers are considered contractors, Uber also has nearly 16,000 employees.

We believe that Uber's market potential expands far beyond the one-off need for a ride from the car dealer or airport--and even the total taxi market. Uber leverages its network of drivers and users for logistics of transporting people, food, and cargo to create a compelling substitute for traditional means of transportation. For these reasons, we believe Uber's total addressable market is the aggregate of the global addressable markets for the taxi, rideshare, and food delivery industries along with the U.S. addressable markets for freight brokerage and the share we believe rideshare companies can take from global public transport and U.S. bikeshare. Taking these submarkets into account and adjusting for Uber's lost stake in China, we estimate Uber's total addressable market to be $630 billion by 2022, with a 26% compound annual growth rate from 2017 to 2022.

We View Uber as a Narrow-Moat Business
In our view, Uber's core business, the ridesharing platform, has displayed some moat sources such as network effects and intangible assets, which could position the company to become profitable and generate excess returns on invested capital in the future. For this reason, we assign Uber a narrow moat rating.

Uber's network effects benefit drivers as well as riders, creating a continuous virtuous cycle. Drivers and riders make up the supply and demand in ridesharing, respectively. As a first-mover in this market, where requests for rides from anywhere could be made in real time via a simple-to-use mobile app, Uber began to attract riders mainly via word-of-mouth marketing. Growth in demand and further word-of-mouth marketing attracted more drivers, increasing the supply of Uber vehicles. As the number of drivers increased, the timeliness and reliability of the service improved, which drove the number of users or riders higher, which attracted more drivers, all of which we believe is indicative of the network effect.

Growth in demand is driven not only by more users, but also likely by more rides per user. Increasing supply is based on more drivers and further capacity utilization of each driver and vehicle. Therefore, what we view as Uber's network effect increases the benefits from and value of Uber's network for new and existing riders and drivers. A figure that we believe supports this and demonstrates increase in vehicle capacity utilization is growth in average number of rides dispatched per unique Uber vehicle, which has been increasing gradually from 2015 through 2018.

While we think Uber has benefited nicely from network effects in recent years, we don't believe it benefits from customer switching costs. In our view, the ridesharing industry currently lacks barriers to entry or exit for customers and drivers. Both customers and drivers can easily switch to Lyft, while customers have other transportation options like taxis and public transit. In early 2017, Uber faced much criticism for appearing to support an immigration order signed by President Donald Trump and attempting to profit from protests related to that event in New York City, both of which led to the #deleteUber campaign launched on Twitter. Also, then-CEO Travis Kalanick was appointed to Trump's economic advisory council, to which some employees at Uber objected. Lack of barriers to exit or switching costs for riders and drivers was on display, as during the same period, other ridesharing providers such as Lyft made headway in New York City and experienced faster growth in trips as riders easily downloaded and used Lyft and other apps for ridesharing services.

In our view, Uber's ridesharing network effect can help the company tap into other markets and generate additional revenue streams. An example is the meal takeout and delivery market. According to Recode, Uber Eats has grabbed share from Grubhub and currently has about 21% of the U.S. market. The same can be said about Uber's plan to extend its reach into the bikesharing and freight brokerage markets.

There are concerns about whether Uber's network effects can remain an economic moat source if the company is forced to incur additional costs imposed through regulations at the municipal, state, and/or federal levels. Additional worries surrounding Uber's network effect moat source include the potential impact of autonomous vehicle adoption on car ownership. Some believe autonomous vehicles could attract more car buyers and increase car ownership, thereby possibly lowering demand for ridesharing services, as self-driving cars may diminish annoyances and other costs currently associated with driving in traffic and/or driving long distances. We disagree, as we think the availability of autonomous vehicles on ridesharing platforms will significantly reduce the necessity of car ownership, which also lowers the return on the much higher car ownership costs.

As Uber benefits from its network effect, we think it gains access to valuable intangible assets in the form of data on riders and drivers, which we suspect helps the company improve its services and increase its vehicles' capacity utilization. In turn, Uber's service may become more effective over time as the company further monetizes its riders via real-time supply and demand-driven pricing. Uber may also use this extensive data and knowledge to tap into other markets. An overall enhancement in service could help the company strengthen its network effect by increasing users and ride requests per user, which helps Uber gather additional data, possibly further increasing the overall value of the data. Simply put, data can also be considered as an indirect network effect moat source.

We do not view Uber's brand as an intangible asset moat source. While many no longer say they "called a cab" and instead say they "called an Uber," we think the company's brand has been tarnished by issues that surrounded former CEO Kalanick. While demand for Uber's services has rebounded, whether such recovery is also applicable to Uber's brand remains to be seen, in our view.

We do not believe that Uber benefits from additional moat sources such as switching costs or cost advantages. Uber users can easily download other apps such as Lyft and begin requesting rides. In addition, drivers can provide service for both Uber and Lyft, as they are not exclusive contractors. Last, while the development of Uber's platform included very high fixed costs initially (according to PitchBook, the company has raised $17.4 billion since 2009), we do not view it as a cost advantage for Uber, as other well-capitalized companies in the technology space, such as Alphabet (GOOG), can replicate what Uber has created. In addition, we view Uber as an asset-light business.

Uber's Ridesharing Is a Software Business
By making on-demand and efficient rides available, Uber has redefined the possibilities for mobility. Knowing rideshare is knowing what Uber is, first and foremost: a software platform.

While "ridesharing" has taken on a variety of meanings, we adopt the definition that Uber tends to use most frequently, which considers ridesharing to be the hailing of a ride via app or platform, usually met by a private vehicle and sometimes a taxi. Though "sharing" is in the name, this definition isn't restricted to pool rides or lines where passengers from different parties ride together. The term also encompasses private rides, which consist of a driver and one-trip party only. Although all Uber rides are hailed via app or an enterprise platform, Uber vehicles aren't exclusively private. In several markets, Uber rides are fulfilled via taxi partnerships under the name UberTAXI to establish name recognition in the face of regulation, such as in Japan. While on the surface it appears that the only difference between the taxi business and the ridesharing business is that the former is hailed by hand or call rather than an app, that major difference opens doors to many others.

Having a sophisticated app for passengers and drivers means that a GPS system can be deployed through the app, rather than via years of street knowledge on the part of the taxi driver or even a built-in GPS. As a result, Uber drivers do not need to know the ins and outs of a city's streets or have the right equipment in their car for trip mapping or for fare computing and payment. On top of that, with driving considered common knowledge to many, there can be almost no extra technical training that is required of an Uber driver, other than understanding the Uber interface.

The second condition that has enabled ridesharing is that by hosting an app through which passengers can request a ride, there is no need for bright yellow cars to roam about, waiting for a hand in the air to match with it. Instead, a private vehicle can pick passengers up, depending only on proximity and efficiency, rather than color, for ride matching. The fact that the only requirements are knowing how to drive and follow GPS directions and having a private vehicle means that almost anyone can be a rideshare driver. This gives way to the gig economy and an asset-light business.

Few requirements and the flexibility of being an Uber driver have funneled rideshare drivers into the contractor pool. With driving a private vehicle being part of the ease and thus appeal of being an Uber driver, vehicles deployed are not owned by Uber. By removing the responsibility for drivers and vehicles, Uber is, at its core, a software platform. Uber's network of drivers and passengers is based on its ability to maintain an ubiquitous medium to connect passengers and drivers efficiently using GPS.

Uber leverages its ridesharing network and technology to support other business endeavors such as Uber Eats, cargo transport, and bikesharing. Uber is also working on helping to reduce commuting time for many Americans by nearly 90%, especially in high-traffic urban and suburban areas, by using vertical take-off and landing aircraft to provide on-demand aviation service. The company will be testing UberAIR in Los Angeles and Dallas in 2020 and plans to make it available to all commuters by 2023.

How Uber's Monetization Fares
The company monetizes drivers by charging a fee for driving through Uber. Based on fiscal 2017 data, that fee floats around 20%-30% of the total costs paid by the passenger, not including tips, to which the driver has full claim. Under all transport options, drivers are not directly compensated for gas, maintenance, or wear and tear. However, Uber does compensate for passenger-originated inconveniences: Passengers are charged for deleting rides or requiring car cleanup.

Enterprises using the Uber for Business platform pay a 10% premium for each trip booked using the service, while the Uber for Health platform, which books trips for non-emergency doctor appointments, remains free. Uber also takes a share for booking external trips or vehicles sans an Uber driver, through freight brokerage or car rental.

Major operating expenses for the company include sales and marketing. In the first quarter this year, Uber disclosed that sales and marketing costs made up 37% of total operating expenses. We believe this is a sign of not only rider acquisition but also Uber's battle to retain drivers. According to a report by The Information referenced by CNBC, Uber's monthly driver retention was reported to be 4% as of 2017, which means that 96% of drivers leave the company within a year of their start date.

Autonomous Driving Has Significant Potential but Meaningful Competition
We believe perhaps the most transformative technology set to affect the world of ridesharing is autonomy, bolstered by powerful economic forces driving adoption in the ridesharing industry. In 2017, Uber recorded $7.4 billion in total revenue, representing approximately 20% of $37 billion in gross bookings. The remaining $30 billion currently goes to drivers, but in a world with autonomous vehicles, more of the gross booking revenue could flow directly to Uber. The tightness of the labor market in the United States adds to Uber's troubles; across the country, companies are having difficulty hiring and retaining drivers. In 2017, the U.S. had a shortage of 51,000 truck drivers, up 41% from 2016. As a result, wages are seeing upward pressure, resulting in margin compression among manufacturers and retailers utilizing freight. At this point, it appears that competition for drivers is fierce, and Uber is competing with other ridesharing apps as well as adjacent industries like freight to attract the same limited pool of workers. CEO Dara Khosrowshahi has spoken about rolling out benefits as a way of retaining drivers disgruntled with their current pay. Clearly, the company faces a challenge in terms of protecting its commissions in the current labor environment. Overall, we see a rather large upside to revenue and margins if Uber can reduce its reliance on drivers on its network in favor of self-driving vehicles.

We believe that Uber is committed to investing to capture this opportunity. In January, Khosrowshahi expressed his belief that Uber would have autonomous vehicles deployed commercially within 18 months. According to the CEO, autonomous vehicles could eventually reduce the price per mile for riders from $2.50 today to around $1.00, representing a 60% price cut. Although this would result in gross bookings per mile shrinking, we believe that increased miles traveled as well as expanded margins will offset this to drive profitability.

We cannot say that Uber is far ahead of other technology companies in terms of autonomous driving, most notably exemplified by the autonomous vehicle crash in Tempe, Arizona. On March 18, a 49-year-old woman was struck and killed by a self-driving Uber-operated XC90 as she crossed a street at night. This incident marked the first pedestrian death caused by an autonomous vehicle. Overall, we believe the Uber crash was largely indicative of a failure in process rather than a failure in technology. In May, the National Transportation Safety Board revealed its initial findings: The vehicle had in fact identified the pedestrian 6 seconds before impact but failed to stop or even slow. According to footage released by the police, the vehicle had an operator in the driver's seat, but neither the car nor the operator took any actions to brake until the impact occurred. Whereas other autonomous driving companies such as Alphabet's autonomous vehicle unit, Waymo, utilize two operators--one to drive and one to monitor data--Uber had just one operator (who was distracted at the time of the crash) doing both. Moreover, Uber had disabled the car's emergency braking, probably because of an unacceptably high number of false positives causing "erratic behavior." The governor of Arizona suspended Uber's ability to test autonomous vehicles in the state pending the investigation, and Uber subsequently pulled out of the state. The company expects to resume testing in August in Pittsburgh and potentially San Francisco as it implements changes to reduce the risk of future collisions.

Nevertheless, the crash showcases that Uber's autonomous vehicle platform is not foolproof relative to other players in the industry. Competitors in self-driving technology include Cruise Automation, which was acquired by General Motors (GM) for $1 billion. Under GM's leadership, Cruise has improved and expanded its testing and development efforts and is working to reach commercialization in 2019.

And then there is Waymo, which we think might be leading in terms of technological superiority and potential scalability. This is perhaps not surprising, given Waymo's first-mover advantage--originally part of Google's self-driving project, the team has been researching and developing autonomous vehicles since 2009. Waymo has also invested a significant amount of capital in self-driving cars. According to leaked court filing documents, Alphabet spent $1.1 billion developing self-driving software and hardware between 2009 and 2015. Moreover, the company recently announced agreements to purchase as many as 62,000 Chrysler Pacifica minivans and 20,000 Jaguar I-Pace SUVs over the next three years for self-driving applications. This represents a potential investment of over $4 billion, dwarfing Uber's announced investments in the space. At 50 trips a day, this fleet could complete over 4 million trips a day.

Waymo's investment in self-driving vehicles may propel it to a leadership position in the autonomous vehicle space, from which it will likely be first to market. Since 2009, Waymo's self-driving vehicles have driven over 7 million miles, compared with Uber's 3 million miles. Waymo's self-driving cars completed more than 2.7 billion simulated miles in 2017 alone. Simulated mileage is often cited as being key to self-driving technology, and we believe that Uber has not invested much in this space. California tracks average miles traveled per disengagement (when human operators have to take over control) for self-driving cars. When looking at this data, Waymo is in the lead, with 5,600 miles traveled per disengagement, followed by GM's Cruise, with 1,250 miles per disengagement. Uber is significantly behind with just 13 miles traveled per disengagement.

Waymo has also significantly reduced the single-largest cost of a self-driving car: lidar, or light detection and ranging. In recent court proceedings, Waymo revealed that it has lowered the cost of its in-house lidar system to just $4,000 per unit, compared with $75,000 per unit for a comparable top-shelf Velodyne lidar system in 2012. The cost of components is high right now, but we believe that once manufacturing ramps up and achieves economies of scale, Waymo's proprietary long-range lidar, midrange lidar, short-range lidar, and accompanying computer chips, cameras, and radar equipment will add approximately $13,000 to the cost of a vehicle, down from $150,000 in 2012.

We believe that for Uber to win from this transportation revolution, it must find a way to gain and maintain access to autonomous vehicles. Even if Uber is in fact behind in the autonomous vehicle race, we still think there is a path for it to benefit from autonomous vehicles: through partnering with an established player. SoftBank Group is a major shareholder in Uber, and its recently acquired 19.6% stake in Cruise could bring the two companies together. And in May, Khosrowshahi revealed that Uber is in talks to get Waymo vehicles on Uber's network. If Uber is able to partner with self-driving vehicle providers like Waymo or Cruise to get their vehicles on its network, it stands to benefit tremendously. If Uber cannot gain access to autonomous vehicles, it risks being disrupted by an autonomous vehicle player entering its market.

There is also potential for Waymo to disrupt Uber in its core competency: ridesharing. Waymo, which has tested in over 20 U.S. cities, has talked about launching a ridesharing service in Phoenix as early as year-end. For Waymo to have a meaningful impact on the world of ridesharing, it will need to build out a network of its own, which may not be as insurmountable a task as it seems at first glance. We believe investors are probably underestimating the potential for Google to optimize and monetize its Google Maps offering for ridesharing. Whereas Uber currently has over 75 million monthly active users , Google Maps has over 1 billion monthly active users, a huge pool that could be tapped into. The application, which is not currently monetized in a meaningful way, already offers ridesharing as an option by linking to Uber/Lyft and giving fare estimates. Alphabet could integrate Waymo into Google Maps as a ridesharing option once the company's fleet is established.

Competition Is a Never-Ending Ride
We believe competition is inherent in the rideshare industry, given low barriers to entry, the prospect of high returns, and comparable intangible assets among competitors. However, we think Uber's competition extends beyond traditional rideshare to all of its exposed markets, including taxi hailing, food delivery apps, and bikeshare.

In the U.S., Uber's main rideshare opponent is Lyft. Like Uber, Lyft offers a variety of rides via private vehicles, including traditional private rides, shared rides, and luxury ones. Lyft operates solely in the U.S. and Toronto and, according to USA Today and eMarketer data quoted by Reuters, has a total active ridership of 21.2 million, about half of Uber's U.S. active ridership of 40.7 million. Lyft gave a total of 375 million rides in North America and brought in net revenue of $1 billion in 2017, approximately an eighth of Uber's global net revenue. In the passenger's seat, the duo's close competition in the U.S. has led to nearly identical features and offerings.

There are plenty of other rideshare apps in the U.S. to get around with, but their user numbers and geographical exposure shuttle them into a fragmented market. A Recode article quoting Second Measure data said that as of August 2017, Gett, Juno (now acquired by Gett), Sidecar, and Via made up 2.2% of the U.S. rideshare market. Apart from rideshare apps that hail private vehicles, we don't dismiss exclusive taxi hailing apps like Curb and Arro. While Curb is available in over 65 cities in the States and has over 100,000 drivers available, Arro is limited to 6 cities across the U.S.

Uber competes with private vehicle hailing and taxi hailing apps on a global scale as well. Didi Chuxing remains Uber's greatest threat globally. Uber sold its business in China to Didi for a 20% stake in the Chinese company in August 2016. However, in April, Didi launched in Mexico, where Uber currently has approximately 7 million users, according to Reuters, and a virtual monopoly. In June, Didi made its next international move by launching in Australia, another Uber market. We believe the moves outside China mark a forthcoming substantial threat from Didi. The Chinese company claims to have hailed 7.4 billion rides in 2017--3.4 billion rides more than Uber's record for the year--with the help of 21 million drivers and a total ridership of 450 million, all in China and all in excess of Uber's global market.

Uber sold its share in Southeast Asia to Grab in May, giving up markets that included Singapore, Thailand, and Vietnam for a 28% stake in the company. On a global scale, Uber's greatest competitors outside Didi and Ola are Gett, Careem, and 99 Taxis. Careem operates in the Middle East and Northern Africa. Ola hails rides in India and Australia, while Gett operates in Russia, the United Kingdom, the U.S., and Israel. 99 Taxis operates in Brazil, hailing taxis and private vehicles, and is majority-owned by Didi. We do not believe Uber will concede any more markets in the near term, unless forced to by legal restrictions.

In the food delivery space, Uber came home late for dinner but has recovered, and its growth is supersized compared with its U.S. competitors. According to a Recode article referencing Second Measure data, Uber managed to increase its share of the U.S. food delivery market from 12% to 21% between August 2017 and March 2018. Uber's share came mostly from Grubhub, which experienced a decline in market share to 50% from 60% in the period while other delivery apps remained relatively constant. Uber is the only rideshare company to venture into food delivery other than Grab.

In food hailing, there are currently two types of apps: those that provide the drivers and those that act as brokers in the transaction. While Uber sticks to the former, we believe both are sources of competition for the company. Uber Eats operates in more than 30 countries. In the U.S. takeout market, Uber's competitors are Postmates, DoorDash, Caviar, and Grubhub. The U.K. is one of its largest international markets, with over 8,000 restaurants on board in approximately 40 cities, according to a Business Insider article. There and in other international markets, Uber Eats' biggest competition is U.K.-based Just Eat and Delivery Hero. Just Eat is the largest food delivery service in the world in terms of revenue, though not by much, and operates in 13 countries. Germany-based Delivery Hero operates in 47 countries. According to Business Insider, Uber Eats is estimated to have brought in $3 billion in gross revenue. We estimate that this lends itself to approximately $600 million in net revenue, based on a 20% take rate.

Uber bought bikesharing company Jump in April for an estimated $250 million, according to PitchBook. Uber claimed a desire to offer more modes of transportation to users and a mindset that it could supersede competition through intangible assets. Uber plans to use its ride data to place Jump dockless bicycles more strategically throughout cities. While we believe Uber's use of data will benefit the bikeshare network, we believe competition in docked and dockless bike programs will thrive, especially as other rideshare apps integrate bikeshare networks. In the U.S., Motivate operates city-sponsored docked bike programs and was acquired by Lyft in July; we expect it will be the biggest bikeshare threat to Jump. Uber will expand outside the U.S. with Jump's launch in Berlin this summer. There, Jump will rival docked bikeshare company Nextbike. Throughout the rest of Europe, Uber will have to compete with Asian companies that have recently moved in, such as Ofo and Mobike.

Economic Benefits of Ridesharing
Ridesharing has risen to prominence partially driven by a demographic shift away from car ownership. In general, millennials seem to be less interested in driving than prior generations. The percentage of 20- to 24-year-olds with driver's licenses steadily decreased from 91.8% in 1983 to 76.7% in 2014. This trend appears to extend to car ownership; the proportion of new-car purchases by young adults has trended down since the recession, with members of Generation Y 29% less likely to own a car than members of Generation X. Given increasing student loan debts and housing costs, it is becoming increasingly difficult for young adults to justify the cost of car ownership. In 2017, the average cost to own a car in the U.S. was $860 per month, and that number increases significantly in cities; in New York City, the average cost to own a car is almost $1,600. Meanwhile, the average monthly amount adults in New York City spend on Uber and Lyft is $84 and $54, respectively. Clearly, there are economic incentives for urban dwellers, many of whom are young adults, to forgo car ownership in favor of public transportation and other alternatives, such as ridesharing.

Demographic shifts are not the only factor lending optimism to the ridesharing industry. We believe that during an economic contraction, ridesharing is relatively well positioned to gain share over private car ownership because of the cost advantage inherent in utilizing assets efficiently.

Ridesharing competes with more than just traditional car ownership. Other solutions to the problem of getting from Point A to Point B in the most economically efficient manner have arisen in recent years, most notably bike- and scooter-sharing startups. These companies have grown rapidly across many U.S. cities, raising billions of dollars in funding from investors. Currently, last-mile trips are dominated by automobiles; according to the National Household Travel Survey, privately owned vehicles account for 60% of trips a mile or less in length. Disruptive compact sharing solutions have the potential to gain a significant amount of share in this market. Uber is paying close attention to this space; in April, it acquired electric bikesharing startup Jump. Since then, Uber has submitted applications to deploy electric scooters in San Francisco and has announced a partnership with Lime, including an investment in the company's recent financing round, which will allow users to rent Lime scooters through the Uber app. Clearly, ridesharing companies see last-mile mobility solutions as being a potentially important part of the transportation revolution.

Other adjacent markets competing with ridesharing include auto rental companies subverting incumbents through innovative solutions, like Zipcar and Turo. Zipcar offers an urban carsharing network for its members. Turo provides an online car rental marketplace matching renters to car owners who want to make extra money by renting out their underutilized vehicles. These marketplaces are typically priced more affordably than incumbent car rental companies, which have costs associated with fleet turnover and administrative overhead.

Mapping Uber's Legal Terrain
Uber’s reputation was tainted under the rein of Kalanick, involving everything from data breaches swept under the rug to a culture of sexual misconduct and accusations of not addressing internal racial discrimination issues. Uber's regulatory issues today involve how the company runs its everyday business, from background checks to its classification of drivers. We believe Uber will need to make compromises in confronting these legal debates.

Uber has created a rideshare market based on a philosophy of asking for forgiveness rather than permission. While the taxi industry has used medallions as capped permits for taxi vehicles, rideshare does not have the equivalent for the individual Uber vehicle. But that doesn't mean Uber is immune from regulation. States and cities have established ordinances for Uber that include guidelines on everything from consecutive driving hours to vehicle inspections. While several cities have discussed capping Uber vehicles, we believe it will be difficult for localities to justify the cap based solely on sympathy for taxi medallion investors. However, capping Uber vehicles could be justified by arguing that the city may have to endure higher costs due to the increased traffic congestion brought on by too many Uber cars. After meeting local demands, Uber self-regulates with app features. Countrywide, Uber enforces a 12-hour limit in driving time by turning the app offline for 6 hours for every 12 hours driven. Also, some states have long-term goals to regulate emissions. Uber has its own goals as well and will require all vehicles to be electric by 2025.

Regarding bikeshare, the more visual effects--a mass of dockless bikes strewn throughout cities--have led some cities to draft quick policies. In the U.S., cities have adopted either a bikeshare permit fee based on the number of bikes in a network or a hands-off approach--at least for now.

Uber's minimum requirements to be a driver in the U.S. include being 21 years of age or older, holding a U.S. driver's license for at least one year (or three if younger than 23), and meeting vehicle requirements, like ensuring the rideshare vehicle has four doors. Driver screening entails a review of the prospective driver's driving record and criminal history done through startup Checkr. Many states require either an internal background check or fingerprinting. Uber's standard Checkr process meets the former but not the latter requirement. Uber has complied in markets where fingerprinting is mandated, though with much resistance. The fingerprinting debate is more pressing given a continuous slew of crimes committed by Uber drivers, as with many other rideshare apps. This has caused some states to conduct their own investigations into Uber's driver base retroactively. Other localities require their own background checks from the get-go. We expect Uber will increasingly be subject to more regulation concerning background checks, such as fingerprinting, that will raise the cost of business.

We believe the legal debate that holds the most risk for Uber's business model is the contractor versus employee debate for drivers, which has heightened in recent years. While few markets have succeeded in classifying drivers as employees, the change would significantly increase Uber's operational costs and could force the company to pass those costs on to riders by charging higher fees. Uber benefits from contracting drivers who, because of their current classification, are not subject to minimum wage requirements, robust insurance benefits, or, more important, trip-related expenses. In Europe, more tension exists in demands for Uber drivers to be considered employees. To cool the debate, the company upped its benefits for Uber Europe drivers, including an optional insurance plan that provides coverage for trip-related injuries and grants maternity leave as well as leave for severe illnesses. Uber plans to extend this plan to other countries.

In the U.S., all drivers are currently insured when waiting for a request and at fault for an accident, up to $100,000 for bodily injury per accident and up to $25,000 for property damage per accident. If in the process of picking up passengers or dropping them off, drivers are insured up to $1 million per accident for third parties outside the vehicle during the accident and up to $1 million per accident for up to a driver's car value whether at fault or not, with a $1,000 deductible.

From providing tipping options to sick leave, we believe Uber will continue to be subject to the increasing demands of drivers and markets other than Europe, the U.K., and U.S. However, we believe these will not have lasting effects, with Uber expected to adopt a network of autonomous vehicles in the future.

Uber is currently under investigation by the U.S. Department of Justice for using tools such as Cascade and Firehouse, which potentially violated federal law that prohibits price discrimination on demographics. Cascade and Firehouse calculated ride rates using assumptions about what riders would pay for a ride based on the destination they selected as well as starting location. Now, Uber calculates fares as a function of time and distance traveled combined with a base pickup fee and surge pricing charge during popular times. Additional fees, such as late fees, can be added to this calculation.

Uber's largest debacle concerning data privacy occurred in 2016, when data from 57 million users was stolen. The data did not include Social Security or credit card information nor location details. However, it did include contact information and license plate numbers. The breach was the 16th-worst data breach in the 21st century in terms of the number of people affected. While the data compromised wasn't as bad as it could've been, Uber's improper handling of the situation led to a settlement with the U.S. Federal Trade Commission. Under an obligation to notify those affected by the breach, Uber paid hackers $100,000 to sweep the issue under the rug. The breach was reported in November 2017, more than a year after the initial incident.

When Uber ceded eight countries in Southeast Asia to Grab, it left before local competition commissions could review the merger. According to The Economic Times of India, the Competition and Consumer Commission of Singapore said Uber and Grab did not disclose the merger details to the commission before the deal's announcement, as they should have. After Singapore's claim, other countries affected by the deal opened their own antitrust investigations. While inquiries are still underway in assessing the merger's potential violation of antitrust laws, as of June, Uber has said it won't return. We believe Uber will maintain this decision despite what findings come from local investigations. According to Rappler, the Philippine Competition Commission said Uber and Grab may offer to remedy the negative effects of the consequent rideshare monopoly if the PCC determines the startups violated antitrust laws.

Uber has had a history of practicing mandatory arbitration, which forces cases to be tried privately rather than in courts, resulting in little detail exposed to the public. In May, Uber ended mandatory arbitration in the U.S. only for claims concerning sexual misbehavior. Shortly after that announcement, Lyft ended its mandatory arbitration policy as well. The change came after Uber experienced accusations concerning sexual misconduct by drivers or fellow employees. CNN found that in the past four years, over 100 Uber drivers have been accused of sexual assault or abuse of passengers. Former Uber employee Susan Fowler's reports of sexual misconduct and the company's improper handling of such aided in the demand for change, which led to Uber's reversal of the mandatory arbitration policy.

We Assign a Fair Value Estimate of $110 Billion
We have taken a look into Uber's valuation as best as possible, given that the company is private and has not filed an S-1 or other Securities and Exchange Commission documents as part of a public offering. Based on publicly available data as a starting point, we derive a fair value estimate for Uber of $110 billion, which represents enterprise value/net sales multiples of 9, 6, and 5 in 2018, 2019, and 2020, respectively. On an EV/gross billings basis, our valuation represents net revenue multiples of 2.0, 1.4, and 1.0. Our valuation is about 77% above the valuation implied by Uber's last round of funding. We project that Uber's net revenue over the next five years could grow at a 39% CAGR, ahead of the 26% growth rate we assume for Uber's $630 billion total addressable market.

We expect strong net revenue growth for Uber at a 27% 10-year CAGR through 2027, resulting in net revenue of $82 billion (equivalent to $397 billion gross revenue or bookings) in 2027, up from $7.8 billion (equivalent to $36 billion gross revenue) in 2017, based on figures published by The Wall Street Journal.

Our gross revenue growth rates imply that Uber has 18% of its total addressable market today but will capture 34% of the $630 billion addressable market we estimate by 2022. From there, we model growth at a 16% rate through 2027.

We project that Uber will stay atop the ridesharing market (excluding certain regions such as China) and its ridesharing revenue will grow at a 39% five-year CAGR compared with our estimate of 28% for the total ridesharing market for the same period. We think such growth will be driven by Uber's continuing expansion in more cities and regions globally, plus an increasing adoption rate as the company attracts more users. As ridesharing also represents a substitute for public transportation, we think it can take revenue from public transportation, which we account for in our projections. Our 10-year gross revenue CAGR for ridesharing is 18%.

We expect Uber to increase its presence in the bikesharing market (U.S. and Europe), which we value at $4.5 billion by 2022 (based on gross revenue) using a 15% average annual growth assumption. We think Uber will gradually take a bigger piece of that pie in the U.S. and Europe, which will drive the 11% 10-year CAGR we assume for this business, resulting in bikesharing gross revenue of $6.3 billion by 2027.

While the meal takeout and delivery services market remains fragmented and Grubhub is the current market leader in the U.S., we think Uber can solidify its position, given its success in ridesharing. In addition, unlike Grubhub, Uber has expanded its Uber Eats services worldwide. In our view, Uber's network effects moat source can help provide more timely deliveries for restaurants and enhance its position in the market as it attracts more drivers in what we estimate will be a $166 billion space (excluding China) by 2022. We model 39% five-year average revenue growth for Uber Eats compared with our estimate of the industry's 25% average annual growth. We apply a 10-year 29% gross revenue CAGR assumption for Uber Eats, compared with our 14% assumption for Grubhub.

We think Uber Freight will face fierce competition from market leaders such as C.H. Robinson (CHRW). We assume that Uber Freight will be mainly pursuing the U.S. freight brokerage market, which we think may be valued at $27 billion by 2022 with average annual growth of 9%. While our model calls for Uber Freight gross revenue to grow 20% annually through 2027, that business will continue to account for less than 1% of Uber's total gross revenue.

As Uber continues to attract more riders and assign drivers to requests more quickly, we think overall vehicle capacity utilization will increase, possibly widening the company's gross margin to 62% during the next 10 years from 49% in 2017. Besides the driver take rate, which is netted out of Uber's net revenue, we believe a portion of Uber's cost of goods sold is fixed and revenue will grow at a faster pace than these costs, leading to gross margin expansion. We also project that Uber will benefit from operating leverage in the years ahead. The company might be able to increase revenue at a faster pace than selling, general, and administrative costs, especially in the sales and marketing lines, while also having to spend relatively less on operations and support costs. However, we anticipate that R&D will remain elevated as Uber invests in new ventures, resulting in only slight declines in R&D as a percentage of net revenue.

We think Uber is likely to begin generating adjusted EBITDA in 2020. In our 10-year discounted cash flow model, we assume the company will turn its current operating loss to operating income in 2022, while expanding operating margin to nearly 17% by 2027.

We also looked at how current investors in the private market value Uber. Data provided by PitchBook indicates that the latest secondary transaction in the private market announced May 24 implies a $62 billion valuation of Uber. The company completed its Series G funding in January, which at the time indicated nearly a $70 billion valuation.

We must note that Uber's valuation during the past 12 months has been volatile. In fact, according to PitchBook, in January, another secondary transaction valued Uber at only $48 billion. Such volatility in the valuation of the company in the private market is expected; however, we think additional uncertainties may have hindered growth of Uber's valuation. These include questions surrounding the safety of the company's drivers and riders and the overall questionable reputation of former CEO and cofounder Kalanick.

Ali Mogharabi does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.