Shares of Lyft are expected to start trading on the Nasdaq on Friday in a highly anticipated initial public offering (IPO). Though not as large as its rival Uber, the ride-sharing company is targeting a lofty valuation of $24.3 billion (based on a $72 per-share price for its IPO). Amid the bluster and excitement, investors need to ask themselves whether Lyft's fundamentals support that valuation. A close look at the company's customer economics suggests it will achieve profitability. But will it be profitable enough?
Starting with the customer
Theta Equity Partners ("Theta" below), a research firm, has pioneered customer-based corporate valuation (CBCV), a methodology that looks at underlying customer behaviors and their impact on a company's value. The key drivers of CBCV for a nonsubscription business are:
- The average cost of acquiring customers (customer acquisition cost, or CAC)
- The value customers generate (postacquisition value)
Subtract the first item from the second and you are left with what Theta calls the customer lifetime value (CLV).
Postacquisition value, in turn, breaks down into customer retention (churn), rides per active customer, revenue per ride, and the variable margin on those revenues. If you can estimate these metrics for a specific addressable market, you can forecast the company's future cash flows (after subtracting fixed costs). Those cash flows, discounted back to the present at an appropriate rate, produce an estimate of the company's fair value.
In a two-part series of blog posts on its website (here and here), Theta applies this framework to Lyft, using data provided in its offering prospectus to derive a fair value for the company. If you're considering buying the shares, I strongly urge you to read both posts carefully -- you won't find a better analysis in the public domain.
"A source of hidden value"
After running the numbers, Theta estimates that Lyft has a positive average customer lifetime value of $19, based on a postacquisition value of $51 and a CAC of $32. But those summary figures mask some key insights (emphasis in the original):
Variability in customers' CLVs is high. The company may be losing money on up to 80% of its customers, but more than makes up for it on the highly loyal other 20%.
Indeed, Theta estimates that many of the customers in that 20% segment will generate a lifetime value in excess of $350! No wonder Theta calls these highly loyal customers "a source of hidden value that makes Lyft's unit economics better than it seems to be on the surface" -- they account for most of the estimated fair value. The company's path to profitability is heavily dependent on its ability to attract those users on an ongoing basis.
Theta's conclusion with regard to Lyft's fair value is a sobering assessment of this overheated offering:
[O]ur results suggest that Lyft's target valuation is not justified by their fundamentals under any practically realistic future state of the world. Our more optimistic scenario implies a fair valuation of about $7B, while our base case scenario implies a fair valuation of $4.5B.
Ouch! Those figures do not compare well to the $24.3 valuation the company is seeking, which requires some genuine contortions in operational performance:
This [$23 billion] valuation [(Lyft's initial valuation for its IPO before it was raised higher)] would be achievable if they were to expand their gross margin to 70% from 45% in Q4 2018 and pull off a successful overseas expansion.
The conclusion is inescapable:
While this is possible, requiring this to be true to not lose money investing into the IPO seems like an unfavorable risk/reward position to us.
Blue Apron: an example of unfavorable customer economics
Perhaps you're skeptical: The methodology is untested/too academic, etc. Great! A healthy skepticism is invaluable for an investor, and I encourage you to review the analysis for yourself. In the meantime, here's an example in which the approach distinguished itself:
Two days before Blue Apron (NYSE:APRN) shares began trading in June 2017, Theta Equity Partners' co-founder Dan McCarthy concluded in a LinkedIn post examining the meal-delivery service's unit economics that a "customer-based analysis spells trouble for Blue Apron, with important measures of customer health in decline." The following graph charts Blue Apron stock's performance since the initial public offering.
This is a single example, and short-term stock price movements don't always mirror business fundamentals. However, Blue Apron's fundamentals have deteriorated over this period -- that's undeniable.
Don't let Lyft take you for a ride
Lyft is the first in a slate of "unicorns" (private start-up companies with a valuation in excess of $1 billion) to come public, with Uber, Airbnb, Pinterest, and WeWork waiting in the wings. These companies have delayed a transition to the public markets, gorging instead on an ample supply of private capital (venture capitalists and other institutional investors) and creating huge anticipation in the process.
There is also reason to believe that successive private funding rounds have inflated some (many?) unicorns' valuations to levels that extended scrutiny by the public markets will not support. Based on Theta Equity Partners' analysis of its customer economics, Lyft is just such an offering. While a heady IPO process generates a lot of excitement (and bankers' fees), long-term investors ought to refuse to share a ride with Lyft.