Uber (UBER 0.48%) is a growth stock, or at least it was until recently. The nature of the growth story has changed over time. First, it was just ride sharing. Turns out it's hard to turn a profit when you have to pay drivers. Then it was self-driving cars making ride sharing work by lowering costs. That was a fantasy. Then it was restaurant meal delivery, which boomed during the pandemic.
These shifting narratives weren't a huge problem when investors were happy to hand out sky-high valuations to fast-growing companies. Never mind that Uber has lost many billions of dollars since going public. Never mind that the company has never proven that any of its businesses are structurally profitable (no, adjusted EBTIDA really doesn't count). None of that mattered because Uber was growing into massive markets.
In a recent letter to employees, Uber CEO Dara Khosrowshahi acknowledged that the growth-centric playbook was going out the window. And with it goes any coherent justification for Uber's bloated market capitalization.
Trading growth and fake profits for real profits (sort of)
Like many companies that are unable to report real profits, the kind that you see on an income or cash flow statement, Uber has pushed adjusted EBITDA as its preferred measure of profitability. Not only does this number back out interest, taxes, depreciation, and amortization, the "adjusted" part backs out stock-based compensation.
"When Wall Streeters tout EBITDA as a valuation guide, button your wallet," says Warren Buffett.
Uber had set a goal of producing $5 billion of adjusted EBITDA by 2024. As recently as November, Uber's CFO stated that the company aimed to improve this metric, but that long-term growth was the "real focus point." Uber wanted to tell a growth story with a bonus of improving "profitability."
That's not the story anymore. Khosrowshahi has made some big changes to Uber's strategy, laid out in a letter to employees that took whatever was left of the bull thesis and hurled it into the sun.
"We are serving multi-trillion dollar markets, but market size is irrelevant if it doesn't translate into profit," Khosrowshahi said in the letter. The company is doing away with its adjusted EBITDA target and instead focusing on free cash flow. Free cash flow isn't a perfect number -- it still backs out stock-based compensation, for example. But it's a much better measure of profitability than adjusted EBTIDA.
Uber will be slowing down the pace of some investments. "We have to make sure our unit economics work before we go big," Khosrowshahi said. That probably should have been a thing before now.
Marketing and incentive spending will be reduced, and hiring will be slowed down. "We will be even more hardcore about costs across the board," said Khosrowshahi.
All of this points to one thing: Uber's growth is going to slow down. Chasing volume at any cost isn't happening anymore. Making Uber actually work as a sustainable business is the top priority.
The end of an era
As I write this, Uber is valued at around $46 billion. It was worth over $100 billion at one point. These kinds of values could be justified, albeit with plenty of mental gymnastics, by pointing to the growth story.
Is it possible for Uber to turn itself into a profitable company? Sure. But that version of Uber is small. Not in an absolute sense, but far smaller than the most optimistic projections of how big Uber could get based on its growth opportunities.
Uber generated $6.85 billion of revenue in the first quarter, and analysts expect around $27.5 billion of revenue for the full year. That estimate could prove overly optimistic given Uber's strategy shift. Free cash flow was nearly breakeven in the first quarter, but that includes $359 million of stock-based compensation.
Uber would have to generate a few billion dollars of free cash flow annually for its current valuation to make much sense, and likely more if growth is subdued. That would require heavy cost cutting, and potentially higher prices. Here's the big problem: Those huge markets that Uber competes in exist partly because companies lose money serving them. Nobody makes money delivering restaurant food, and that's partly the reason why so many people have restaurant food delivered.
Uber doesn't just compete with Lyft and DoorDash. It competes with walking, driving, public transit, picking up takeout, and cooking at home. Operating under the constraint that it must turn a meaningful profit, the alternatives to Uber are going to look more attractive, especially in an inflationary environment. The artificially low cost of convenience, subsidized by massive losses, makes Uber's markets look much larger than they really are.
Uber may manage to transform itself into a sustainable, profitable company. But justifying its current value with real profits looks like a pretty big longshot to me.