Christopher Mims’ piece Uber’s $18.2B Valuation Is a Head Scratcher is getting a lot of play, and deservedly so: it’s a good encapsulation of many people’s objections to Uber’s recent round that valued the company at $18.2 billion.
However, I think Mims is wrong. I would argue he:
- Dramatically underestimates Uber’s potential market
- Undervalues Uber’s ability to differentiate as a consumer product
- Mistakes venture capital for public markets
I’ll take on each one-by-one
Uber Is More Than a Taxi Replacement
Last fall I proposed a new term in the business lexicon: Obsoletive
The context of the article was smartphones, and the point was to distinguish “obsoletive” from “disruptive”:
Of course the easy answer is to say “The iPhone disrupted cell phones.” Except, at least to my reading, that kind of misses the point of what disruption is…
Disruption is low-end; a disruptive product is worse than the incumbent technology on the vectors that the incumbent’s customers care about. But, it’s cheaper, and better on other vectors that different customers care about. And, eventually, as the new technology improves, it takes the incumbent’s market. This is not what happened in cell phones.
In 2006, the Nokia 1600 was the top-selling phone in the world, and the BlackBerry Pearl the best-selling smartphone. Both were only a year away from their doom, but that doom was not a cheaper, less-capable product, but in fact the exact opposite: a far more powerful, and fantastically more expensive product called the iPhone.
The problem for Nokia and BlackBerry was that their specialties – calling, messaging, and email – were simply apps: one function on a general-purpose computer. A dedicated device that only did calls, or messages, or email, was simply obsolete.
Examples of obsoletive technologies include PCs, the Internet, search, and smartphones. All replaced multiples single-use tools with one (usually more expensive) single-purpose solution; more pertinently to this article, obsoletive technologies are huge opportunities, much greater in fact than disruptive ones (Read the original “Obsoletive” article here).
This, then, is the first thing that Mims gets wrong in his criticism of Uber. From the conclusion:
Even the most aggressive estimates of Uber’s value — let’s assume the company captures 50% of the world taxi market in 5 years — mean the company would still be worth less than $18.2 billion…It’s quite possible that investors have wildly overestimated the ultimate size of Uber’s potential revenue.
This is a relevant comparison today, but to my mind sells short Uber’s potential: the addition of technology to people driving cars does not make Uber a taxi competitor; rather, it makes Uber a taxi obsoleter. 1 Moving passengers around for money is but one small job that could be done by a nearly infinitely scalable logistics company, just as typing documents is one small job for a PC, or making phone calls one small job for a smartphone. In other words, to suggest that Uber’s ceiling is the size of the taxi industry is no different than suggesting typewriters are the ceiling for PCs.2 If you’re considering upside it’s far better to look at the market caps of UPS ($95 billion), Fedex ($42 billion), or even Toyota ($182 billion).3
Low Barriers to Entry Do Not Mean the End of Differentiation
This is Mims primary objection. From the article:
Uber’s larger vision, according to CEO Travis Kalanick, is to disrupt transportation and “make car ownership a thing of the past.”
That’s a worthy mission, but the wrinkle is that Uber is entering what is essentially a frictionless market (for both drivers and riders) in which its services are a commodity. The company’s phenomenal growth so far (we don’t know the actual numbers, but doubling in revenue every 6 months is what Kalanick claims) has been built on the back of low-hanging fruit — expansion into new cities, particularly where taxi availability is low — and levels of dissatisfaction among taxi drivers that may be temporal. (When I asked drivers who had a particular loyalty to Lyft why they liked the company, they said they felt it treated them better in general.)
In both respects, Uber’s growth is reminiscent of Groupon, and we know what happened to them.
Actually, what did happen to Groupon? Mims contention, as far as I can tell, is that Groupon lost its value because of competitors. But actually, Groupon’s competitors have largely disappeared! (LivingSocial exists, but barely; it’s a surprise it’s even a going concern at this point)
This was, in fact, what I predicted long before Groupon’s IPO: that while Daily Deals would be commoditized, there would always be an advantage that would accrue to the market leader based on brand and consumers’ willingness to tolerate managing multiple options (honestly, how many Daily Deals emails are too many?). After all, there are entire industries – consumer packaged goods, especially – built on the idea that, in the consumer market, commodities can be sustainably differentiated by brand, channel, distribution, etc. (Be right back – I’m going to snack on some Ritz crackers). Similarly, while the truly cost conscious may manage multiple ride-sharing apps, most will default to one, and in that case, the market and brand leader has a clear advantage (just like every branded item in your local grocery store).
The problem with Groupon was the entire premise of their business; in short, daily deals were a terrible deal for small businesses, which meant the cost of getting more daily deals eventually became prohibitive (Groupon’s sales force costs were through the roof). In this respect, Uber stands in stark contrast: drivers are getting a great deal with Uber (and Lyft and all the other competitors). In other words, I believe Groupon lost most of its valuation because it had a crappy value proposition for its core constituency, not because it faced too much competition. If I’m right, and Uber v Lyft plays out the same way as Groupon v LivingSocial, then only Uber will be left standing (a la Groupon), but standing on top of a much healthier industry (unlike Groupon).
Venture Round Valuations Do Not Equal Public Market Valuations
At this point Mims could justifiably argue that Uber as logistical network or differentiated brand are simply pie-in-the-sky fantasies that pale in reality to today’s market. And that would be a fair thing to say if Uber were a public company and $18.2 billion were their market cap.
But, in fact, $18.2 billion is a valuation used in a venture round, and that has entirely different implications. Venture capitalists are not buying stock per se, but rather mis-priced optionality. In the case of Uber, $18.2 billion valuation is the result of a $1.2 billion investment; for the investors ponying up the cash, their downside is capped at $1.2 billion (and likely much less, given that Uber’s valuation will never go to zero, and that investors get preferential treatment in a below valuation exit). The upside, though, is by definition infinite, because Uber’s valuation has no theoretical limit (again, the bottom limit is $0).
The truth is that whenever Uber goes public, they are not an $18 billion company. They are either a $4 billion company, like Groupon, or a $180 billion (or more) company befitting their status as an obsoletor. While I think the latter is more likely, just for the sake of argument I’ll say the downside position has a 90% chance, and the upside position a 10% percent change. That means this investment round has an expected return as follows:
10% * ($180b * $1.2b/$18.2b) + 90% * ($4b * $1.2b/$18.2b) = $1.4b return
Again, in an extremely pessimistic scenario in which Uber has only a 10% chance of realizing its potential, investors in this latest round will still make their money back. There isn’t that much downside, and the upside is enormous. Opportunities like this investment round are the entire premise of venture capital, and the valuations that result just aren’t that analogous to public market valuations, at least in the short term.
I don’t particularly like picking on individual writers or articles, and there’s a non-zero chance that Mims ends up being right – I still have friends giving me grief for being bullish on Groupon. However, even there I think my reasoning was sound: you can differentiate in consumer markets with low barriers to entry. Add that to the obsoletive nature of Uber’s product, along with an understanding of how venture valuations work, and $18.2 billion ends up looking downright reasonable.
Interestingly, the inflation-adjusted value of the typewriter industry in 1975 was about $22 billion, the same as today’s taxi market ↩
To be fair, Mims acknowledges this viewpoint; the fact he dismisses it matters for point number three ↩