The one thing Lyft needs in order to be a great investment

Cash ‘stache.
Cash ‘stache.
Image: Reuters/Lucy Nicholson
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It’s official: Lyft is leading the race among so-called unicorn startups to become a publicly-listed company, having announced its intent to sell shares with an S-1 regulatory filing last week.

There’s a lot to love about Lyft. It claims to be a mission-driven company that’s trying to remove cars from the road and be good to both its drivers and riders. Lyft wants to embody the values it promoted with its pink mustaches–that it’s a fun and safe company—and that helps it draw a contrast with Uber, which has been plagued by ethical scandals. Lyft is still run by its founders who grown the company from a college ride-sharing service launched in 2012 to a ride-hailing company serving more than 30 million people in more than 300 markets.

Those founders—Logan Green and John Zimmer—suggest there’s more to come, like building an autonomous vehicle fleet and providing transportation as a subscription service. Lyft is also growing fast: It doubled revenues in the last year and has more than a third of the US ride-hailing market, making it one of only two possible ride-hailing investment options once Uber goes public, as it’s expected to later this year.

Investors may want to own Lyft shares because they believe in the mission and its founders (who, through a special share class, control the company) or because they believe in ride-hailing enough to own any company in the sector. That approach worked in early, fast-paced markets like the internet and could lead investors to buy Lyft and Uber once they are both public.

But there’s one glaring problem: Lyft loses money. A lot of money. Over $900 million in 2018. And there’s no clear indication how the company will turn a profit — ever. As part if its upcoming initial public offering, the company is asking investors to fund continuing losses with the hope that it will be able to turn a profit someday in the future. If it can’t turn profitable fast enough, though, owning Lyft shares could be painful once investors lose patience.

Let’s start with the big, elephant-in-the-room question: can Lyft ever turn a profit and, if so, how? We’ll walk through the three main ways Lyft could grow its business.

1. Grow the core ride-hailing business

Lyft is doing a great job growing its core ride-hailing business, with the total number of rides increasing 65% last year. But this growth costs quite a lot. Out of the company’s total $800 million of sales and marketing expenses in 2018, Lyft spent $300 million on driver and rider incentive programs. These incentive programs equate to about $50 per net new active rider (comparing the total quarterly active riders at the end of 2018 vs 2017). That seems expensive since each active rider generates only $56 per year in profit after the cost to deliver services.

And after the cost to market, sell and deliver rides, the company only has $7 per active rider per year to fund the rest of the business. No wonder Lyft is having trouble making ends meet.

Growing its core ride-hailing business is clearly an expensive proposition. It takes a lot of money to get the attention of consumers. And it takes even more money to get their attention instead of Lyft’s primary competitor, Uber, which is larger, better capitalized and has a name that has become a verb (“I’ll just Uber over”). Uber and Lyft regularly get into price and incentive wars to increase market share and Uber has been accused of predatory price practices to drive competition out of the market. All of that means that growing Lyft’s core business won’t be easy or cheap.

Let’s assume that Lyft can continue to grow its ride-hailing business as it has been. That introduces a second issue: how to finance the massive cost of scaling. Even though Lyft earned $3.48 in revenue per ride in 2018, it made only $1.47 per ride in after the cost to provide the ride and it lost $1.58 per ride overall when you account for all expenses. This total loss per ride is coming down, declining by around 30 cents, or 16%, per ride last year. But the rate of improvement isn’t fast enough to get to profitability any time soon.

If Lyft continues to reduce its loss-per-ride by 30 cents per year, it would break even in 2025. But if Lyft continues to decrease its loss by the same rate–16% per year–it wouldn’t break even until somewhere around 2040. This is a long time to wait and a lot of losses to finance. Using the two scenarios above–reducing losses by 30 cents per year or by  16% per year–the cash required through 2025 ranges from $3 billion to $30 billion.

This wide range of possible losses highlights the uncertainty over how Lyft will get to profitability at all, let alone how quickly. In the past year, Lyft has driven its gross margins up to 42% from 38%, by increasing its revenue per ride while limiting how much it passes on to drivers. Can it extract even more profit per ride rather than paying its drivers more? Perhaps from some but it seems a bit extreme to think that Lyft could take more than half of the revenue from each ride without some sort of driver revolt.

It’s important to note that Lyft’s highest active user growth period was in the first half of 2017. The company explained that period as a time when “our brand and values continued to resonate with riders and increased their usage of Lyft instead of competing offerings.” In other words, Uber’s ethical mess and the resulting #deleteuber campaign helped double Lyft’s active user base in six months. That was a gimme and no one should expect that to be repeated.

2. Add bikes and scooters

Lyft has a vision of providing a platform that includes not just ride-hailing but also bike and scooter rentals, access to public transit, and autonomous vehicles. Even though Lyft’s revenue is almost exclusively ride-hailing (it has “non material” revenue from bikes and scooters), the idea of offering multiple transportation options is so important that the company mentions the word “multimodal” 49 times in its IPO filing document.

The first step to accomplishing Lyft’s vision of broadening its platform is adding bikes and scooters to its customers’ options. Lyft has already made big bets in this area by paying $250 million for Motivate, a bike sharing company, and committing to invest $100 million in New York City’s bike sharing system.

Management clearly thinks bikes and scooters are an exciting opportunity but given the fact that half a year of Motivate’s revenue was considered non-material, it doesn’t seem likely to boost Lyft’s revenue soon. And, given the massive costs of building out a bike and scooter network, it seems pretty certain that this first move to new modes of transport won’t help Lyft get to profitability in the near term –and will likely keep it in the red for longer.

3. Embrace autonomous vehicles

Lyft sees self-driving cars as a pathway to profitability. Autonomous vehicle operation drops the unit cost per mile making ride-hailing more affordable and increases demand. However, forecasting the speed and scale of a transition to fully autonomous cars–where no driver is required–is difficult. So far, Lyft doesn’t seem to be any better than anyone else at doing this.

Back in 2016, Zimmer wrote a lengthy essay on Medium describing his vision for the future of transportation. At the time, it grabbed people’s attention with some key predictions, especially that self-driving cars would account for the majority of Lyft rides within five  years, or by 2021. A couple of years on, Lyft’s predictions for autonomous vehicle adoption have been pushed out significantly: Lyft’s S-1 says to expect some autonomous vehicles within five years, with a majority of trips by driverless cars within 10, a re-forecasting of nine years. The readjustment of expectations has been driven primarily by real-world testing of the technology. We should expect more adjustments as testing moves beyond technology and performance into testing business models and human factors.

In Zimmer’s essay, he rightly pointed out that there will be a period of time where a “hybrid” approach is required, with both driven and driverless cars on the road. But testing has revealed that this mixed mode of driving is likely much further out. Apart from some very particular use cases—such as retirement villages and university campuses—there is less appetite by the public for fully self-driven vehicles. It’s now more likely that the public will instead expect to have a safety driver in the vehicle at all times for some time to come.

This hybrid approach messes with the business model. By doubling up on costs—incurring both the high cost of a new technology and the cost of a safety driver—it’s harder to see the road to profitability being as smooth or as linear as Lyft forecasts. There is simply no way of predicting how long it will take for riders, regulators, and the public-at-large to be comfortable with having no safety driver in an uncontrolled environment. Worse, it’s possible that insurers will require safety drivers for years to come. We haven’t dropped either the airplane pilot or the co-pilot even though there are plenty of flights that operate in “normal” or “easy” conditions, e.g, no congestion, no snow, and no difficult airports.

This exposes Lyft to another really big concern — a massive shifting of its competition As a ride-hailing company, Lyft competes with Uber and other livery or taxi services. However, as an autonomous-vehicle ride hailing company, it could also compete with Google and Apple. The path of least friction for a consumer to get a ride in a world of autonomous cars is using their Siri or Google assistant to leverage the power of Apple or Google maps with a fleet of independent vehicles. While Lyft’s S-1 explicitly accounts for the integration and interoperability risks associated with using Google maps as a partner, we believe the frenemy dynamic is likely to be underestimated.

As competitors, Google and Apple also highlight Lyft’s extreme capital disadvantages. Autonomous vehicles will be very expensive, especially at the beginning, and financing them through cash or debt will be tough for a small, unprofitable company like Lyft. Google and Apple, on the other hand, are perhaps the best positioned companies in the world to take on this capital problem given their extraordinary balance sheets. As a result, Lyft’s driver-based service could get replaced by Google’s and Apple’s self-driving services.

How should investors think about Lyft?

Given enough time and capital, any of these options–or some combination of the three–could grow Lyft’s business and potentially get it in the black. The optimists will say Lyft’s profits-be-damned approach is required for success. Lyft is spending heavily to grab market share in what could be a massive transition in the transportation market. In this new world of platform scale and winner-take-all economics, the prevailing wisdom is that speed (hence large scale investment) is the key driver of success. They will argue investors should jump in and join the revolution.

We’re skeptical that getting Lyft to profitability will be easy. More likely, this is a long and rocky road. You may think it’s boring to talk about such mundane things as profits while we’re talking about changing the world. But there isn’t anything as important as profits for investors over the long haul. Simply put: The true value of any company is the present value of future cash flows—always has been and always will be. No matter how Lyft is valued today, it will someday be valued on cash flows, too. And that means that having some sense of if, when, and how profitable Lyft could be is critical when analyzing Lyft’s IPO as the potential start of a long-term investment.

Investors who believe in the long-term growth potential of reinventing transportation—and can afford a volatile holding—may want to jump in, close their eyes, and hope that things will work out. But be prepared for some turbulence. Lyft’s stock will trade on its story and hedge funds love to create rumor-based narratives to move “story stock” prices around for their own gains. That may work well for them but it may make the rest of us remember the fun of 1999 and then the pains of 2000.