Uber Technologies Inc. recently raised $1.2 billion at about a $17 billion valuation, a number that has raised quite a few eyebrows. To be sure, there are reasons to doubt Uber’s long-term success, but that doesn’t make it a bad investment.
The first objection to Uber’s valuation is that the total taxi and limousine market is only worth around $11 billion in the U.S. Perhaps it's worth double that worldwide. Surely Uber isn’t going to simply capture the entire market without competition?
The problem with this objection is the assumption that Uber will only ever be a taxi replacement. There is another way to look at Uber: as a general purpose logistics company that just happens to transport people. In this view, the taxi market is just one of many markets that Uber will take over, making its addressable market much larger than $22 billion. Uber has experimented with everything from delivering Christmas trees to offering Manhattan courier services; within this context, humans are just another type of package to be delivered.
More broadly, technologies that effectively subsume entire industries usually turn out to be extraordinarily valuable (I call these “obsoletive” technologies). Consider the PC: It took over the typewriter industry, but to have measured the PC’s potential according to the market size of typewriters would have been remarkably shortsighted. Similarly, revenue and profits from smartphones are much greater than those enjoyed by feature-phone manufacturers, largely because the use cases for smartphones are far broader. There’s a chance that Uber fits the same mold, and if so, its potential valuation could be 10 times greater than the $17 billion currently raising eyebrows.
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Ten-times returns are exactly what venture capital and growth funds are looking for; venture capital is all about mispriced optionality, and this round is a great example of just that. First off, from a pure dollars-and-cents perspective, the downside for investors is by definition capped at $1.2 billion, while the upside is much greater. The reality, though, is even less risky. This investment is almost certainly for preferred stock; as long as Uber exits for more than $1.2 billion, investors are getting their money back. If rumors about Uber’s excellent financials are to be believed, then any future liquidity event will be worth far more than that. After all, even Groupon Inc. has a market cap of more than $4 billion.
I used Groupon as an example on purpose. There's a sense that Groupon’s decline from a post-initial public offering market capitalization of $16.7 billion stemmed from the fact that it offered an undifferentiated product that was done in by competition. Uber’s critics suggest the same will befall the would-be logistics company. But I'd argue that this comparison is flawed, if for no other reason than Groupon's competitors have largely disappeared. (LivingSocial Inc. exists, but barely.)
In fact, I was once a Groupon bull, largely because I expected Groupon to outlast its competition: While daily deals would be commoditized, there would always be an advantage that would accrue to the market leader, based on just how willing -- or, more likely, unwilling -- consumers and brands would be to tolerate managing multiple options. Honestly, how many daily deals e-mails are too many? Plus, 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.
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Instead, the problem with Groupon was the entire premise of its business. In short, daily deals were a terrible deal for small businesses, and, in the long run, not that terribly attractive to customers, which meant the cost of getting more and better 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 Inc. and all the other competitors), and consumers are using Uber more over time, not less. In other words, I believe Groupon lost most of its valuation because it had a bad value proposition for both users and especially small businesses, not because it faced too much competition. If I'm right, and Uber versus Lyft plays out the same way as Groupon versus LivingSocial, then only Uber will be left standing (a la Groupon), but standing on top of a much healthier industry.
There is a decent chance that Uber’s critics are right. I still have friends giving me grief for being bullish on Groupon. However, I think my reasoning was (and is) 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 $17 billion ends up looking downright reasonable.
To reach the writer of this article: Ben Thompson at email@example.com.
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