The other day I was cornered by one of my strategy colleagues on the topic of Uber. Uber’s recent fundraising puts a value of $50bn on the business, three times higher than a year ago and making it the fastest ever start-up to get to $50bn. When, asked my accuser, is accounting going to catch up with these new paradigms and start producing the metrics and the models we need to value them?
That evening I had my first Uber ride. We were in Brixton, South London, it was late, and someone had just flicked the switch on a torrential rainstorm – this weather really is a paradigm shift. London black cabs are like hens’ teeth in Brixton, but one of us had the Uber app and in an instant there was a car at the pavement. Of course the driver didn’t have ‘the knowledge’, but his satnav took him the right way and the price was okay. So I suppose we are waving bye-bye to another piece of cultural history. That Uber ride certainly created value for the customer. But what about the value of Uber itself?
Firstly, we don’t need a new valuation model. The value of any investment is simply a function of the free cash flow it will earn for its investors, directly or indirectly. That has always been so, and always will be. For an investor who wants a return of 7% – probably reasonable for nowadays – a $50bn valuation needs to return the equivalent of $3.5bn a year in cash forever, or $7bn a year over a 10 year horizon, or $12bn a year over five years. And if the payoffs will not happen any time soon then they will have to be that much higher, for the uncertainty and for the discounting. That is the challenge.
This arithmetic makes Apple’s remarkable market capitalisation of $650bn unremarkable – Apple’s free cash flow was $46bn last year. By contrast Google’s current market capitalisation of $450bn is on a free cash flow of slightly over $6bn last year. 20 years after its creation, Amazon remains the enigma. 15 years ago, during the dot-com bubble, I wrote a piece in this Review arguing that most of those valuations would probably turn out to be wrong, using Amazon as the worked example. Amazon’s market capitalisation went sideways for the next decade, at around $30bn, +/- $10bn. It is now $250bn, though Amazon’s free cash flows in its last three full years were $0.4bn, $2bn and $1.9bn.
So will Uber justify its $50bn price tag? Of course that is possible. Many new economy categories are clearly showing the winner-take-all nature of network economics. That favours Uber, which is globally well ahead of the competition in its ride-hailing business while pushing aggressively into adjacent businesses. On the other hand, Uber faces some credible competitors and some regulatory pushback in many territories. The more fundamental question is how profitable this new business model will turn out to be when it beds down and whether, as well as changing the world, it will be a place where investors make money. It will be a while before we know the answer to that.
We don’t need a new accounting model either. But what we do need is to actually see some accounts. The story is that Uber’s annual revenues were around $400m last year and will be $2bn next year. The presumption is that Uber currently makes losses and burns cash. However Uber inhabits the accounting omertà of US private companies. The golden circle of early investors can see its financials, but the rest of us are just guessing.