The Uber IPO’s High Risk

Jeremy Siegel’s research into initial public offerings, which found that IPOs underperform the market by four percentage points annually during the five-year stretch following the IPO, speaks to the elevated valuations and hype that occur at the time of the offering. Most notably, Warren Buffett’s 1990s talk to Florida MBA students mentioned that Coca-Cola IPO’d in 1919 at a price of $40 per share, and then fell by over 50% to $19 per share the next year. For your own research, pull up the stock performance history of companies that have had an IPO at some point over the past decade and you will typically see the price droop in the years following the IPO.

I understand why Uber has become popular in recent years. It has displaced the taxi industry and seems to be the apex of the Modern Millennial Company.

The problem is that, from 1974 through 2018, the average global returns for the ride transportation industry were 4% (compared to the Dow Jones’ annual returns over 8.7% annualized over the long term).

With very few exceptions, the typical investment returns generated by companies within an industry tend to act like gravity, pulling all the industry participants within its reach. In my life studying the markets, I have only encountered one example in which one particular industry participant greatly outperformed its industry peers (and that is Southwest Airlines, which has delivered roughly 20x the returns of the airline industry as a whole over the past thirty years).

The next line of inquiry when pondering a possible Uber investment would be this: If the industry as a whole has delivered 4% returns over the decades, what is it about Uber that would enable it to outperform?

Well, for starters, it has survived by cutting costs and legally treating its workers as independent contractors rather than employees, saving costs on health care, taxes, vehicle-related usage, and even the “dead time when there are no customers but the taxi driver is on the clock” aspect of the industry.

The problem is that I do not believe the classification of drivers as independent contractors will last over the long term. There is an old legal maxim that says: “What the California courts do, the rest of the world mocks, and within a generation, adopts.” The California Supreme Court, starting with the line of rulings that have flowed from the Dynamex case, has been skeptical of the gig economy and has been adopting the test of “if you direct and control the worker like an employee, then he must be regarded as an employee.” There is a very real regulatory risk here that could wipe out Uber’s competitive advantage.

Possibly, Uber may be able to sustain itself on its surge pricing, which allows it to charge premium rates for that Friday night 3 AM pickup or Sunday 6 AM flight to the airport. That is a legitimate advantage that Uber has been able to exploit over the taxi industry, but also a policy that seems highly prone to copycat behavior.

When you look at a company like Amazon where factory workers make $26,000 or Wal-Mart where store clerks earn nearly the same amount, the poor pay is within the context of the employer-employee relationship subject to minimum wage laws which have some predictability. If Uber has to treat its American drivers as employees, the cost structure would explode to the point that it is very possible Uber would operate at a loss.

There are still so many industries in the world that have splendid economics, be they distillers like Brown Forman or software makers like Adobe. Why not spend your life acquiring delightful assets that have uniquely strong competitive advantages in which the industry as a whole is so healthy that even the mediocre performers also deliver high single-digit returns?

From 1918 through 2018, the annual inflation rate in the United States was 3.6%. Big Transportation, as a whole, delivers 4% long-term returns. IPOs in general are overhyped, and Uber has the realistic threat of a dramatically rising cost structure. I do not believe that any Uber IPO would be worth of a long-term investment.