Uber IPO: The Myth Of One-Day Wealth

The significance of an initial public offering is that stocks become openly traded on some type of exchange/counter and, in this day and age, can be purchased online in an impersonal manner by any investor rather than on some privately negotiated terms that involves communication either directly or through a broker with a person who owns the stock. That’s it.

If anything, an initial public offering is a sign that those who bought shares on the private side now have an eye towards selling their stock and want to open the bidding up to the entire world of investors rather than the narrow subset of investors that deliberately contact the private shareholders.

It follows, then, that the “perfect” IPO, in terms of fairness to public buyers and the formerly private sellers, would be one in which the immediate first day’s trading was 0% or arguably something that mimicked the relevant index’s movement as a whole.

If a stock goes up 50% or some crazy amount, and the rise is attributable to anything other than speculation, it means that the private sellers did not price the IPO at a high enough price–i.e. they undervalued their own shares. And vice versa is true for when the stock goes down. In the latter case, it is often the underwriting company/issuer that bears the cost, as they acquire the shares from the private owners to act as a holder/intermediary to provide shares on the market when public trading begins.

Of course, the above paragraph is subject to the caveat that speculation is present in an IPO’s early trading and it is possible that a private seller gets a fair price for his stock but the stock just so happens to rise substantially in short-term value due to the manifestation of “animal spirits” surrounding the stock.

With this background in mind, it should be clear why there is so much folly in expecting to ever acquire instant profit from Uber or any other IPO activity. In order for a business to go public, the management must think that the value of the business is optimized in some manner to be valued at the highest possible price in the foreseeable business cycle. That is why IPOs get shelved during recessions or during periods of poor economic news–the private sellers know that they will not receive full value for what they sell.

On the other hand, this all spells bad news for the public buyer of an IPO. Private investors, with experience and knowledge of the business to go public, have decided that this is the time at which they will have the highest probability of maximizing their value. This doesn’t mean they can’t be wrong in their appraisal of value, but it does mean that you are buying at a time when those with the most knowledge of the business consider it a wise time to dispossess themselves of the stock.

The 1990s were an odd time where “greater fool theory” was in full effect. Businesses with no profits, and no real prospects of profits, were debuting at wild prices and then being sold to someone down the line for an even wilder price. Even though the dotcom bubble burst, the financial media has still adopted the 1997-1998 timeframe of one-day and other short-term stock gains following an IPO as their paradigm for analyzing a company going public because it captivates the imagination even if it results in the furthest thing from wealth building.

The only reason someone would buy the Uber IPO is because they expect someone else to pay even more. I can’t think of a rational reason to buy it, as it’s a $45 billion company that is losing $2 billion per year. The transportation index of stocks has delivered 5.5% returns since 1962. It’s never been a great way to make money, and state legislatures are taking action to increase Uber’s labor cost by giving Uber drivers “employee-ified” rights as the state courts, particularly the California state court, revises independent contractor law to be more like employer/employee law for gig economy drivers.

If I were put in charge of Uber, I’d charge a $19 annual fee to all users so that the fee income could be used to fund the development of the platform (the reason why Amazon and Costco are so formidable). Uber has been scared to do this because it figures that Lyft would gain market share, which may or may not be true depending upon whether Uber could charge lower fares and convey that to customers at the time it rolled out such a fee.

In any event, Uber is a company that might make $1.5 billion in profits seven years from now in a best case scenario. In a reasonable case scenario, profits aren’t even guaranteed.  At a market cap of $75 billion during the May 2019 IPO, we are looking at a valuation of 50x 2026’s hypothetical best-case scenario earnings. In order for the stock to justify its price of $45 per share, it would need to come up with $4 billion in annual profits sooner rather than later.

It is losing billions of dollars in an industry that is historically below-average while trading at a valuation with the best of the high-flyers while already being a mega-cap stock. These are not the circumstances that facilitate the creation of long-term wealth. It’s socially sanctioned gambling.

Despite the hype, I would not expect Uber to outperform the S&P 500 Index from 2019 to 2029, and there is even a fair chance that Uber will substantially underperform it. I’d rather, cough cough, invest in a certain Midwestern company sitting on more cash than Uber’s market cap.

Originally posted 2019-05-11 12:19:03.

Like this general content? Join The Conservative Income Investor on Patreon for discussion of specific stocks!