Steering Lyft’s IPO: What Investors Will Weigh During the Roadshow

Xconomy San Francisco — 

Much has been said about Lyft’s early lead over Uber in the “horserace” to become the first ride-hailing app company to go public. But now that San Francisco-based Lyft has filed its 276-page IPO prospectus with the U.S. Securities and Exchange Commission, potential investors can focus on much more detailed considerations as they decide whether to make bets on the smaller of the two U.S. ride-hailing leaders. Lyft’s IPO roadshow, during which it will make pitches to stock market investors and analysts, may begin as early as March 18.

Lyft is one of the companies that best illustrate the cultural shift that IPO candidates navigate when they leave the Silicon Valley venture capital support system that fueled their early growth, and seek capital instead from Wall Street investors who may judge the company by a whole different set of standards. Will Lyft’s proposal fly with them?

One automotive industry analyst says Lyft’s filing brought no new answers to a key question: How will the company turn a profit?

“Lyft is the first transportation-as-a-services company to have an IPO, but in terms of service offerings and defining a new path forward—that is unchanged, apart from having stockholders to answer to,” says Valerie Sathe Brugeman, the Center for Automotive Research’s senior project manager for the Ann Arbor, MI-based organization’s transportation systems analysis group. “One thing Lyft has going for it? It’s ubiquitous. People rely on [it]. The service itself is not going away anytime soon.”

Like Uber, Lyft is recording big losses as it continues to grow, and its path to profitability is uncertain. Some analysts, not surprisingly, have declared that pattern unsustainable in the long-term.  The bright spots: Both revenue and market share have risen significantly over the past two years, but that’s no guarantee that Lyft’s financial numbers will ever flip into the black.

Lyft’s revenue rose from about $343.3 million in 2016 to nearly $1.1 billion in 2017—a 209 percent hike. In 2018, revenue was nearly $2.2 billion—another year-over-year bump of 103 percent. But while the revenue growth rate was slowing in 2018, the company’s losses were accelerating, rising from $688.3 million in 2017 to $911.3 million in 2018. The company’s revenue amounted to 26.8 percent of its $8 billion in bookings for 2018.

Here are some of the factors that may inspire Wall Street investors to depart from the judgment of venture capital firms, which often prize growth over shareholder profits and thrive on risk as they bet on the future.

Profitability

Silicon Valley VCs don’t need their portfolio companies to achieve profitability in order to make a return on their investments: the VCs get their financial reward when the portfolio company goes public, or when it’s acquired by another business. By contrast, investors in public companies—such as pension funds with retirees to support—want to see profits and a rise in share values, which often correlate with financial performance.

Lyft acknowledges in its IPO filing that it may never reach profitability, while simultaneously struggling to present a clear path to financial solvency. However, the sheer size of the transportation market—the prospectus valued it at $1.2 trillion annually as of 2017 in the U.S. alone—suggests a big opportunity.

Without offering assurances that its plans will lead to profitability, Lyft says it will continue to pursue growth in its rider base, its geographic territories, and its roster of drivers. This will come by means such as discounts for new riders, and more expenditures on marketing. Lyft, which operates in the United States and Canada, has already boosted its market share in those countries  from 22 percent in December 2016 to 39 percent in December 2018. But some of that jump may be the result of an expensive commercial push as the company prepared for its IPO. The total amount Lyft spent on sales and marketing leapt from $567 million in 2017 to $803.7 million in 2018, according to its IPO filing.

Lyft identifies some other routes to progress: By capturing masses of data about rides and routes, the company says, it can continue to improve the efficiency of its platform in scheduling trips, which would benefit both riders and drivers. The company also believes that its total market will increase because car ownership will decline as consumers realize that it’s more expensive than on-demand ride services—and this trend will be more pronounced among digital-native millennials.

Also, like Uber, Lyft is starting to build out its platform as a one-stop app where riders can plan all stages of a trip, by linking to bike and scooter rentals as well as public transit options. All this could lead to higher business volume for ride-hailing companies as a whole—but will it lead to profits for any of them?

Lyft continues to sound the credo of the “sharing economy,” saying it provides flexible opportunities for drivers to make money in their spare time. But the cost of constant recruitment of part-time non-employees must be factored into the company’s financial prospects. Investors may want to hear about the turnover rate for drivers, and ask for a breakout of the recruitment cost per driver. Lyft says 91 percent of its drivers provide rides for fewer than 20 hours per week. It’s possible that some of those drivers are also working for Uber and other ride-hailing services.

Lyft and Uber are trying to offer safe, standardized, on-demand rider experiences for mass populations, while depending on a casual workforce in a period of very low unemployment in the United States. Meanwhile, their competitive rivalry maintains downward pressure on fares.

Investors who are interested in how much drivers are paid won’t find those figures broken out in Lyft’s filing. The company subtracts driver payments before it reports its revenue.

Faith in Network Effects

Silicon Valley often values user growth above other measures of a startup, based on the belief that growth yields “network effects” that make a service more valuable to all participants as each new user is added. Walter Frick, a deputy editor for HBR.org at Harvard Business Review, says these network effects won’t work as well for Lyft and Uber, compared with companies such as Google and Airbnb, because of two factors identified in an analysis by the Harvard Business School:

—Clustering: Ride-sharing outfits compete in geographic clusters, and a small local competitor in a particular city can take away market share, even from a leading nationwide or global company.

—“Multi-homing”:  Lyft doesn’t really “own” its network. Both drivers and riders use Uber as well as Lyft. This “multi-homing” often happens when the cost of adopting a new platform is low, such as simply downloading another app. “When multi-homing is pervasive on each side of a platform (both riders and drivers), as it is in ride hailing, it becomes very difficult for a platform to generate a profit from its core business,” as Frick quotes the Harvard Business School writers’ view in their earlier article.

Governance

Among Silicon Valley startups, it’s not unusual for founders to try to maintain control of a company by issuing themselves greater voting rights compared with outside investors. But Wall Street investors may be turned off by such a provision, found in Lyft’s proposal. Outside shareholders after the Lyft IPO would have little control over Lyft’s governance, as Recode explains. The founders’ shares come with 20 votes per share, while investors in the IPO would receive one vote per share.

Regulation 

Silicon Valley supported Lyft and Uber during their early days, when both companies claimed that their novel services weren’t bound by regulations that applied to more traditional transportation businesses, such as taxi operators. But shareholders in Lyft as a public company may see its value eroded by the cost of new regulations from government agencies that are catching up to the impact of the ride-hailing model on traffic, workers’ rights, safety, and other factors. For example, in December, the New York City Taxi & Limousine Commission passed new regulations that would institute a minimum wage of $17.22 after expenses for drivers dispatched through ride-hailing apps such as Lyft and Uber.

Another potential thorn in Lyft’s side is U.S. officials’ dawning realization that consumers need more stringent data privacy protection.

“I think consumer data is a big piece of Lyft’s perceived value,” notes Brugeman of the Center for Automotive Research, adding that she’s not sure how successful the company has been at monetizing that data so far.

Big tech companies like Google and Facebook (NASDAQ: FB), which derive much of their value from the vast amounts of consumer data they hold, have essentially gotten a free pass from stateside regulators. That is changing rapidly in Europe, and the same is expected to happen eventually in the United States. This could be detrimental to Lyft’s future prospects—a note of caution that the company sounds in its prospectus.

In 2016, the consulting firm McKinsey noted that the treasure trove of data collected about travelers in connected vehicles was creating a host of new “value creation models,” from entertainment to targeted advertising. Rakuten, a Japanese e-commerce platform with a market data division called Rakuten Intelligence, holds a 13 percent stake in Lyft.

Future Autonomy and Shared Mobility

According to TechCrunch, VCs and other investors so far have poured $5.1 billion into Lyft as one of the vanguard companies that have redefined transportation as an online service. Lyft’s task in the roadshow will be to persuade investors that as a pioneering company with an “open platform initiative,” it can earn an important role in the growing mobility business ecosystem—even if that role can’t yet be foreseen precisely.

For example, Lyft might one day be able to replace human drivers with vehicles that pilot themselves, or it might serve as the consumer-facing ride-hailing app in a partnership with a car manufacturer or other fleet operator. It already partners with GM (NYSE: GM), which owns a 6.7 percent stake in the company, as well as Ford (NYSE: F), Aptiv (NYSE: APTV), and others.

Lyft says its fate may hinge on its ability to develop its own self-driving cars, and to compete with other companies aiming at the same goal. But will potential IPO investors see this as a profitable way for Lyft to shed the financial burden of paying drivers? The move would require billions of dollars in capital to create autonomous vehicle fleet networks—and then the company would have to garage the vehicles, repair them, insure them, and so on—all to compete with rivals to deliver a commodity service (rides) while consumers make their choices based mainly on price.

Brand Equity

Many consumers were so turned off by 2017’s rash of bad Uber press that a #DeleteUber social media campaign took root, causing Lyft’s biggest competitor to reportedly lose half a million users during one especially bad week. Although some consumers are loyal only to low prices, Lyft has historically been seen as a friendlier brand than Uber, especially among millennial and Generation Z riders. (To be fair, Uber CEO Dara Khosrowshahi, brought in after founder Travis Kalanick resigned as CEO in 2017, has been trying to rehabilitate Uber’s image.) Whether Lyft’s brand equity will translate to Wall Street confidence remains to be seen, but the company believes its positive reputation with users is a significant part of its value.

Trendspotting

Lyft makes clear in its prospectus that there are macro trends favorable to ride-hailing: In short, young adults who live in places with multiple transportation options are less eager to own cars or even to drive than their parents—a trend affecting the automotive industry as well. The harmful effects of climate change also loom large.

“In 2018, almost half of our riders reported that they use their cars less because of Lyft, and 22 percent reported that owning a car has become less important,” the company says in its SEC filing. “As this evolution continues, we believe there is a massive opportunity for us to improve the lives of our riders by connecting them to more affordable and convenient transportation options.”

Lyft will have to be diligent—and convincing—about presenting that message during its roadshow, and Brugeman says it’s an area where the company has already had some success. “Lyft has been more proactive in discussing societal and sustainability goals—they’re better at talking about it,” she adds.

As the financial, tech, and automotive industries wait eagerly to see if Lyft will reach its reported potential IPO valuation of $20 billion or more, a successful offering could be a major turning point signaling the reality of an autonomous future. Or it could be an emperor-wears-no-clothes reality check for the mobility industry.

As Brugeman says, “Lyft has a lot going for it, but the [ride-hailing] industry in general has challenges. It will be very interesting to see how it all shakes out.”