Are Sky Rocketing Valuations Justified for Uber and Lyft?

Last year, after seeing the growth of alternative cab type services being provided by several companies, the California Public Utilities Commission created a new category of utilities – Transportation Network Companies. A transportation network company was defined as a company that uses an online platform to offer ridesharing services by connecting passengers with drivers.

Uber’s Offerings
Founded in 2009 by Travis Kalanick and Garrett Camp, San Francisco-based Uber is a leading provider of such services. The company provides the ability for drivers and passengers to connect with each other using text messages, an iOS, BlackBerry, or Android-based app or through the web. Uber’s software alerts drivers with taxis, sedans, or SUVs and arranges for the ride sharing. Details of the ride are communicated back to the rider using text messages or the mobile interface. Uber also enables riders to make payments for their rides through credit cards. Since launching their service in San Francisco, Uber has grown to 144 cities across 38 countries.

Uber claims that their service is “changing the fabric of these cities.” By enabling drivers to get rides even in their down times, they are not only helping them generate more income, but are also helping create 20,000 new jobs per month.

However, Uber is now moving beyond ridesharing. Last year, they launched Uber Ice Cream, which routed ice-cream trucks on order and let users pay directly through their Uber account. Following its success, earlier this week, Uber is rumored to be working on the launch of another service, the Corner Store. Corner Store is a product-delivery service which will let users order items such as first-aid products, candies, and common cure products for allergy relief, cold, and cough.

Uber’s Financials
Uber charges a transaction fee for every ride that is booked through them. Analysts estimate that they charge nearly 20% as commission for the ride. They have come under criticism for letting demand and supply dictate the prices charged to the riders. Other critics of the service include local cabs who are not pleased with the availability of mobile apps that let riders hail cabs from their phones instead of waiting for them on the road.

But these criticisms haven’t hurt Uber’s revenue growth. While their financials are not publicly known, analysts peg their revenues at $213 million last year. The market is very optimistic about their potential and projects $10 billion in gross revenues translating to $2 billion net revenues sometime soon.

Uber has been venture funded so far and has raised $1.5 billion from investors including Fidelity Investments, First Round Capital, Lowercase Capital, Founder Collective, Benchmark, Innovation Endeavors, Menlo Ventures, Jeff Bezos, Goldman Sachs, CrunchFund, TPG Growth, and Google Ventures. Their latest round of funding was held earlier this year when they raised $1.2 billion at a whopping valuation of $18.2 billion in a round led by Fidelity Investments. That is a significant increase from the $4 billion valuation in August last year. Uber does not have any plans of an IPO soon, but if it does list, it will be among the biggest tech IPOs.

Lyft’s Offerings
Uber is not alone in the market. San Francisco-based Lyft was founded in 2007 with a similar intention. They call themselves “your friend with a car” as they offer a friendly, safe, and affordable transportation option. Like Uber, Lyft riders can also request rides through iPhone or Android-based apps. The Lyft software communicates to the drivers the requirement and the rider gets a background-checked and interviewed driver within minutes to offer the ride.

Lyft is comparatively much smaller with the service offered in about 60 cities across the country. But Lyft is growing fast as well. Despite being focused on domestic markets, Lyft has seen rapid growth, recording 6% growth every week. The company also keeps hosting interesting events to attract riders. Last year, they ran a trial version of Prime Time Tips in Los Angeles that provided drivers with a premium payment of up to 25% during peak traffic hours. Earlier this year, they also released Happy Hour, a discounted rate service during the lean hours of the day. Riders could get as much as 50% discount during these hours and last Halloween, they let 50 of their San Francisco drivers dress up as Zombies and offer candy to the riders.

Lyft’s Financials
Lyft also earns revenues on a similar model as Uber. But, their financials are not known. They just claim that they are tracking on to “IPO-Level” revenues. Lyft too is venture funded with $332.5 million raised from QueensBridge Venture Partners, Coatue Management, Mayfield Fund, Founders Fund, Andreessen Horowitz, Alibaba, Ooga Labs, K9 Ventures, FLOODGATE, AFSquare, and Keith Rabois. Their latest round of funding was held in April this year, when they raised $250 million from QueensBridge Venture Partners, Coatue Management, Mayfield Fund, Founders Fund, Andreessen Horowitz and Alibaba at a $700 million valuation. Lyft plans to use these funds for market expansion including growth in international markets.

Both Uber and Lyft have surprisingly high valuations. Academics and economists like Aswath Damodaran have questioned their multi-billion dollar valuation. Then there are others like Bill Gurley of Benchmark capital who have justified their valuation claiming that both the total addressable market and Uber’s market share are much higher than anticipated.

I am not entirely convinced though. My big concern lies in the scalability of these companies. They are exploring alternate markets – such as Uber’s Ice Cream, Corner Store or even diversifying to logistics for companies like UPS and FedEx. However, at the end of the day, ridesharing is not a product business; it is a service business. To be able to scale fast enough to cater to the market opportunity that Bill Gurley talks about, both the vendors will have to add both drivers and cars. Whether they will they be able to add quality drivers and cars at the right pace will still remain a question.

For now, the services they each provide are valued and useful, so there is no question mark around their sustainability or monetization ability (unlike a lot of other mobile apps).

The only real question is valuation. The market will sort that one out as they reveal themselves in the public market.