Ride-sharing startup Lyft Inc. is gearing up for its initial public offering this week and investor enthusiasm is currently running high. The IPO is reportedly already oversubscribed, and there seems to have been little pushback thus far on its targeted valuation of $23 billion.
Yet, for all this excitement swirling around Lyft, prudent investors would be wise to think better of trying to get in on the action. Lyft is relying on highly questionable valuation metrics to sell its IPO, even as it continues to face persistent losses, as well as questionable growth prospects going forward. Investors buying into this offering may quickly find their smiles of joy turning to tears of anguish as warm glow of the roadshow fades and a far more bitter reality sets in.
Perpetual money-loser
Startups frequently lose money for years. Indeed, many investors have come to expect such losses as a matter of course as the startups spend external capital to fuel their rapid growth. Hence, it is not terribly surprising that Lyft is currently a money-loser. However, what is of interest is the sheer scale of the company’s losses. In 2018, Lyft lost a staggering $911.3 million. That means Lyft has the dubious honor of having the largest loss in the 12 months leading up to its IPO of any U.S. startup in history. Lyft will not hold this top spot for long, however. When its larger ride-sharing rival, Uber Technologies Inc., debuts to public markets later this year, it will dwarf Lyft’s record losses.
If history is any guide, capital markets may not be kind to Lyft for long. Indeed, the common fates of the five biggest pre-IPO money-losers to date show just how quickly the market can turn against a growth story built on burning cash: Groupon Inc. (GRPN, Financial), Moderna Inc. (MRNA, Financial), Snap Inc. (SNAP, Financial) and Vonage Holdings Corp. (VG, Financial) have all been beaten down far below their IPO prices, while Viasystems Group Inc. has returned to private hands (at a considerable discount to its IPO).
Lyft could raise up to $2 billion in its IPO, which would be more than enough cash to keep the lights on for a year or two. It is hoped that the cash invested from the raise will allow it to achieve operational sustainability in the relative near term. But it appears more likely that this will simply be the first of many capital raises to fund what could end up being a perpetual money-loser of a company.
Dubious metrics underpin raise
Lyft is relying on a few important metrics to justify its valuation and sell its growth narrative to the market. One is the take rate, which is essentially a measurement of revenue as a percentage of bookings. The take has been climbing quarter over quarter and, in the fourth quarter of 2018, had hit a fairly impressive 28.7%. So far, so good.
While the take rate offers a positive sign of things to come, Lyft is more concerned with its “contribution” metric, a non-GAAP concept of somewhat suspect provenance. This is the best explanation of contribution we have come across:
“Contribution is the difference between a profit of $921 million last year, and the actual net loss of $911 million that the company reported on a GAAP basis, on revenue in 2018 of $2.2 billion.”
“The company arrives at it by stripping out all the normal costs of business after the immediate cost of revenue -- i.e., the cost to pay and insure drivers, process charges and pay hosting and other fees to run the Lyft ride-sharing network.”
“That means ignoring operating costs, research and development, sales and marketing, and general and administrative costs. The company even strips out three items from its actual cost of revenue -- the amortization of intangible assets, stock options expense and insurance reserves, making the cost of revenue appear less than it actually is.”
“In other words, contribution is rather like gross profit but sweetened up a little bit, with none of the annoying operating expenses that go with running a company.”
In other words, contribution is a highly doctored measure of gross margin. At first glance, this ersatz metric appears to have done as intended, portraying a strong growth story and progressive improvement. However, a deeper dive suggests the story is more complicated than Lyft would like investors to believe. Most worrying is the apparent lack of much further leverage opportunity. For example, protests by drivers against pay cuts are already putting pressure on Lyft. Clearly, Lyft has limited room to maneuver even now. Without significant improvements in this arena, however, there can be little hope of Lyft becoming legitimately profitable.
Verdict
Despite the positive spin coming from Lyft and its underwriters, a closer examination of the financial metrics provided in its IPO filing paint a worrying picture. Like so many tech startups, there appears to be a hope that Lyft will somehow be able to turn profitable thanks to scale, making up its current losses via higher volume, while leveraging network effects to improve margins. Unfortunately, this rosy view of the future fails to comport with the reality as portrayed by the data.
Investors would be wise to steer clear of this IPO and should definitely avoid the stock once it starts trading normally. We predict a strong shorting opportunity in the near future, but would caution against jumping in on that side of the trade too soon. Until the usual lockup period ends, the options market and borrow rate will likely make any short dangerous in the very near term. After the lockup expires, however, it may well be open season on Lyft.
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Disclosure: No position.
