If you are doing an intrinsic valuation, the principle that the value of a business is the present value of the expected cash flows from that business, with the discount rate adjusted for risk, cannot be contested. That is true for any business, manufacturing or service, small or large, old economy or new economy. Since that is what a discounted cash flow valuation is designed to do, I have to believe that what critics find objectionable in my Uber DCF model is not with the model itself but in how I estimated the cash flows for Uber, and adjusted for risk. I followed the aggregated model for discounted cash flow valuation where I estimated the cash flows to Uber as a company, starting with its revenues and working through the consolidated expenses and total reinvestment each year and discounted these cash flows at a cost of capital that I estimated for the entire company. Along the way, I had to make assumptions about a total market that Uber would go after, the market share that I expect the company to get in that market and the operating margins in steady state.
Value is additive and you can value any company on a disaggregated basis, breaking it down into different divisions/businesses, geographical areas or by units:
I may be misreading the critics of my Uber valuation but it seems to me that some of them, at least are making the argument it is better to value Uber, by valuing an individual Uber user first, and then scaling the value up to reflect not just the number of users that Uber has today (existing users) but also new users it expects to add in the future.
User Based Valuation
Now that we have laid out the pluses and minuses of aggregated versus disaggregated valuation, let us think about how you would construct a disaggregated valuation of a company that derives its value from users or subscribers. In general, the value of such a company can be written as the sum of three components:
Value of user-based company = Value of existing users + Value added by new users - Value drag from corporate expenses
1. Valuing Existing Users
The key step in a user-based valuation is estimating the value of a user and that value is a function of many variables: the cash flows that you are currently generating from a typical user, the length of time you expect that user to use your product or service, your expectations of how much growth you can expect in cash flows from a user over time and the uncertainty that you feel about all of these judgments:
Consider the implications that emerge from this simple framework:
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The value of a user increases with user stickiness and loyalty (captured in the expected lifetime of a user and the annual renewal rate).
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The value of a user is directly proportional to the profitability of that user (captured as the difference between the revenues from that user and the cost of servicing that user).
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The value of a user is directly proportional to the growth that you can generate in profits over time, by either getting the user to use more of your product or service or coming up with other products or services that you can sell that user.
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The value of a user decreases as you become more uncertain about future cash flows from that user, with that uncertainty being a function of the revenue model that you use and the discretionary nature of the product or service. A subscription-based model, where users agree to pay a fixed amount every period, will generally be less risky and more valuable than a transaction-based model or an advertising-based model, that delivers the same cash flows. A product or service that delivers a necessity (transportation) is less risky than one that meets a more discretionary need (travel).
If you can value a user, you can then estimate the value of an existing user base, by multiplying the value/user by the number of existing users. If you have multiple types of users, with perhaps different revenue models for each, as is the case with LinkedIn's premium and regular members, you can value each user group separately.
Value Added by New Users
The second segment of value is the value added by new users that you expect to see added in the future. To estimate this value, you can start with the value per user from the last section but you have to net out the cost of acquiring a new user, which can take the form of advertising, introductory discounts and/or infrastructure investments to enter new markets. That net value added by a new user (value per user minus cost of acquiring a user) then has to be multiplied by the number of new users that you expect to add each period and brought back to the present, adjusting for both the risk in the cash flows and the time value of money.
Again, I will agree that this is simplistic but consider the common sense implications:
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The value added by a new user increases with the value of a user, estimated in the last section. A strategy of going for fewer and more intense users may create more value than one with more and less engaged users, a warning that pursuing user growth at any cost can be dangerous for value.
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The value added by a new user decreases as the cost of adding users increases. That cost will be a function of the competitiveness of the business (increasing as competition increases) but also of networking effects. If you have strong networking effects, the cost of adding new users will decrease as you accumulate new users, thus creating a value accelerator for your business.
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The value added by a new user decreases as you become more uncertain about user growth. That uncertainty will be a function of competition and whether the technology that you have built your product or service on is sustainable.
To get from user value to the value of the business, you have to bring in the rest of the company into your analysis. To the extent that you have expenses that are unrelated to servicing existing users or adding new ones, i.e., corporate expenses, for lack of a better term, you have to compute the value of these expenses over time and reduce your value as a company by this amount:
While at first sight, this item may look like wasteful that should be eliminated, it represents both a danger and an opportunity for young companies. It is a danger to the extent that bloated corporate expenses can drag a company's value down, but it can be an opportunity insofar as it is at the basis of economies of scale. If corporate expenses represent necessary expenses to keep a business going, and they grow at a rate much lower than the growth rate in users and revenues, you will see margins improve quickly as a company scales up.
Valuing Uber: A User based Model
Can Uber be valued using a user-based model? Yes, but it will require assumptions about users that are, at best, tentative and at worst, based upon little information. While I will attempt with the limited information that I have on Uber to do a user-based valuation, I will leave it to someone who has access to more information than I do (a VC invested in Uber or an Uber manager) to tweak the numbers to get better estimates of value.
Deconstructing the Financials
The numbers that we have on Uber's operations are minimalist, reflecting both its standing as a private company and its general secretiveness. In 2016, according to the financials that
Uber provided to a Bloomberg reported, Uber reported $20 billion in gross billings, $6.5 billion in net revenues (counting all revenues from UberPool) and a loss of $2.8 billion (not counting the $1 billion loss on the China operations). According
to other reports, Uber had about 40 million users at the end of 2016, up from 24 million users at the end of 2015. Finally,
other (dated) reports suggest Uber's contribution margins (revenues minus variable costs) in its most profitable cities ranges from 3-11% of gross billings and its contribution margin in San Francisco, its longest standing and most mature market, is 10.1%. Bringing in these noisy and diverse estimates together, here are my estimates of user statistics:
These numbers are stitched together from diverse sources and vary in reliability, but based upon my judgments, I break down Uber's operating expenses in 2016 into three categories: to service existing users (48.17%), to get new users (41.08%) and corporate expenses (10.75%); the last estimate is a shot in the dark, since there is no information available on the value. The annual profit from an existing user, based on 2016 numbers, is about $50.50 (Net Revenues - Expense/user) and the cost of adding a new user is about $238/75, and both will be key inputs in my valuation.
Valuing Existing Users
To value Uber's existing users, I use the framework developed in the last section, in conjunction with the estimates that I obtained from the limited financial information provided by Uber. I valued existing users, assuming four additional parameters: a
lifetime of 15 years for users, an annual
renewal likelihood of 95%, a
compounded growth rate of 12% in annual revenues from users expanding their user of Uber services and a growth rate of 9.9% a year in annual user servicing expenses (on the assumption that 80% of the servicing cost is variable). Assuming a
cost of capital of 10% (in the 75th percentile of US firms), the resulting value per user and the overall value of existing users is shown below:
The value per existing user is about $410 and the overall value of Uber's 40 million existing users is $16,412 million. Not surprisingly, this value is sensitive to user stickiness (as measured by user lifetime) and user growth potential (as measured by the growth rate in annual revenues):
In a market where investors swoon at user numbers, this table makes an obvious point. Not all users are created equal, with more intense, sticky users being worth a great deal more than transient, switching users.
Value Added by New Users
To estimate the value added by new users, I start with the value per user (estimated in the last section to be $410), which I
grow at the inflation rate to get expected value per user over time, and use the cost of acquiring a new user from 2016 (about $240/user). Assuming a growth rate of 25% a year for the next five years, 10% between years six and ten and overall economic growth after year ten, I estimate the value added by new users over time. (With those growth rates, I more than quadruple the number of users over the next ten years to 164 million.) In coming up with value, I assume that new user growth is more uncertain than the value created by existing users, and use a 12% cost of capital (at the 90th percentile of US firms) to get today's value.
The value added by new users, based upon my estimates, is $20,191 million. That value is sensitive to the net value created by each new user (value of a new user minus the cost of adding a new user) and the growth rate in the number of users:
This table illustrates the point made earlier about how some companies will be better off trading off higher value added per user for lower user growth, since there are clearly lower growth/ higher value added scenarios that dominate higher growth/lower value added scenarios in terms of value creation.
Corporate Expenses and overall Value
The final loose end is the corporate expense component, a number that I estimated (arbitrarily) to be $1 billion in 2016. Allowing for the tax savings that these expenses will generate and assuming a 4% compounded growth rate, well below the 15.16% compounded growth rate in total users, I estimate a value for these corporate expenses (using the 10% cost of capital that I used for existing users):
The value drag created by corporate expenses is about $10,369 million. Bringing together all three components, we get a value for Uber's operations of $26.2 billion
Value of Uber's Operating Assets:
= Value of Existing Users+ Value added by New Users - Value drag from corporate expenses
= $16.4 billion + $20.2 billion + $10.4 billion = $26.2 billion
Adding the cash balance ($5 billion) and the holding in Didi Chuxing (estimate value of $6 billion) results in an overall value of equity of $37.2 billion for the company (and its equity, since it has no debt):
Value of Uber Equity = Value of Operating Assets + Cash - Debt = $26.2 + $5.0 + $6.0 = $37.2 billion
This is close to the value that I obtained for Uber on an aggregated basis, but that is a reflection of my understanding of the company's economics.
Pricing versus Valuing Users
As you can see, valuing users requires assumptions about users that can be difficult to make. So, how do venture capitalists and other early stage investors come up with per user or per subscriber numbers? The answer is that they do not. Drawing on an
earlier post that I had on how venture capitalists play the pricing game, venture capitalists price users, rather than value them. What does that involve? Very simply put, the price per user at Uber, given its most recent pricing of $69 billion and the estimated 40 million users is $1,725/user ($69,000/40). To make a judgment on whether that number is a high or a low number, you would compare that price to what you the market is pricing a user at Lyft or Didi Chuxing and if naive, argue that the lower the price per user, the cheaper the company. Using the most recent estimates of pricing and users for the five big ride sharing companies, here is what we get:
Company |
Most Recent Pricing (in $ millions) |
# Users (in millions) |
Price/User |
Uber |
$69,000 |
40.00 |
$1,725.00 |
Lyft |
$7,500 |
5.00 |
$1,500.00 |
Didi Chuxing |
$50,000 |
250.00 |
$200.00 |
Ola |
$3,000 |
10.00 |
$300.00 |
GrabTaxi |
$4,200 |
3.80 |
$1,105.26 |
If you follow the user valuation in the last section, you can see why this pricing comparison can be dangerous. The aggregate pricing that you get for individual companies reflects not only existing users but also new users, and dividing by the existing users will give you much higher numbers for companies that expect to grow their user base more. Even if every company is correctly priced, you should expect to see users at companies with less cash flows per user, lower user growth, less intense and loyal users and more uncertainty about future cash flows to be priced much lower than at companies with intense and sticky users, with more growth potential.
The Bottom Line
If your argument against using discounted cash flow valuation (at least in the aggregated form that it is usually done) is that you have to make a lot of assumptions, I hope that this process of valuing users brings home the reality that you cannot escape having to make those assumptions. In fact, the assumptions that you need to make to value a company on a disaggregated basis (based on users or subscribers) are often more involved and complex than the ones that you have to make in an aggregated valuation. That said, I do agree that looking at value on a disaggregated basis can not only give you insights about value drivers but also about questions that you would want to ask (and get answered) if you are thinking about investing in or building a young company whose value is coming from its user or subscriber base.
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Attachments
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Uber User-based Valuation
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Uber aggregated DCF
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