Once again markets opened sharply lower on Friday but rallied in the afternoon, this time to finish with moderate gains. For the week, however, given the sudden negative turn in trade talks, stocks lost about 2% in value.
In addition to the news on trade, the Uber IPO was a resounding disaster. I cannot remember a major offering that never traded during the first day at its offering price. Although the stock spent a good part of the session trading within 1-2% of the offering price as underwriters valiantly tried to support the deal in hope that aftermarket interest would develop, the stock fell sharply in the afternoon even as stocks were rallying strongly. So far, the failures of the Uber and Lyft offerings have not killed the IPO market. But they certainly have injured it. Too many issues of size are in line to go public, and almost have to in order to give liquidity to investors waiting to cash out after many years, that it will take more than poor reception to Uber and Lyft to put the entire IPO market on hold. But their weak performance certainly will make valuation of every subsequent offering a major subject. Some, maybe several, are going to have to sell stock, assuming they still have the need to go public and are going to have to settle for an IPO price below recent private financing rounds. Never before have so many companies waited so long to go public. But the market offers a different message. Never before have so many companies focused on revenue growth without regard to how or when they might actually make money. There is little doubt, for instance, that ride sharing and urban transportation have been changed and disrupted by the emergence of Uber and Lyft. But with that said, it is also unclear whether either company has a clear path to profitability or free cash flow.
The current model, hiring independent drivers who use their own vehicles and share subsequent revenues with their parent, has become very popular. But in order to keep fares competitive with existing competition, i.e. taxis, the fares to date have been insufficient to cover costs, including what drivers need to retain. Indeed, we have seen some actions by groups of drivers protesting how little they make. Ordinarily, one might think greater volumes might provide a path to profits, but in mature markets like New York, it is hard to imagine how Uber and Lyft can double or triple volumes from here. Furthermore, given the low fixed cost base of the current operating models, there isn’t enough leverage to get to profitability doing business as they are today.
So why the fascination? There are two basic reasons. First, users love the service they provide and equate that with present and future value. Second, both companies suggest a new future world of automated vehicles without the need for drivers that will afford a different economic model that will be sensationally profitable.
Maybe that will happen. But there are major-league risks.
1. While there will be a 10-car test fleet, hopefully involving Waymo a subsidiary of Alphabet#, and Lyft that might begin next year in Phoenix, the idea of a national fleet of driverless cars anytime soon may be highly optimistic.
2. No one knows what the ultimate capital investment might be and how it will be financed.
3. While Uber and Lyft are leaders in providing ride sharing alternatives to taxis, there is no assurance, should a riderless vehicle taxi service develop, that Uber and/or Lyft will be leaders at that time. Waymo, General Motors and Tesla are all much further advanced in the development of autonomous vehicles, for instance.
In sum, these two companies, based on current market values, are roughly a $100 billion bet that these enterprises can double in size in the coming years while forging a path to profitability. I would suggest, by the market action of both deals so far, that there are far more skeptics than believers. You, obviously, can add me to the list of skeptics. Should you want to take a flyer on either, here’s a suggested road map. I don’t know when the next bear market will occur, but I believe there will be one before either is profitable. Stocks whose foundations are built on stories and not on earnings, dividends and positive cash flow tend to get hit pretty badly in a bear market. If you recall the Internet bubble, about the only company pre-2000 that turned out to be a resounding success was Amazon. And you could have made a killing buying Amazon 2 years after the Internet bubble burst. Almost all the companies other than Amazon have either disappeared or sell for much less than they sold for in 1999. Thus, I suggest watch, wait, and decide a few years from now. You will almost certainly get a better opportunity to buy in at lower prices and you will have a much better idea whether either is on a path to success.
As for other pending IPOs, the reasoning is much the same, especially for those that don’t earn any money and don’t have a defined pathway to profitability. The few that are profitable and growing fast have been well received and deservedly so.
Now to China and trade. Although both sides continue to talk, there are no signs of agreement imminently. The hopes and promises that continuing talks provided last week are fading. I do believe some sort of agreement can still be reached within the next several weeks or months but there is far less certainty than one believed a week ago. The U.S. can’t sign a weak agreement. Even if President Trump wanted to do so for show, Congress wouldn’t approve such a deal. China appears unwilling to take major steps in the directions the West wants them to go: protecting intellectual property, reducing the level of forced technology transfers and allowing foreign companies easier entry into China. The talks aren’t back to square one, but they aren’t near the finish line yet. In the meantime, it is obvious that increased tariffs will hurt. They are a direct tax on U.S. importers and prices will get passed through to users to some degree. Corporations will be more reticent to make new investments until they know the rules of engagement. Companies will have to contemplate major shifts in supply chains away from China. How much will GDP be impacted? I don’t know. But there will be an impact and, before long, stocks will have to adjust to the likelihood that trade peace is further away than most expected a week ago.
Given that, some sort of correction appears likely unless there is a sudden breakthrough in trade negotiations. The damage doesn’t have to be great, but there will be some. This isn’t the moment to be aggressive.
Today, Stephen Colbert is 55. Stevie Wonder turns 69.
James M. Meyer, CFA 610-260-2220