To Acquire a Unicorn: A Waterfall Analysis of Lyft’s (Inevitable) Sale
Lyft is a privately held American on-demand transportation company widely publicized as the pink-mustache rival to its competitor Uber. Based on recent events in the past quarter, there have been compelling signs that Lyft’s sale is inevitable. This post highlights the key reasons and provides an original waterfall analysis to help you understand the impact of a sale.
Signs of a Lyft Sale:
Most on-demand markets trend towards consolidation. On-demand expansion is typically a city-by-city (ultimately country-by-country) play; currently Uber dominates the U.S., Didi Chuxing (“Didi”) rules China, GrabTaxi (“Grab”) controls SouthEast Asia, and Ola reigns India. In the end, there is this Highlanderesqe (“There can only be one!”) mentality as players saturate their respective regions. We already see Uber aggressively expanding into global territories; for example, CEO Travis Kalanick notably stated in the past that the company lost $1 billion (Bn) annually in China. Uber has now turned its focus towards India after ceasing expansion efforts in China. In response to this aggression, Didi, Lyft, Grab, and Ola have formed a global alliance to combat Uber’s growth.
On-demand transportation is ultimately a game of earning marketshare rather than profits. The players here understand that the window of opportunity to create tangible network effects is limited; defensible network effects in one’s territory create an incredibly high barrier to entry for competitors. In the end, you can either spend hard to break down those barriers (Uber) or create alliances to share territory (anti-Uber alliance). For either one of these strategies, the high barriers to entry is what makes consolidation inevitable. As Uber grows stronger, the need for a more consolidated entity to combat it rises — this increase the probability of M&A activity among the smaller ride-sharing services. As Uber finds it increasingly expensive to expand into entrenched territories, especially in India at the moment, it may break out its war chest for acquisitions of its own. Finally, the market is still ripe for any larger corporation (ahem, Alibaba) to swoop in and get into the ride-sharing business. It wouldn’t come as a surprise if consolidation occurs vertically— there are plenty of strategic buyers among car manufacturers (General Motors) and self-driving auto companies (Google) that would benefit tremendously from acquiring a transportation network. With Didi, Grab, Ola, and Lyft already in bed with powerful strategic backers Apple, General Motors (GM), Alibaba, and Softbank, this theory seems more and more feasible.
Lyft recently hired Qatalyst, a famous boutique investment bank that specializes in advising technology company sales. Notable deals brokered by Qatalyst are Linkedin’s $26.2Bn acquisition, Informatica’s $5.3Bn buyout, and Twitch’s $970 million (MM) acquisition. While the counter-argument here is that Qatalyst has been brought on simply for fundraising reasons, I find it odd that Lyft would hire Qatalyst for fundraising purposes when they just recently raised $1.0Bn in January (2016). We should also note that Lyft has raised over a whopping $2Bn in primary financings within 7 years. The most recent Series F financing round done at a $4.5Bn pre-money valuation represents a 133% increase in valuation from its last round in March, 2015 (less than a 1 year time gap!). In addition, taking a look at the company’s certificate of incorporation, preferred shareholders all came in a common-friendly terms. We see non-participating, pari passu liquidation preferences with no dividends issued. Based on financing details and rapidly rising valuation, there are no signs of punitive terms commonly found in startups desperate to raise capital. Notable follow-on investors in the last round are Alibaba Group, Didi, and Kingdom Holding Company. Notable new investors are GM, DSCN Capital, Janus Capital Group, and Olympus Partners. It is abundantly clear that Lyft is not short of good funding opportunities. Qatalyst is likely here to broker a sale.
How much would the offer be?
We know that Lyft can offer a tremendous amount of value to a number of strategic buyers. With a projected $2.7Bn in 2016 gross sales ($700MM in net revenue after subtracting revenue split to drivers), Logan Green and the board understands that Lyft still holds large growth potential. So how much should buyers bid after taking into account liquidation preferences and holding time? I modeled out a waterfall analysis that breaks down returns for each preferred shareholder as well as common-holders. The link to the full spreadsheet of the waterfall can be found here.
Waterfall Methodology and Assumptions:
I utilized Lyft’s most recent certificate of incorporation which provides information on all of the financing rounds. There were seven preferred financing rounds — seniority for all preferred shareholders were all pari passu with a 1x liquidation preference multiple on the original issue price (OIP). Liquidation preferences were all non-participating and uncapped. Conversion rate for preferred shares to common were all at OIP and there were no dividends issued on preferred shares. This information, along with specific financing details (# of issued shares, OIPs, etc.) can be found at the top of the “Returns Model” tab. The purpose of this waterfall analysis is that in the event of a sale, preferred shareholders have the right to either exercise their liquidation preferences or convert their preferred shares into common shares. Investors will only convert if returns/share at conversion is greater than their liquidation preference/share (or just OIP in this case as liquidation preferences are only 1x). It is impactful to understand conversion points because the aggregate liquidation preferences are large enough to significantly influence common-holder returns.
There would have to be a minimum $5.5Bn exit value (or in other words, the most recent post-money valuation) for all investors to convert on their shares. Because Series F investors came in at the highest OIP, their threshold for conversion is the highest. Mapping out the rest of the conversion points, a minimum exit value of only $4.3Bn for Series E, $3.0Bn for Series D, $2.4Bn for Series C, $2.2Bn for Series B, $2.1Bn for Series A, and $2.0Bn for the seed round is necessary for a conversion.
A bid at the most recent post-money valuation would actually be the bear case as the business has grown significantly within the past six months. In addition, historical acquisition bids in the technology sector are often attached with large premiums (take a look at Microsoft’s 50% premium for Linkedin). With liquidation preference thresholds being low on a pari passu format, a sale is much more likely to pass. If a bid of only $6Bn (GM’s most recent offer) for Lyft occurred today, it would translate into a $29.22 price per share for both preferred and common shareholders. That’s roughly a 9% return in 6 months for the Series F investor, 50% return in 16 months for the Series E investor, 188% return in 27 months for the Series D investor, 588% return in 37 months for the Series C investor, 1290% return in 41 months for the Series B investor, 3732% return in 57 months for the Series A investor, and 12879% return in 70 months for the Series Seed investor. The common holders here would receive approximately $2.16Bn on a $6Bn sale. While a $6Bn sale in present day generates very strong results for Lyft shareholders, it only represents a 9% premium on its last post-money valuation (set 6 months ago). I predict at least a 25%-45% premium ($6.9-$8.0Bn bid) set by a serious buyer. The board, which consists heavily of investors, would likely vote favorably on this sale.
Who are the likely bidders?
While Lyft provides exceptional value to a variety of buyers, it is difficult to determine how each company will bid. I opine that Lyft will ultimately be bought by an entity that already owns a stake. It is only natural for invested parties to protect their positions against any competing shoppers. While Didi participated in the last round, they offer a larger array of services and already have access to Lyft territories with their alliance. More importantly they are not profitable yet, so bidding billions for a business that does very little for them strategically would not be the best idea. I believe GM and Alibaba are buyers that would gain the most. GM already owns about 9% of Lyft with their $500MM stake and it is quite apparent already how Lyft’s transportation network would benefit them.
However, the anticipated dark horse here is Alibaba. Alibaba found success by having a monopoly on ecommerce in China through its relationship with the Chinese government. It makes sense that after going public it would want to diversify its revenue streams outside of China in case their relationship with the government dissolves. This is evidenced by the variety of its investments in sectors such as augmented reality (MagicLeap) and media (Snapchat). Thus, it wouldn’t be a stretch for Alibaba to buy Lyft just to maneuver its cash into the U.S. ride-sharing market. Whether it is GM, Alibaba, or any other strategic buyer, I see this sale announced before the end of 2017. Look for Lyft’s shareholders to be Uber happy!