Discounted Cash Flow Valuation of Uber (October 2017)

With Uber reportedly getting ready to sell a 14–20% share of itself to Softbank at a $50-$70 Billion valuation, my students at Sierra Nevada College and I decided to do a discounted cash flow valuation of the company.

While DCFs are often discounted (pun intended) when trying to value fast growing startups and growth stage technology companies, we were interested in the “stories” that must be told (and believed) in order to justify this valuation. Even Peter Theil, in his book Zero to One, mentions using DCF analysis to better understand the story of technology startups.

Our analysis was heavily influenced by NYU Professor, Aswath Damodaran. Over the past few years he’s taken several stabs at developing a valuation for Uber.

DCF is normally seen as complicated, but based on lessons learned from Damodaran’s blog, we determined there really were just 7 “stories” (which turn into the inputs in our model/spreadsheet) that we needed to tell to do our analysis.

1. Market Size: How big is the market today and how fast is it going to grow?
2. Market Share: What % of the market will Uber be able to capture?
3. Revenue as a % of billings: Uber’s business model is to keep a percentage of every transaction on it’s platform.
4. Operating Margin: How much does Uber spend running its business?
5. Sales/Capital Ratio: Uber will need to keep investing to continue to grow and keep its customers happy.
6. Discount Rate: We will want to take into account both the risk of being a young company as well as their cost of capital.
7. Probability of Failure: All startup companies have a failure risk, we want to account for this in our analysis.

Of course, we also will need some other basic information such as tax rate, cash on hand, and the value of investments Uber holds (in this case, their major stake in the Chinese rideshare company Didi).

While finding this sort of information can be difficult for startup companies, we’re lucking in this case as Damodaran has done much of the heavy lifting for us. Not only has he done his own analysis of the market size, he also provides a large treasure trove of data that we can use to compare Uber to its industry and peers (for things like Discount Rate, Sales/Capital Ratio, tax rate, etc). In addition, there has been several leaks of financial data on Uber that we were able to reference.

Here are our inputs:

Inputs

Starting with these inputs, we performed the following cash flow analysis:

Cash Flow Analysis

And based on this we come up with the following valuation:

Valuation

As you can see, based on this version of the stories, we found that $50B is indeed a fair valuation for the company. Of course, Softbank isn’t going to buy in at this valuation just for the sake of owning a piece of Uber, they must have a version of the story for the future that increases this valuation significantly.

Entrepreneurship is all about telling stories. We tell stories to potential customers to get them to buy our products, we tell stories to existing customers to keep them happy and to get them to refer us to new potential customers, we tell stories to investors to get them to believe in us and invest in us, and we tell stories to ourselves to convince ourselves we’re not crazy for being entrepreneurs. It’s always bit more reassuring when our stories are backed up my numbers, so let’s look at the stories in this discounted cash flow analysis.

1. Market Size: There are many opinions on Uber’s potential market size, summarized well in this article from Bloomberg. Damodaran estimates the potential market size at $310B and believes Uber will succeed in 2/3rds of these areas, giving it a market size of ~$200B. Investor Bill Gurley sees Uber as a substitute for car ownership and believes the market could be between $150B-$750B. Morgan Stanley Research also bases its market estimated on car cost of ownership data and estimates the market at $250B. We have chosen to stick with the $200B estimate (it’s important to remember that Gurley is an investor in Uber and Morgan Stanley hopes to underwrite the IPO). We do believe that the presence of Uber accelerates the growth of the overall market, and have chosen a 15% growth rate for the market for the first 10 years. From that point we chose a 2% growth rate (approximately the growth rate of the economy). Perhaps this is too conservative, Theil points out in Zero to One that Paypal continues to grow at 15% two decades after it was founded.
2. Market Share: Based on our market size, we’re able to compute that Uber currently has a ~15% share of the market. We believe this will grow, with Uber being one of the dominant players in the market (even with them giving up on China). We decided that eventually Uber will command 40% of its overall market.
3. Revenue as a % of billing: Again, we were able to compute the current value of ~31.5% from data we found online. This surprised us, as we believed Uber was paying a larger percentage of billings to drivers. In the future we believe they will have to increase this to remain competitive and reach their 40% market share. Thus, we decided that after 10 years they would retain 15% of billings. One note here, we did not consider the potential opportunity that driverless cars presents.
4. Operating Margin: Based on leaked financial data, Uber’s current operating margin in -40%. We believe that cost pressures will continue, though Uber obviously will have to become profitable (and apparently they have been, at least in certain markets). We’ve followed Damodaran’s lead and estimated operating margin will grow to 20%.
5. Sales/Capital Ratio: Again, we followed Damodaran’s lead here in observing this is a high capital intensity model and used 3 as the sales/capital ratio.
6. Discount rate: How do we choose a proper discount rate? This seems to be an art in and of itself, and yet as my students constantly observe, somehow we always end up using 10%. Damodaran decides the eventual discount rate will be 8%, in the 75th percentile for US firms. Given the current risk profile for the company (including it’s seeming endless ability to create bad PR for itself) we increase this to 10% for the next 5 years, then step down to 8% by year 10.
7. Probability of failure: Uber continues to face stiff competition, risks that the regulatory environment will move in a direction against the company, and the aforementioned propensity to be its own worse enemy when it comes to PR and scandals. However, in class we decided that at this point Uber has reached the “too big to fail stage.” While we aren’t ready to assign a probability of failure of 0%, we decided the probability is very small, and used 5%.

While there are still many assumptions in or model, we find ourselves happy with the story it’s/we’re telling. Will we be exactly correct? Of course not, we never are. The great thing about building a model like this is we can simply change the numbers and see what happens. Perhaps Gurley is correct and Uber’s market is really $750B:

Uber Valuation Assuming a Starting Potential Market of $750B

Now we find a valuation pushing $150B. What if we then assume that Uber moves to driveless cars and starts keeping 80% of billings:

Uber Valuation Assuming Potential Market of $750B and 80% Revenue %

Wow, now the story starts to get REALLY interesting :)