Lyft Has 99 Problems, But This Ain't One

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Summary

Just recently, a fellow market follower commented to me (offline) that he saw little value in Lyft (LYFT) not only because it was making no money, but also because it seemed like it was far too easy for competitors to enter the market and compete away whatever profits it may ultimately be able to generate.

I've heard variations of this argument for quite some time, including here on Seeking Alpha. In truth, I'm less sanguine about Lyft than I once was, because I did not expect the company to make some of the strategic decisions (and non-decisions) that they have the past few years.

But this particular argument has never really held water with me, and after hearing it so often I wanted to tackle it and explain why I think, respectfully, it's not quite right.

The Argument

Rather than reproduce the whole offline conversation, I want to refer you to this excellent piece by Seeking Alpha Contributor David Trainer (a far smarter man than me) so you can get a sense of what exactly is the argument I am responding to. The piece is really worth your time to read, but I'll just briefly summarize the key point here.

Why, he points out, should Lyft be worth $20-$25 billion when GM (GM) can simply build a Lyft competitor from scratch for $3 billion, much like Lyft built itself from scratch for the same amount?

Many will probably expect me to agree, since $3 billion is almost the exact number I calculated for building a US ride-hailing service four years ago. But what I would say to that is, the number is not static. It is rather a dynamic number changing with the dynamics of the market.

While I agree someone could have built a ride-hailing competitor three or five years ago for $3 billion, they will not necessarily be able to do that now.

The Conceptual Premise

The cost of building a new ride-hailing company is essentially equal to the cost of maintaining a sufficient network of drivers to put wait times for riders at three minutes or less, minus whatever revenue can be extracted from those few early adoption riders who use the service. The first number should hold more or less steady, with wage pressures perhaps exerting some upward push.

The second number, however, is on a steady downward trend, as prices in the ride-hailing space decline. The second number is basically determined by the price a new competitor can charge for the rides they do give in their initial startup phase, when bonuses to riders and drivers to reach critical mass are still well above the revenue that is coming in.

When Uber (UBER) and Lyft were first entering the market - more or less together - they could charge relatively high prices for rides because their only competition was traditional taxis, a highly inefficient and overpriced competitor that was used to extracting monopoly profits out of riders through the use of the medallion system or something very similar. This reduced the gap between the guarantees and the revenue coming in, though it didn't eliminate it, as the continuing red ink at both companies can attest.

New competitors seeking entry, however, do not have that luxury. Their primary competitor is no longer taxis - it is Lyft itself. And Lyft is charging far lower prices than taxis did back in the dark days of circa 2009.

But a new competitor cannot use Lyft's lower prices as an excuse to pay its drivers less - drivers' wage rates don't decline just because a new competitor wants to enter the market, if anything increased competition for drivers might increase their wage rates.

Can We Get Numbers?

It is somewhat more difficult to calculate exactly how much the cost of launching a new ride hailing company has gone up. Lyft does not publish regular updates about their average price per mile nationwide, and at any rate rising utilization and increased penetration of Shared rides, which did not exist in 2009, would make such comparisons inexact at best. What's more, Lyft is still not profitable yet, so the argument could well be made that the book of "competitor creation cost" is still being written.

A general sense may still be possible, however. Like I said, Uber and Lyft more or less entered the market and grew the market simultaneously. If we take Uber prices as a proxy for Lyft prices, and compare news articles from early days, we see a rather dramatic plunge in cost per ride - and, by extension, dramatic increase in cost to create a new competitor from scratch.

Economy Prices Have Economized

Back when Uber first launched, it didn't even have a proper economy option - Uber was what we today think of as Uber Black. When Uber X, the "basic" option, finally launched, it featured a jaw-dropping price of $3.25 per mile and a $5 base fee. Assuming an average trip distance of four miles, that puts the real cost per mile at $4.50, plus the time charge that ride-hailing companies also include. We'll assume that fell proportionately with the per-mile charge.

Today, most third parties estimate that Lyft charges about $2.80 in base fees and $0.90 per mile. Assuming the same four miles on average, that puts cost per mile at $1.60 - barely one-third the price when economy ride-hailing began. And that still doesn't account for the pre-economy years when prices were even higher. If the gap between costs and payment is also three times as large, that means the $3 billion Lyft spent to become a major American ride-hailing provider would take $9 billion to replicate today.

Shared Rides Matter Too

And that is for a typical private ride. Costs can be reduced still further if riders agree to take a Shared ride, which didn't exist back when Lyft was starting up but will be a major headwind to new competitors because, even assuming they offer Shared rides, they'll be far less likely than Lyft to fill them with multiple riders and make up their Shared ride discounts.

Shared discounts vary widely and again, it's hard to find solid numbers. But Shared rides routinely promise around 40% discounts in their marketing, or even higher. If we do the unthinkable and simply take a major corporation's advertising at face value, that would take the cost to "replace" Lyft with a new competitor up to $15 billion.

The Future Premium

And finally, as I said, remember that Lyft isn't through growing yet. These numbers are still moving, and from a competitor's perspective they're moving in the wrong direction.

From a Lyft shareholder's perspective, of course, they're moving in the right direction. Because the market is a discount mechanism, its valuation of Lyft, even if all it's doing is calculating what it would cost to duplicate it, should reflect at least a portion of this "future premium," its potential to further raise costs for entry going forward.

I honestly don't know how to calculate that with any exactitude, so I leave you here, with the "$15 billion plus the future premium."

Summary

I have several major concerns about Lyft, and I haven't bought in yet despite my prior enthusiasm. I'm not entirely happy with the direction the company has taken the last two years or so. But while I see significant problems, I do not agree that a new entrant can simply order up another company like Lyft for $2-$3 billion. If we're going to knock Lyft, we should do it for the right reasons. Lyft is not exactly on the right track at the moment, but nor is it easy to duplicate.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.