Uber finally delivers

0:06Pushkin. Big news from ride-sharing land. Uber, which I'm sure you've taken before, they've made a profit. No accounting gimmicks, no BS, just a real genuine operating profit. $326 million in the second quarter, up a billion dollars year over year. It's the first time they've done this, and it's a big change for a company that's been bleeding money really since it came onto the scene. Today on the show, we discuss what took it so damn long. This is Unhedged, the markets and finance show from the Financial Times and Pushkin. I am reporter Ethan Wu. joined today in the New York studio by Uber snob, Rob Armstrong, who will not take Lyft on principle.

0:50I'm a one ride sharing company man. You helped them with that$326 million profit. I'm doing my part. Yeah, very nice. So, you know, Uber's been one of these just really exceptional, you know, growth stories out of Silicon Valley, you know, starts in San Francisco, like scales across the country, transforms the way we, you know, get around, disrupts the taxi industry. But the weird thing's always been, Rob, that they've never made any damn money. But you could imagine, and I think this was the initial pitch from Uber, how they could, which is that they're this perfectly platonic tech layer between an independent contractor driver and a customer just wanting to get around town.

1:29They take a little slice for pairing up the two and beautiful. They get the network effects. They scale up. It's a wonderful, lovely business. All is well. They make money. What's wrong with that? That really did not happen. Why not? That really did not happen. I mean, all of the excitement about this profitable quarter at Uber, and it is definitely better to be profitable than it is to be not profitable. Yes, this is true. So there has been a turning point for Uber. The fact is, on their balance sheet, here's what they have. They have an accumulated deficit on their balance sheet, which is, roughly speaking, all the losses they've made over their history of$33 billion.

2:08dollars. So$33 billion has sunk into this business, has been disappeared by this business, and paid in capital is$42 billion. So a huge amount of money has been put in, and the majority of it has been set on fire so far to make$300 million in one quarter. That's kind of the history of this business as we have it. So why did that happen if this was a frictionless technology business that just took a little clip of money as the money went rushing by. It was like, why isn't this, I'm just repeating your question back to you, but why isn't this the kind of Microsoft of transportation? Why isn't it the MasterCard of transportation where two people do a transaction, they get a fraction of it and they just walk away with free money, no capital costs, whatever.

2:55And I think, you know, to anyone that's taken Uber, it may be clear why that it's not so frictionless. I mean, there's just a lot of stuff involved. The first thing is you're driving a hunk of metal hurtling down the road at 60 miles an hour. And there will be crashes. People will get injured. And the tires will have to be replaced and the oil will have to be changed and all of that. So you could put it like this. In the very best tech businesses, in the very best network businesses, the marginal cost of providing the service is zero. Like once Microsoft has written the software, once MasterCard has built the payment network, selling another unit of the software, selling another transaction over that network costs nothing.

3:38Yes. And Uber, for all its history and for all of its future, will have high marginal costs because a person who is made of meat has to be moved around in a huge metal thing. Yes. And that costs a lot every time you do it. Yeah. So that's one difference between those businesses and Uber. Yeah. And you've written about this nicely on just on the cost side, that insurance is a really significant expense for Uber. Yeah. You would think, well, that's the driver's problem. Right. Right. You know, it's like any other driver. You have your own insurance. But you have to assume the drivers aren't fools.

4:14Yeah. They're not like, oh, I'll drive for you. You pay me a low salary. And if there's an accident, I'll pay for it. That sounds great. So that's like, oh, I'll go to work for McDonald's. And if the fryer catches on fire, I will pay for the fire department to come. Thanks so much for that good deal. So the drivers have to be compensated for the depreciation on their vehicles and the risk of an accident. Yes. On top of making a wage that is better or comparable to another industry. Yes. Right? That's just a high bar. And so on the cost side, like you said, it's not free. It's very far from free for Uber to scale up.

4:50But I would emphasize, though, that that is not the fundamental economic question. The fundamental economic question is not, what does it cost? Right. The fundamental question is, how much can they get paid for bearing those costs? Yes. So this is cost, and we're talking now about revenue. Yeah, yeah. So what is the competitive dynamic, which means they can't just jack up their prices to the point where they're making a lot of money? Yeah. Right? And why have other tech businesses been able to charge a big margin over their marginal costs and Uber has not? Yeah. Well, Microsoft, to just use your example, they don't have to compete with your legs or the subway.

5:29Yeah. Or, you know, asking your friend for a ride. Yeah. I think that's really an important point is whatever Uber charges, it has to be the best combination of price and convenience for the ride that I want to take. And under most circumstances, I have other options. I can take the city bike. I can take the subway. I can get my own car out of the garage if I have a car. There's a local taxi company. And those options persist. Yeah. And as much of the ride-sharing business as Uber controls, it doesn't control very much of the getting around business. Yeah, yeah, yeah. So we're talking here, Rob, about in some ways like a highly commoditized service.

6:15There's a lot of people competing to take you from point A to point B. And the costs of that business are very far from negligible. Timothy Lee, who's a tech analyst and a reporter, has written a very nice piece about this a couple years back, saying that Uber faces this kind of fundamental tradeoff between growth on the one hand and profitability on the other, which isn't always true of some tech companies. A lot of tech companies can grow while being profitable. You know, Google and Microsoft are great examples of this. Scaling up and making money are not intention. For Uber, it definitely is because of these revenue dynamics and because of the cost dynamics.

6:47And in the last couple of years, it seems that Uber's been, under the new CEO, Dero Kosar-Shahi, trying to pivot toward profitability. And they've finally gotten there. But there's all of these caveats too, to this number that they're reporting this quarter. I just want to mention before we push forward to the future, one other important competitive dynamic that an unhedged reader kind of wrote a letter and said, have you ever thought about this? And that is extending on a comparison that I've made to Airbnb. So Uber is fundamentally in the core of its business, a business that I use, I become a customer of moving around my city or my locality.

7:31Of course, I also use it when I'm on vacation and whatever else, but I'm kind of aware of the universe of options in my city and I can always choose among them, Uber being just one choice. With a business that is superficially very similar like Airbnb, almost every time I use Airbnb, I'm using it in a market that I'm not familiar with. Yes. Where Airbnb is one of a small number of options. It's like FRBO, Airbnb, or a hotel. Yeah. And so the market is kind of self-limiting because it's sort of global and I'm doing it at a distance. Whereas locally, I always have my pick of a smorgasbord. I've always wanted to say that on the air.

8:15The smorgasbord of transportation options. Smorgasbord. Smorgasbord. That's the title of this episode. Smorgasbord of Transportation Options. The Transportation Smorgasbord. But as of right now, to get us back on track with your growth point, Uber is growing. Now it's making money, has a profitable quarter, and revenue grows 17 % in the quarter. Yeah. I think it's telling that they've spent, in recent quarters, so much emphasizing the other lines of the business that Uber's growing out. So they've got this freight business that's scaling up. They've got a food delivery business. They've even got an ad segment.

8:53If you take Uber these days, you'll get an ad for, I get them for like JP Morgan Wealth Management or for Amazon or whatever. Because this ride business, it seems like they're trying to move toward, okay, it's maturing. We've kind of capped out on growth. We have a dominant market position and it's still not that profitable. So let's just kind of cut costs and eke out the money we can and try to get growth elsewhere in the business. And I also think that we need to take the current profit with a tiny grain of salt and to think about the totality of the business and its history. So let's take that classic example of a lemonade stand.

9:27So my son comes to me this summer and he says, dad, I want to sell lemonade on the street and make some money. I say, great. So I go to the grocery store. I buy a bag of lemons and a bag of sugar, a couple of bags of ice. I give him my pitcher and my table to put on the lawn of my house, which I pay for. And then he says, lemonade, lemonade. And some poor suckers come along and they buy three cups of his lemonade for a dollar each. And he holds the$3 up to me and he says, look, dad, I made$3. And then off he goes to the store to buy whatever it is that kids buy at the store. A fractional share of Uber.

10:02A fractional share, a tiny fraction of a share of Uber. And the point is he didn't really make $3. He doesn't have$3 in profit. He's got$3 minus the lemons that I bought, the sugar that I bought, the rent I'm paying on the house, the life of drudgery working as an FT journalist that I've endured all these years. And he's just dancing around with his three bucks. And that's a little bit, that analogy applies to Uber. They have made$325 million of operating profit in a single quarter on the back of upwards of$40 billion of money flowing into the business. The best way to make$300 million in ride sharing is to start with$42 billion of investment.

10:49Right. And I think another way of making this point is to just ask the question, who made money on Uber? The executive surely did. The people that invested at the very beginning in 2009 and the 2010s and then sold the public markets in 2019, maybe they made some money. But if you bought on the IPO price, which is$45, the stock today is$47, which is not a good return over five years. Now, it is important to remember that there's one thing, which is the internal economic dynamics of the business. And then there's the stock price. Stock price implies that the business is worth$95 billion. I think that's the number.

11:26Yeah. So$45 billion investment in, the stock market's saying the cash flow that's coming in the future is going to be worth$95 billion. So collectively, the market is saying that investment was at least in the black. Yeah. Of course, that's speculative. Stock market gets things wrong all the time. But that's a vote of confidence in the business that Uber has built. You know, the management is projecting confidence. The CEO in this quarter's earnings call said they would be making operating profits for many quarters to come. and they said investors have been too bearish on Uber, have misunderstood the unit economics.

12:00We always knew we were going to be profitable. But just kind of the fundamental baseline for this market expectation, like you said,$95 billion market cap to come to pass is they're going to need a lot more quarters of profits and they're going to need better profits than this for quite a while. And we haven't had a major recession since Uber has been around. Investors could be right about the unit economics, that they're just not that good, that this is a a break-even business, plus a little bit more. The ultimate measure of a business is not whether it shows profit at the bottom of the income statement.

12:31The ultimate measure of a business is whether it makes a good return on investment. Yes. All the money that's tied up in the business, are you making a better return on that money than you would be if you just bought treasuries or if you put your money to work in some other way, in a savings account or whatever? Uber has proven that it can stop the bleeding. it has not proven that it is a high return on investment business, a high return on capital business. Absolutely. All right. We'll be back in a moment with Long Short.

13:07Welcome back. This is Long Short, that part of the show where we go, long thing we love, short a thing we hate. Rob, a couple of weeks ago in this section, I talked about seeing Barbenheimer and why maybe despair for humanity. But, you know, man, I got to tell you, I'm short the endless reaction cycles to movies in general you know like can we find something new to talk about I feel like I've read pieces reacting to the movie pieces reacting to the reaction to the movie pieces reacting to the reaction to the reaction to the movie I've read too many I'm over it let's move on to something else Oppenheimer Barbie comment period is now over please close your laptops op-ed writers and move on I'm with you Ethan yeah man I am long the 10-year U.S.

13:54Treasury, and I am saying that specifically because... It's a painful trade. Fitch downgraded the United States sovereign credit rating this week. Everybody agreed this was a silly thing to do. I am with them, and I'm looking at the 10-year yield today at 4.17%, And I would like to signal my willingness to lend the U.S. government money at that price. I think it is both rational and patriotic to do so. Oh, yes, yes, yes. They should just sell some kind of like war bonds to you specifically to finance the deficit. Rob Armstrong. The Rob Armstrong bond. That's right. All right, listeners, we'll be back in your feet on Tuesday with another episode of Unhedged.

14:38Catch you then.

14:42Unhedged is produced by Jake Harper and edited by Brian Erstat. Our executive producer is Jacob Goldstein. We had additional help from Topher Forges. Cheryl Brumley is the FT's global head of audio. Special thanks to Laura Clark, Alistair Mackey, and Jess Trulia. FT Premium subscribers can get the Unhedged newsletter for free. A 90-day free trial is available to everyone else. Just go to ft.com slash unhedged offer. I'm Ethan Wu. Thanks for listening.