Uber

[Update: See Pando’s follow-up article reflecting on Uber investor Bill Gurley’s response to professor Damodaran’s valuation.]

Enough is enough with armchair venture capitalists trying to poke holes in Silicon Valley valuations. Yes it’s a stretch that Uber is worth $17 billion today based on any academic assessment of their business fundamentals. No shit. The same is true of Airbnb and Drobpox’s most recent $10 billion valuations. But that’s not how private company valuations work.

Yesterday, ESPN’s Fivethirtyeight.com took on Uber’s valuation in a contributed post by NYU Stern School of Business finance professor Aswath Damodaran. To say that he missed the point would be generous. After a bit of back of the envelope math in which Damodaran valued Uber as if it were a late-stage, slow-growth, publicly traded stock – while similarly ignoring any potential growth beyond its current core livery service business – he arrived at an estimated value for the company of just $5.9 billion.

Stop the presses.

Fivethirtyeight and Damodaran want you to believe that household names in venture investing – names like Benchmark, Menlo Ventures, and Kleiner Perkins – not to mention a handful of savvy public market investors like BlackRock, Fidelity Investments, and Wellington Management – are so bad at their jobs that they misvalued this company by nearly 3X.

Please.

Uber’s valuation may be a stretch and the company may fail to live up to the growth expectations that allowed its investors to justify this price, but that hardly means the valuation is incorrect, let alone wildly, irresponsibly so.

Damodaran is a well respected professor and widely published author. I’m sure he’s forgotten more more about finance than I’ll ever know. But it seems that expertise is more at home on Wall Street than Sand Hill Road. And the two couldn’t be more different in how they look at valuations.

Private market valuations are as much an expression of power and how badly investors want to get into a deal as they are fundamental reflections of a company’s value based on some financial metric like discounted free cashflow. VCs gladly “pay up” to get into the best deals because they make money doing so. The venture game is inherently one of making educated bets on black swan events. Put enough shots on net and hopefully you score on one out of 100.

Beyond that, private company investments are structured such that investors are significantly protected on the downside if companies fail to live up to their valuations. Uber has raised a total of $1.5 billion to date. That’s no small sum, but it’s a fraction of the company’s most recent valuation and similarly less than 20 percent of Damodaran’s laughable $5.9 billion valuation estimate. The company’s most recent investors almost assuredly purchased preferred stock with a liquidation preference, meaning that as long as Uber exits for more than the capital it’s raised everyone gets their money back.

There are a list of two dozen private companies and even more PE funds and hedge funds that would jump at the chance acquire Uber today for $1.5 billion (or even $5.9 billion) sight unseen.

Of course getting your money back isn’t why VCs get out of bed in the morning. Uber’s latest round is a bet by its investors that the company will continue its rocketship growth, taking an ever-increasing share of the existing global taxi and livery market, while also growing that market well beyond its current size.

To arrive at his valuation, Damodaran conservatively estimates that Uber may one day own 10 percent of the global transportation market. My bet is that its investors think that number could be more like 40 to 50 percent. Remember, the company doesn’t aspire to own and deploy taxis and towncars around the world. It simply wants to be the software hub through which the world’s passengers and livery drivers connect and book rides.

Uber is currently operating in just 130 cities, meaning it has plenty of potential growth ahead. Moreover, the bulk of the company’s revenue – a figure its CEO says is doubling every six months – reportedly comes from just five of these cities, with the remaining markets being fairly new and still maturing. If the company finds even a fraction of the success in its growth markets as it has in its initial few then this market share question doesn’t seem that far fetched.

Most importantly, Uber’s valuation is based on its investors’ belief that the company will be much more than just a ride booking service. Rather, the bet is that the company will morph into an on-demand transportation and logistics platform for more than just shuttling around people. Want your groceries delivered? Call Uber. Need a package dropped off at Fedex? Uber. The list of possible applications abounds.

Damodoran naively writes off the potential of this future business opportunity by saying simply, “I don’t see evidence that it has succeeded in making any breakthroughs yet.” Uber is growing so fast its executives likely forget to eat many days. Give the company a bit of time to grow into its massive vision. Besides, the larger Uber’s taxi business grows, the better position it will be in to launch complementary services.

Is any of the above a sure bet? No. But early stage and growth stage investing never is. If Damodaran wants predictability and formulaic valuations he should stick to blue chip public company stocks like Coca-Cola. Uber’s investors certainly aren’t mistaking the company for such.

Private companies routinely fail to live up to the valuations they receive. But occasionally they blow by them so convincingly that one-time critics are left looking foolish. Facebook was once “wildly overvalued” at $1 billion (Yahoo), $30 billion (SecondMarket), and $104 billion (IPO). Now the company has a NASDAQ market cap of $168 billion (up 180 percent over the last 12 months). The same was true of Google’s post-IPO market cap of roughly $50 billion. Now the company is valued at $373 billion.

Uber, which is still just five years old as a company, could be the next Facebook or Google. Or it could be any of the thousands of overhyped companies that failed to deliver (pun intended). Eventually, Uber’s valuation will need to align with the reality of its business fundamentals should it want to exit via IPO or, in a far, far less likely scenario, acquisition. But investors today are still betting on massive growth and the future potential of this business, not the realities of the company’s business today.

These investors, who have access to far more data than Damodaran or I – both financial data and knowledge of their investment terms – are obviously comfortable with the reported $17 billion price. Let’s assume there’s some method to their madness.

[Update: See Pando’s follow-up article reflecting on Uber investor Bill Gurley’s response to professor Damodaran’s valuation.]

  1. Uber is a technology platform that is evolving the way the world moves. By seamlessly connecting riders to drivers through our apps, we make cities more accessible, opening up more possibilities for riders and more business for drivers. From our founding in 2009 to our launches in over 200 cities today, Uber's rapidly expanding global presence continues to bring people and their cities closer.

    1. Shervin Pishevar
      Past Investor
    2. MG Siegler
      Past Investor