Express to success is now leaving from platform Uber
Even when the music dies for Spotify, you’ll still need a ride or a takeout delivery, writes The Finance Ghost
The word “platform” tends to get thrown around a lot in the investing world.
For example, you’ve perhaps heard an investment holding company talk about various “platforms” that address “market verticals” in a particular way. This is just a fancy way of saying it has invested i n a business that has potential for bolt-on acquisitions to help it grow, so this is a “platform for growth” more than anything else.
The context we are interested in for this piece is technology companies and how they think about platforms. If you go to Google (itself a platform), you’ll find that a platform business model is described as one that creates value by facilitating exchanges (of services, products or anything else) between two groups. This would typically be consumers on one side and producers on the other.
The term “ecosystem” will frequently be used when describing a platform business. This is just a reference to the extent to which the platform touches users on both sides, measured by metrics such as number of users and the extent of engagement. The greater the number of engaged users on a platform, the more powerful the ecosystem.
It becomes exponentially more valuable as it increases in size and achieves scale. A consumer is much more likely to use a platform when there is a very good chance of finding whatever that consumer is looking for.
You hopefully just noticed another word that is absolutely critical in the world of technology companies: scale. Without scale, nobody is interested in what you’re building. This is usually because the economics of the business are terrible unless there are many users of the platform. The costs to develop, maintain and market the platform are extensive, which is why venture capitalists are needed to support lossmaking platforms in their early years.
The “early years” can go on for a very long time, mind you. There are many examples of loss-making technology companies on markets such as the Nasdaq. We can debate all day what a “start-up” really is and when a company graduates beyond
that category. To my mind, when the economics of a business model (rather than just its product-market fit) are still being proved, we are in start-up territory.
It turns out to be rather difficult to explain these terms without introducing another important term that warrants its own explanation. “Productmarket fit” is a beautiful thing that happens when a solution was built for an existing problem.
The way we define the problem is important here. Though nobody was asking for something like Facebook to be built, people were clearly interested in staying in touch with old friends and finding new ones. This is a social problem that was addressed quite magnificently by Facebook and many other social media platforms since then.
Once product-market fit is achieved, the chances of successfully scaling a product improve exponentially.
The power of a platform business is on full display once scale has been achieved. Investors suck up losses in the initial years because they know how big the size of the prize is. Once a platform is really ticking over and all the growth flywheels are spinning at pace, cash starts falling out of the sky.
At scale, it’s not uncommon to see free cash flow margins of 30% or more. This is why the market will often pay 10 times revenue for a platform business, as this effectively works out to a 3% free cash flow yield. Valuestyle investors, look away now.
One of the best times to invest in a platform business is just as it reaches the inflection point for the economics to start to get juicy. If you’re really lucky, the market might have lost patience by that stage, which means that the valuation multiple might be “only” four or five times revenue instead of the 10 times revenue (or more) that we see in the hyped-up names. It might be even lower, in which case you should spend some time figuring out whether things can get better and the multiple can expand.
For example, Uber Technologies is up more than 150% in the past 12 months, whereas Airbnb is 40% higher. Nobody is going to drive anyone to tears for being up “only” 40% in dollars, but it’s still hard to look at Uber investors with anything but envy.
A year ago, Airbnb was on a revenue multiple of nine. Uber was trading on just two. The market loved the Airbnb story and fully believed in the economics of the platform, whereas Uber had been lossmaking for years and many had given up. Today, Airbnb has pushed higher to a 10.6
multiple as the broader technology sector has done well.
Uber is the real star though, up to a 4.4 revenue multiple. Even if Uber’s revenue was flat, just the multiple expansion would’ve more than doubled your money.
Whether you are a value or a growth investor, building in a substantial margin of safety in a valuation is always a good idea.
Is the market’s improved view towards Uber justified? Why is this platform business suddenly more popular after such a long period of disappointment for investors? We need to dig into Uber and learn some important lessons about platform businesses along the way.
For a long time, Uber was purely a solution for people to catch a ride. A vast amount of technology was built in the back end to support a service offering that wasn’t exactly lucrative. Uber lost many billions of dollars along the way, with free cash flow finally turning positive in
2022 and increasing substantially in 2023.
There’s still a long way to go in recouping the losses made in the initial years, but that’s not your problem if you are only investing in Uber now.
The losses over the years weren’t for nothing. The company’s technology is robust and flexible, which means it has found it a lot easier to add on entirely new product verticals such as food delivery and freight, as well as tweaks to the mobility solution such as different price offerings and even the ability to catch a ride on a scooter in some markets. Ultimately, the shared infrastructure across identity, payments and maps makes it economically lucrative to add on new offerings. A new entrant in any of these offerings would need to build that infrastructure from scratch.
Each product launch brings benefits beyond just that product. If you use Uber to catch a ride, you’re more likely to try a food order on the same app. This is the power of a platform business, where the value moves exponentially higher as the number of consumers and suppliers increases on the platform. The easier it is to catch a ride or order food (because there are more drivers available and restaurants on the app), the more likely it is for users to want to use the app.
Another feature of Uber that is appealing for investors is market penetration. There are two very important growth flywheels here. The first is to increase the number of users of the app for example, people who have downloaded it. This would include the point referenced above, which is to get more users trying out more of the products.
The second flywheel is to get a greater proportion of rides or meal orders (and preferably both) from each customer. Uber is a mobility solution and there are many, many times in a week where consumers need to move themselves somewhere or get products delivered to them. This gives Uber an exceptional growth runway.
The management team explains it eloquently and powerfully, talking about the opportunity to achieve consumer growth in countries where Uber isn’t yet a verb.
That really does get the point across to the market that there’s plenty of revenue still to win. This supports the plan to grow revenue in the midto high teens over the next three years and adjusted earnings before interest, tax, depreciation and amortisation by more than 30% a year.
Platform businesses are amazingly powerful things. This makes it easy to overpay for them, especially if you don’t do the work to figure out what their prospects are. For example, Spotify is now trading on a revenue multiple of nearly three. If you draw a chart of the revenue multiples of Spotify and Uber over the past few years, you’ll see how remarkably similar they are.
The correlation is clear, with both companies seen as fringe technology platforms with unproven economics. Uber has pulled ahead in the past year, though, as the market started to recognise that Uber’s economics are perhaps superior to Spotify’s.
If you dig into both models, you may arrive at the same conclusion that IM did: Spotify is a tremendous app with questionable economics and Uber is an annoyance (at least in South Africa) with strong economics. It’s easier to improve the customer experience than the entire foundation of the business model.
You see, Spotify will never be the asset in and of itself. It connects people to something they love: music and podcasts. The platform doesn’t own the artists and it never will. If the music goes somewhere else, so will Spotify’s users.
At Uber, there are assets on both sides of the platform. On one side, there’s a fleet of trusted mobility providers (drivers of vehicles and delivery scooters) who aren’t easy to find any other way. On the other, there are tons of users looking for those solutions, who also aren’t easy to find without the app. This makes Uber more powerful than either the drivers or the users.
At Spotify, the platform will never be more powerful than the musicians and podcasters themselves, particularly with so many other ways to distribute content online.
In platform businesses, you have to be careful not to be swept away by how much you love a particular product. You’re investing in it, not downloading the app as a user. You might be a premium user of Spotify paying a subscription, but not necessarily want to own shares in the company as there is doubt whether the economics are strong enough.
Despite not ordering food through an aggregator such as Uber and hardly ever getting a ride any more, a punter might buy shares in Uber if they can see how the economics can improve further.
How it will work out is unclear. But surely there is more comfort paying four times revenue for Uber than paying more than 10 times for Airbnb?
The power of a platform business is on full display once scale has been achieved