Is Uber’s buyback a good idea?

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Is Uber’s buyback a good idea?

Yesterday Uber announced a $7bn buyback authorisation as part of a larger investor update. Also yesterday (just before Uber’s announcement) we argued that Uber was not really a tech company but a “fast-growing, moderately profitable transport company”. Combining the two, we can ask: should this fast-growing, moderately profitable taxi company buy back its own shares? Is that a good use of capital?

There are two roughly equivalent, but not identical, approaches to thinking about whether a buyback is a good idea.

The first is valuation. This approach thinks of a share repurchase as exactly analogous to buying out a partner. Imagine a company owned by three equal partners. Two use the company’s money to buy out the third. This leaves the company with less cash, and the remaining two partners with larger ownership stakes. A wise move? It depends entirely on the price paid. If the price implied a value for the whole company that was lower than its true value, the remaining partners have made themselves richer. If it implied a value higher than true value, they have made themselves poorer. The cash they spent was worth more than the thing they bought.

So to answer the question about Uber’s buyback, you can just ask: is Uber’s stock too cheap? A slippery issue, because Uber is very much a growth company. You can’t just take a multiple of current earnings or cash flow and compare that to the market or to similar companies. You have make a bunch of guesses about the company’s future.

To illustrate: Uber trades at 114 times 2023 true cash flow per share (that is, operating cash flow less capital expenditures and stock compensation expense). That seems awfully steep (Google, to pick an example, trades at 40 times true free cash flow). But the company said yesterday that it expects to grow cash flow very quickly. It is guiding for “adjusted ebitda” (don’t ask) to grow at 30-40 per cent a year for the next three years, and cash flow to grow in line with that. If that is right, the current price might look very cheap in a few years. Here is Uber’s slide (“MAPC” just means monthly user):

This brings us to the second way to think about buybacks: considering the best use of capital. Doing a buyback is a good idea only if the company doesn’t have a higher-returning way to invest the cash. Looking at the above slide, one has to wonder if Uber wouldn’t be better off reinvesting in a business that can increase profits at 30-40 per cent a year, rather than letting the money leave the company with the shareholders who sell. Not many businesses increase profits at 35 per cent! 

Of course the company says the buyback is for “excess” cash, and that growth is the first priority. But the question stands. Much of Uber’s presentation yesterday was about how massively underpenetrated Uber is across its addressable markets, and how the business will only become more profitable because of the efficiency benefits of scale. If that’s true, don’t you want to put every dollar back in the business?

I can think of three ways Uber might answer this question. 

1. “The great things about our business is that it is actually not that capital-intensive! The big investments have now been made (see our $30bn or so in historical losses) and now we can grow quickly while spending less than we earn, leaving excess capital to distribute.” This is what the company is saying, and it likely has some truth in it. But it sort of begs the question: if there is so much room for profitable growth, why is there a limit on what you can invest? Why not keep spending? It worked for Amazon.

2. “Wall Street is myopic, and they are unable to see how much profitable growth is ahead, so we have to return some capital to show them we are ‘disciplined.’ Otherwise, the share price will fall and we’ll all get fired. If we need more capital we can always borrow it later, once we’re more profitable and our cost of debt is lower.” Of course the leadership team could never say this, but I strongly suspect they believe it. 

3. “We have given tons of value to employees in the form of stock based compensation — $10bn over five years, as we account for it on the cash flow statement — and that is going to start showing up as a seriously higher share count when all those options and stock units start to vest. We need to offset that with a buyback, or the whole ‘adjusted ebitda’ thing where we excluded the cost of stock comp is going to start looking bad. Luckily, we can pitch the buyback as a shareholder friendly return of capital, when really we’re just absorbing the cash cost of an expense we used to ignore.” I absolutely believe Uber’s management thinks this way, and while that may sound awful, they are not alone. Most fast-growing tech companies engage in this perfectly legal swindle. It’s the industry standard. And if Uber does grow very fast and becomes much more profitable, no one will care because there will be plenty of money to go around. If it doesn’t, there will be plenty of other things to cry about. 

I believe some blend of these three explanations holds in Uber’s case. I will leave it to readers to decide the mix, and if they are on board.

One final thought. Much of what I have written about Uber has been focused on whether it has the capital-light financial structure and perpetually increasing returns of a tech company. As I think about it more, I wonder whether this is the wrong question. Maybe Uber is just a company that will always have middling, non-tech-type returns on capital, but which can get really, really big because it provides a very good service at a slightly better price than its competitors. Maybe, in other words, Uber is less like Google or Amazon than, say, Walmart.

One good read

Baylor’s endowment manager has a good idea: frequent rebalancing.

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Letter in response to this article:
Uber buyback reflects a confidence its best days are yet to come / From Dara Khosrowshahi, Chief Executive, Uber Technologies, San Francisco, CA, US