Tuesday, August 15, 2017

The Gig Short

            A friend of mine did something recently that he’d never done before: he used Lyft instead of Uber on a business trip.
            He did this because he needed a ride, and the Lyft driver was going to get to him faster than Uber.  While he had never actually used Lyft before, he had downloaded the app and figured why not?  After all, the Ubers that he (and everyone else we know) has ridden lately have been not-much-better than a cab, which is quite a come-down from the early days of Uber, when the driver had a bottle of water ready for you and the car smelled like a car, instead of a dorm room, and the worst you could say was that the drivers were too reliant on Waze to get around.
In brief, Uber has become what the haters always sniffed: it’s a taxi app.
So why not try Lyft?
Now, for the record, we’re not haters.  Uber seemed as transformational as anything we’ve ever seen: you didn’t have to leave your office or apartment and wander around outside in the rain/snow/hot/cold trying to guess on which street the empty cabs would appear. You no longer needed to rent a car in most cities, eliminating the wasted time driving and the parking, not to mention the overnight garage fees.  You could cut it closer leaving one meeting for the next, because you could see where the driver was and you had a good idea when the car would be downstairs before you even had to leave the building.  And the driver you got was generally pleasant or at least not surly, and motivated to provide good service because you could rate him or her.  And when you got to where you were going, you just got out and left—no fumbling with the credit card machine and waiting for that goofy little ticker to print out an illegible receipt on curly little paper that you never could find later anyway…
And when that network effect kicked in—wow: all of a sudden you could get to JFK for a hundred bucks instead of the $225 charged by livery services. 
Truly transformational.
Yes, there were cracks in the model.  Drivers who really had no idea where they were going if the Waze wasn’t working (I had one guy try to take me to JFK through Manhattan—turned out he’d set his map to “no tolls” by mistake); drivers who complained about what they cleared after gasoline, insurance and the vig to Uber; and that slip in standards that’s made Uber almost indistinguishable from a cab—a slip that happened like Hemingway’s character who went bankrupt “gradually, and then suddenly.”
By way of example, out of the 26 Uber rides I’ve taken year-to-date, maybe two or three stand out for having nice, personable (but not too personable, if you get my drift), and conscientious drivers.   The rest could have been cab rides, some in dumpy cars, some in unsafe cars, some with drivers who left the music on way too loud…and then there was the driver who suddenly stopped at a gas station on the Hutch—to use the bathroom, not to get gas—without saying why until he got back in.
Oh, and there was the creep who took our daughter on a roundabout route without her being aware—we were watching on the Uber app, another extremely cool feature—and when we complained afterwards we only got half the inflated fare back.
And I haven’t even gotten to the stuff that’s been in the papers lately—founder Kalanick’s argument with an Uber driver (watch it here) in which he (Kalanick) comes off like your least favorite Princeton legacy nephew; Kalanick getting fired for the kind of behavior that came as no surprise to anyone who had watched that YouTube video, which the Uber board members apparently did not; the car leasing business that was so ineptly conceived and poorly managed it makes you wonder what the Uber board members have been doing the last few years besides counting the endless markups on their investment (see here); and a most recent report in the New York Times (here) that at least one of Uber’s original and truly brilliant investors, Benchmark, is trying to sell stock to others, including SoftBank, at a discount to the $69 billion valuation everyone tosses around as if—and this, we think, is a mammoth ‘if’—that valuation has any bearing on reality today.
For our part, we think a rational look at where Uber stands today makes that valuation the biggest top-tick since AOL merged with Time Warner during the previous dot-com bubble.
That look is informed by only a few data points, unfortunately, because they’re all we have, but it includes a Wall Street Journal report that Uber has “burned through at least $8 billion” during its short, happy life and has $7 billion in cash on hand and “an untapped $2.3 billion credit facility.”
Furthermore, according to Bloomberg Uber lost $2.8 billion in 2016, excluding a billion dollar loss in China, which is now gone from the Uber dare-to-dream scenario of world domination.  And while “gross bookings” grew 126% that year (we have no idea if this includes China or not), that looks like a mighty big slowdown after tripling in 2015, if the following chart of gross bookings is accurate:
Worse, the loss didnt shrink appreciably despite the revenue growth—meaning the business does not appear to be scaling, as Google did when it was young and growing like Uber: Uber said it lost $708 million in the first quarter of 2017, and that excludes employee stock comp.
So, what, we wonder, is this business really worth?
What’s a money-losing, growth-slowing, CEO-self-destructing, board-of-directors-asleep-at-the-switch-looking business worth?
Is it worth the $68.5 billion valuation from last year?
Some potential Uber investors reportedly don’t appear to think so, otherwise why would the board be considering ways for some existing investors sell at a lower valuation, as reported in that New York Times article cited above?
And while we have no idea where the next trade in Uber will take place, price-wise, it would come as no surprise if the next tick is down, and down a lot.
Sure, we get that Uber transformed the nature of human transportation, giving riders a life-changing ability to find affordable rides on command while giving drivers a life-changing ability to add a flexible source of income that could help pay for college or clothes or a new car, or just put extra spending money in their pocket.  
We get how cool the app is.  
We get why somebody thought Uber would be worth investing in at a $68.5 billion valuation last year.
But things are different now.
Uber didn’t conquer China, or Russia.  Lyft didn’t go away—it got stronger.  And more worrisome of all, we think, for the so-called “gig economy” business model the company pioneered, is that good old-fashioned labor tightness is coming back into the U.S.—the kind of labor tightness the US economy hasn’t seen since Lehman Brothers went kablooey ten years ago and companies began shedding workers like my dog Charles used to shed fur.
“Help Wanted” signs are everywhere—not just San Francisco and NYC, but Northern Michigan and beachy Rhode Island; and not just at cool tech companies but at Bob Evans restaurants and at Wal-Marts in a neighborhood near you.
And that kind of labor tightness, we believe, puts the Uber model at no small risk of coming undone, whether by the heavy hand of a corruptible government bureaucracy that never trusted the libertarian two-sided model Uber pioneered (because it could not figure out how to profit by it); or by the invisible hand of Adam Smith.
And then there is that pesky competition from Lyft, which, in years past, no business person we knew of had ever used because of those silly pink moustaches on the cars, but which, as I pointed out at the top, has made at least one convert in recent weeks.  [Moreover, as one loyal reader pointed out after reading an early draft, many Uber drivers also drive for Lyft, and vice-versa, so what really is the key Uber asset underlying the Uber business model, anyway?] 
Okay, a reader might say, but what if Uber develops a self-driving car?  Wouldn’t that solve the driver problem?
To which we’d offer the observation that, for starters, Uber acqui-hired a guy from Google to run its self-driving car business who is accused of self-dealing while at Google—the article is here—that would make Donald Trump blush.  More generally, it’s hard to fathom how a company that could run a simple car-leasing business as ineptly as described in the Wall Street Journal would ever possibly be a better bet to develop those self-driving cars than Google, or Apple, or Tesla.
And if Google, for example, developed a really great self-driving car, why not just offer a Google Driver app themselves?  Why give the vig to Uber?
We don’t know what valuation somebody else will decide Uber is worth if a piece of the business does trade, but here’s how we’d look at it:
 If I’m a growth stock investor would I rather buy shares of Uber, with something like 80% market share and a sort-of-global opportunity that is growing at a slowing but undisclosed rate with operating margins that appear to be negative and also has labor issues, management discontinuity and the potential for disintermediation by Google, at $68.5 billion?  Or would I rather buy something in the public marketplace that’s been around for a couple decades and has 80% market share but only 5% market penetration with a global opportunity growing at a steady double-digit rate with 75% gross margins and 25% operation margins, plus or minus, at a $14 billion valuation?  I’d rather own the $14 billion valuation, which comes in the form of Align Technologies.   I don’t own either right now, but, again, if I was a growth stock kind of investor, I would own ALGN at $14 billion, not Uber at $14 billion.
            So I wouldn’t touch Uber at $68.5 billion, or $65.8 billion or whatever the “whisper number” might be.
In fact, if Uber had gone public already, and if for some reason Mr. Market was still insisting it was worth $68.5 billion in the face of all the above, I’d be short it.
            Call it The Gig Short.

JM


P.S.  We love to hear from those who know more than we do on the subject at hand because we hate to make anything up.   Corrections, amplifications and examples are welcome, with complete anonymity, of course.


Jeff Matthews
notmakingthisup@gmail.com
Author “Secrets in Plain Sight: Business and Investing Secrets of Warren Buffett”
(eBooks on Investing, 2015)    Available at Amazon.com

© 2017 NotMakingThisUp, LLC



The content contained in this blog represents only the opinions of Mr. Matthews, who may have a long or short position in shares of the company discussed here, but this commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever.  The market ultimately decides who’s right, not bloggers or company PR hacks.  Also, this blog is not a solicitation of business by Mr. Matthews: the content herein is intended solely for the entertainment of the reader, and the author.

Monday, July 24, 2017

Chipotle (pronounced chi-POAT-lay): “It’s Not Me, It’s You”

Chipotle (pronounced chi-POAT-lay) reports second quarter earnings this week, and far more interesting than the earnings themselves—quarterly reports are, after all, backward-looking—will be whatever management chooses to divulge about the impact of last week’s norovirus outbreak at the Sterling, Virginia Chipotle (pronounced chi-POAT-lay), not to mention the mouse video taken at a Dallas Chipotle (pronounced chi-POAT-lay) that went viral at about the same time as the Sterling headlines were peaking.
We’ll dispense with the pronunciation of Chipotle (pronounced chi-POAT-lay) from now on—we only included it because the company does so on its Investor Relations web site, apparently on the presumption that potential investors in CMG stock are morons who don’t know how to pronounce that word.  That presumption stems, we think, from the world view of Steve Ells, the self-described “classically-trained chef” who created the first Chipotle, saw its potential and, to his everlasting credit, ran with it, and who has run Chipotle ever since.
How else to explain why Ells spent several years telling investors on conference calls how ShopHouse, the company’s Asian food concept, reminded him of the first Chipotle—the implication being that Chipotle had another mega-hit in the wings—until he suddenly stopped talking about it, and then, with no comment from Ells, the company quietly shut down all 15 locations earlier this year?  (See here.)
Or the fact that, after using the 2015 annual report to highlight the company’s “restaurateur” program devised by his high school buddy and co-CEO Monty Moran, Ells one year later sacked Moran and put seemingly the entire blame for uneven store performance on the restaurateur program?
Or that despite the company’s current struggle to hit its previously-declared $10-per-share 2017 earnings target, the stock, at 40-times that imaginary earnings number, attracted the likes of Bill Ackman and the folks at Sequoia in a very public manner—both, coincidentally or not after getting their heads handed to them in Valeant?
Or why those outsiders (although Ackman is now an insider, because apparently it worked so well at Valeant he thought he’d do it again at Chipotle) appear to have more confidence in the Chipotle recovery than Chipotle itself, because the company added language in its 2016 10-K about “Risks Related to Our Plans to Return to Sales and Profitability Growth and Restore Our Economic Model”?
In any case, Chipotle’s cynical world view appeared on display last week when the company downplayed the number of people sickened by the Sterling, Virginia norovirus outbreak which, according to the folks at the Loudoun County Health Commission’s office, affected at least 60 people, while according to the Wall Street Journal it was double that amount.
According to Jim Marsden of Chipotle, however, the Sterling outbreak sickened only “a small number” of people.
We’re pretty sure that the 60-to-130 people who got that thing—it is not fun; some folks went to the ER, some to the Urgent Care, and most all of them puked their brains out, because that is the essential side-effect of the norovirus—would agree that 60 or 130 is not a “small number.” 
So, how else did Chipotle respond besides downplaying the number of people involved?
Well, they announced a new marketing campaign with RZA of Wu-Tang Clan, a noted food spokesman and health advocate—wait, sorry, he’s a rapper—which you can see here.
More importantly, they closed the Sterling, VA restaurant immediately upon hearing the first report of an outbreak, announced a public apology to the people who were sickened, gave them a full refund with coupons for free meals, and suspended the Wu-Tang Clan advertising campaign—ha!  We’re kidding!
No, they acted pretty much like the last time there was a norovirus outbreak traced to a Chipotle: Mardsen, their food safety guy, said, “The reported symptoms are consistent with norovirus,” which pretty much everyone knew anyway; he emphasized that “norovirus does not come from our food supply,” which if you had gotten it at the Chipotle and had spent a couple of days puking your brains out would seem like a distinction without a difference; and he declared, “it is safe to eat at Chipotle.”
Oh, and they tweeted this, among other things:


And as far as that Dallas mouse video goes, they said the mice got into the store from the outside through a structural gap, not, apparently, from a nest inside the store itself.  (How they determined this is not clear: the mice were not talking.)
In other words, as is always the case with Chipotle, “It’s not me, it’s you.”
But instead of delving into Chipotle’s bloodless PR response to the Sterling outbreak, which makes Donald Trump seem almost human by comparison, it’s more worthwhile to delve into the question of why exactly do these things seem to happen at Chipotle, anyway?
Why isn’t McDonald’s hit with more norovirus outbreaks than Chipotle?   McDonald’s, after all, has over 14,000 restaurants in the U.S., more than 6-times the number of Chipotles.
Yet Mickey-D’s has had no similar outbreaks in the last few years that we could find, while the “Food With Integrity” folks have had three-and-counting.
Indeed, if you Google Norovirus McDonalds” you get about 31,000 results:


But Google Norovirus Chipotle” and you get about 1,460,000 results:

So, what gives?
We’ll take a stab at it, because we think it exposes the key weakness in the Chipotle business model that the Ackman/Sequoia analysis appears to ignore. 
For the record, the Ackman and Sequoia views on Chipotle, as discerned from public statements and publicly available investor letters, are one and the same: the company has 2,250 or so stores now; it is a long way to fixing its food safety issues; customers will come back like they came back to Jack-in-the-Box (which actually killed people, and yet survived); and when those customers do come back, revenues will rise back to the $2.5 million-per-unit good old days and EBITDA margins get back to the 20% good-old-days and the company will grow units to 5,000 stores like Ells always said it could, in which case the stock is cheap at 40-times current, hoped-for earnings.
But the weakness in the Chipotle business model that’s been exposed by the E. coli and norovirus outbreaks is, we think, that the true cost and complexity of handling fresh proteins and preparing the food right in front of the customer is order-of-magnitude more difficult than a normal fast-food chain that uses frozen beef patties and frozen pre-cooked chicken (even down to the grill marks on the chicken to make you think you’re eating something that was grilled on some big mother Weber grill behind the McDonald’s).
Talk to any McDonald’s franchisee about the move to fresh burgers the company recently announced for 2018: it’s a big supply chain headache and safety issue.  There was a good reason why McDonald’s went to frozen patties years ago, old-timers will tell you.  And while they get the need to go fresh, they know it will cost time and money.
Of course, with $2.5 million average unit volumes, like Chipotle in its heyday, whatever it takes to get food safety secured should be easy, especially when you don’t have to advertise, right?
Right.
But it gets tougher when the AUV is down, like it is now; and when the unemployment rate is as low as it is now and wages are rising like they are now; and when the company is wasting money advertising with rappers at the very moment the Loudoun County health department is reporting on a norovirus outbreak at the local Chipotle.
So whatever the PR folks at Chipotle are preparing for the script on the upcoming earnings call about the Sterling outbreak or the mouse video, or the ShopHouse failure or the restaurateur 180 or whatever else might come down the pike at the “Food With Integrity” joint near you, we’ll take the over on the corporate arrogance  and the under on the business recovery.

JM


P.S.  We love to hear from those who know more than we do on the subject at hand because we hate to make anything up.   Corrections, amplifications and examples are welcome, with complete anonymity, of course.


Jeff Matthews
notmakingthisup@gmail.com
Author “Secrets in Plain Sight: Business and Investing Secrets of Warren Buffett”
(eBooks on Investing, 2015)    Available at Amazon.com

© 2017 NotMakingThisUp, LLC



The content contained in this blog represents only the opinions of Mr. Matthews, who may have a long or short position in shares of the company discussed here, but reminds you that this commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever.  The market ultimately decides who’s right, not bloggers or company PR hacks.  Also, this blog is not a solicitation of business by Mr. Matthews: the content herein is intended solely for the entertainment of the reader, and the author.