Lyfting Off to a Narrow Moat

Lyft, the second-largest ride-sharing service provider in the United States, is set for an initial public offering in late March. The company has gained share from leader Uber in an addressable market that we value at over $500 billion (based on gross revenue) by 2023, growing 24% per year over the next five years. In our view, Lyft warrants a narrow economic moat and a stable moat trend rating, thanks to the network effect around its ride-sharing platform and intangible assets associated with data on riders, rides, and mapping, which we think can drive the company to profitability and excess returns on invested capital.

Lyft has raised around $5 billion in capital, according to PitchBook. Its 11th and last round of funding in June 2018 was for $600 million, which implied a valuation of $15 billion. We believe the intrinsic value of Lyft is probably over $24 billion, as further growth remains in the ride-sharing market. We think Lyft’s top line can grow at a 36% compound annual growth rate through 2028 to more than $21 billion, driven mainly by increased adoption of ride-sharing globally. We assume that the company will become profitable in 2022. On the basis of PitchBook data on recent venture capital-backed software companies, we expect the IPO price to represent Lyft as an $18 billion-$30 billion company.

From a strategic standpoint, Lyft is well on its way to becoming a one-stop shop for on-demand transportation. It has tapped into the bike- and scooter-sharing markets, which we think are worth over $9 billion and growing 9% annually through 2028. Lyft also appears to be aggressively pursuing the autonomous vehicle route as it understands that self-driving cars may help it expand margins; without drivers, it could recognize a bigger chunk of the fare as net revenue. In contrast to Uber, Lyft is not focused on food transportation or logistics. We like Lyft’s relatively narrower focus on consumer transportation but note that Uber has an edge on Lyft in terms of an earlier start, higher market share, and a stronger network effect around its service.

Many risks remain around legal and regulatory matters In the rapidly growing ride-sharing space. Lyft’s regulatory issues today involve how the company runs its everyday business, from employee type recognition to a minimum pay requirement. Various other requirements such as background checks and driver classification are also being enforced. In our view, pressure from such legal matters will persist.

Possibly Emerging From Uber's Shadow While its rider and driver matchmaking is not available globally, as is Uber's, Lyft has displayed strong growth in the U.S. in terms of rides requested and provided, revenue generated, and variety of services offered. According to Lyft's S-1 filing, it more than doubled its net revenue in 2018 to around $2.2 billion, and we think this will be followed by more than 60% growth this year.

We believe that Lyft will remain one of the top players in ride-sharing mainly in the U.S. and Canada, with further growth opportunities in Latin America. Its ride-sharing revenue growth is will to outpace the overall market thanks to continuing expansion in more markets plus an increasing adoption rate as the company attracts more users. As ride-sharing also represents a substitute for public transportation, we think it can take revenue from public buses and trains over time.

We also expect Lyft to increase its presence in bike-sharing and scooters. As Lyft continues to attract more riders and assign drivers to requests more quickly, we think overall vehicle capacity utilization will increase. Besides the driver take rate, which is netted out of Lyft’s net revenue, we believe a portion of Lyft’s cost of goods sold is fixed and revenue will grow at a faster pace than these costs (albeit variable costs associated with assets such as bikes and scooters), leading to gross margin expansion. We also project that Lyft will benefit from operating leverage in the years ahead.

In the U.S., Lyft’s main ride-share opponent is Uber. Based on data from Second Measure, as of January 2019, Uber’s market share was 68.5% versus Lyft’s 28.9%. Yet in its S-1, Lyft stated that it had 39% market share in the U.S. by the end of 2018, based on estimates from Rakuten Intelligence (we should note that Rakuten is a 13% investor in Lyft). Our prior estimates would have pegged Lyft’s market share at 30%-35% before the filing. Despite the fuzziness around market share data at this early stage in U.S. ride-sharing, Uber still appears to have a leg up on Lyft when looking at ride-sharing as a whole, as Uber has said it has more than twice as many riders and has completed 10 times more rides than Lyft since inception. While Lyft has fewer riders on its platform and fewer rides taken because it is focusing mainly on the U.S. market, it may be able to avoid some bumps on the road toward profitability, including the international regulatory-related ones that may require additional costs. However, given Uber’s already established leadership position in the U.S., Lyft may also need to more aggressively acquire riders via lower pricing or more spending on sales and marketing.

Based on our samples obtained in February 2019, Uber’s prices are slightly higher in total, perhaps as Lyft has been pricing a bit more aggressively to grab some market share from Uber. Based on our price checking of 5-, 10-, 15-, and 20-mile trips in 10 major cities in the U.S. (New York, Boston, Miami, San Francisco, Los Angeles, San Diego, Denver, Dallas, Houston, and Chicago), it appears that on average, Uber charges around 11% more than Lyft. Uber charges over 20% more in New York City and Los Angeles, while Lyft charges a bit more in Dallas and Denver. Results of our price check were supported by a Feb. 25 report published by The Information, which said Lyft has been pricing more aggressively as its IPO nears.

Based on data from eMarketer, Lyft had over 30 million riders in the U.S. in 2018, more than double what it had in the beginning of that year. According to Lyft, the company services its riders with more than 50 million rides per month, which is growing rapidly. In less than 12 months, Lyft more than doubled its total rides to 1 billion in September 2018. In comparison, Uber has more than twice as many riders (75 million) as Lyft, as it provides service in more than 65 countries. According to Uber, it has already completed more than 10 billion trips worldwide.

However, by providing bike-share offerings in cities such as Boston, Chicago, and Washington, D.C., Lyft now has around 80% of the bike-sharing market in the U.S. Along with bike-sharing, other last-mile alternatives to ride-sharing provided by Lyft include scooters, which according to the company are now available in nine cities in the U.S. We think bike- and scooter-sharing could lure consumers to stick with Lyft while using various transportation options available. We assume the two could represent more than 2% of the company’s net revenue by 2022.

Lyft is also active on the autonomous vehicle front. For over a year, the company has been working with Aptiv on testing ride-sharing using self-driving vehicles in Las Vegas, which has amounted to around 25,000 total AV rides. It has other partnerships for further testing and parts manufacturing of AVs. Last year, it expanded its Level 5 AV group by acquiring London’s Blue Vision Labs to enhance mapping off which AVs can operate.

Widening Network and Robust Ride Data Merit a Narrow Moat Rating We believe Lyft warrants a narrow economic moat rating stemming from two main moat sources. First, like many other platforms that connect various parties (including narrow-moat Uber), Lyft benefits from network effects between drivers and riders, in our view. Second, we believe Lyft has accumulated valuable intangible assets around driver and rider data that will be hard for startups and newcomers to replicate. Ultimately, we believe these moat sources will help lift the company to profitability and allow it to generate excess returns on invested capital.

We view Lyft’s moat trend as stable. Lyft’s network is clearly expanding on both the rider and driver front. We think Lyft is collecting even more valuable data around driver and rider supply and demand, which can probably be leveraged in order to provide better service in the future. On the other hand, Uber is making similar progress in the ride-sharing market and with its collection of supply and demand data. Because we see few barriers to entry or exit in the ride-sharing industry today, we don’t necessarily see Lyft’s network or data as becoming even more valuable to riders or drivers in the future. Additionally, Lyft faces other risks, such as its treatment of drivers, pricing, and regulatory issues. Government intervention could offset any of Lyft’s recent gains surrounding its network effect or user data. These concerns prevent us from assigning Lyft a wide moat rating.

In our view, Lyft’s network effects benefit drivers and riders; the benefits for each create a virtuous cycle. Drivers and riders make up the supply and demand in ride-sharing, respectively. As an early mover in this market, Lyft began to attract riders mainly via word-of-mouth and other marketing channels, which also helped Uber. Growth in demand and further word-of-mouth marketing attracted more drivers, increasing the supply of Lyft vehicles. In turn, as the number of drivers increased, the timeliness and reliability of the service improved, which drove the number of riders and rides higher, which in turn attracted more drivers, all of which we believe is indicative of the direct network effect. Lyft was able to accelerate this network effect by focusing on smaller areas, such as San Francisco, before expanding into more and more cities. This initial focus enabled Lyft to gain the critical mass needed to have enough riders to ultimately attract drivers in other cities and regions. We think experience attained from launching initially in and focusing more on the North America market may help Lyft more effectively allocate capital to possible launches in international markets.

In the meantime, the network effect moat source is evident in the company’s growth of riders. Lyft’s number of riders has increased since 2016, driven mainly by increased adoption of overall ride-sharing services plus Lyft’s gradual expansion in other markets. With more riders, the number of rides also increases. Per Lyft’s recent S-1 filing, overall growth in rides has been apparent over the last three years. We note that growth in demand for rides is driven not only by more riders, but also likely by more rides taken per unique rider, further supporting our view of a network effect moat source for Lyft.

In our view, Lyft is also likely to increase the use of its platform by consumers as it provides additional options such as last-mile offerings (bike- and scooter-sharing). In the long run, consumers may begin to rely more heavily on Lyft’s platform to manage their transportation requirements.

Such higher utilization of the platform has been evident since 2015. According to Lyft, rides ordered by riders that joined the platform in 2015, 2016, and 2017 have grown at annual average rates of 56%, 34%, and 44%, respectively. Similarly, Lyft’s revenue earned per rider is also on the rise. In our view, such data not only shows the higher usage of the platform but could also be indicative of Lyft’s higher retention rate of riders. We note that the higher usage is not only driven by Lyft’s quality of service, but also by overall higher adoption of ride-sharing in the U.S. We expect similar rates for Uber.

While an increase in riders and rides is evident, the question remains whether Lyft can also improve its monetization of riders. Based on data points provided by Lyft, we think it can. Lyft’s revenue per rider has been increasing since 2016. According to the company, the growth has been driven not only by higher usage per rider but also higher fees taken from drivers and less aggressive pricing, both of which we believe display the network effect economic moat source.

Similarly, growth in supply can be measured not only by the number of drivers, but also higher capacity utilization in terms of the number of rides completed by each driver and vehicle. On the latter point, we estimate (based on NYC data) that the average number of rides dispatched per unique Lyft vehicle rose 6% in 2017 and grew even faster (by our estimates) at over 8% in 2018.

We are also seeing indications of possible operating leverage for the company. Sales and marketing expenses as a percentage of net revenue declined to 37% in 2018 from 53% in 2017. While those costs grew 42% in 2018, Lyft’s net revenue went up 103%. Growth in average number of riders in 2018 (58%) also outpaced growth in sales and marketing expenses.

There are concerns about whether Lyft’s network effect can remain an economic moat source if the company is forced to incur additional costs imposed through regulations at the municipal, state, or federal levels. For example, Lyft may be forced to conduct more thorough background checks on all driver applicants, such as adding the costlier fingerprinting to the process everywhere in the U.S., although it already conducts an annual background check on all of its drivers. We estimate that this may add an average of $100 million annually to the company’s operating expenses and could provide an approximate 40-basis-point headwind to our 2028 operating margin projections, currently at 14.5%

Other regulatory issues may also serve to inhibit Lyft’s network effect benefits, but we don’t yet see government intervention as a burden. Concerns include whether Lyft will have to meet minimum wage requirements for its drivers. We think the company will have to concede and implement such a policy, likely taking an overall higher percentage from the gross revenue generated per ride, as its price is likely to remain competitive with Uber’s. With this, we think the company’s take rate will remain in the 20%-30% range.

Additional worries surrounding Lyft’s network effect moat source include the potential impact of AV adoption on car ownership. Some believe autonomous vehicles could attract more car buyers and increase car ownership, thereby possibly lowering demand for ride-sharing services, as self-driving cars may diminish annoyances and other costs currently associated with driving in traffic and/or driving long distances. We disagree, as we think the availability of AVs adds higher costs to car ownership, which would yield a lower return for an individual car owner. We think this dynamic would create demand for an AV-driven ride-sharing platform, since it could derive greater yields from having a stake in AVs when compared with individuals.

We think Lyft has secured access to valuable intangible assets in the form of driver and rider user data, which we suspect helps it improve its services. Such data should help to improve the capacity utilization of drivers, in turn making it more attractive for drivers to keep driving for Lyft. For riders, Lyft’s knowledge of supply and demand may help the company resolve any imbalances that might otherwise force riders into using an alternative transportation service. Additionally, and holistically, Lyft’s service may become more effective over time as the company further monetizes its riders via real-time supply/demand-driven pricing. The company also utilizes the mapping data it gathers to enhance its AV offering.

We Calculate a $500 Billion Addressable Market by 2023 We believe that Lyft's market potential is tethered to the outcomes of a changing mobility landscape. Lyft is in the early stages of shifting from a ride-share-only service to a one-stop mobility platform in which users can opt for bikes, scooters, or public transit to move from point A to point B. We therefore believe Lyft's total addressable market is the aggregate of the global addressable markets for taxis and ride-share along with the share we believe ride-share companies can take from global public transport, as well as U.S., Canadian, Latin American, and European bike-sharing and scooter-sharing. Taking these submarkets into account and omitting China (due to the hefty costs needed to succeed in the Chinese ride-share market), we estimate Lyft's total addressable market to be over $500 billion by 2023, growing at a 24% compound annual rate from 2018 to 2023.

Our total addressable market is based on the estimates we made for Uber in our July 2018 assessment. We adjusted these assumptions based on new data available and market exposure differences between Uber and Lyft. We note that Lyft values its addressable market in the U.S. at $1.2 trillion, based on consumer spending on transportation as reported by the U.S. Bureau of Labor Statistics. While we view that figure as a starting point, we expect Lyft and its peers to capture only a portion of that. In our view, it is unrealistic to view ride-sharing, scooter-sharing, or bike-sharing as complete substitutes for current public transportation or car ownership (and other expenses related to it).

Ride-Sharing Has Also Become Popular With Regulators Lyft's regulatory issues today involve how the company runs its everyday business, from employee type recognition to a minimum pay requirement. Various other requirements such as background checks and driver classification are also being enforced. Lyft will probably need to make compromises in confronting these legal debates. In our view, things such as minimum wage requirements could create barriers to entry into the ride-sharing market, which would make it easier for leading companies such as Lyft and Uber to pass the cost on to the riders.

In August 2018, New York City began to show sympathy to its taxi medallion investors as it put a 12-month cap on the number of active ride-sharing vehicles in the city. The New York city council now awaits the results of a study to be completed by the Taxi and Limousine Commission that may indicate how ride-sharing has affected the city. The council also decided to force Uber and Lyft to pay their drivers a minimum per trip, which began this year. In our view, these policies could create a barrier to entry as only the larger players like Uber and Lyft are able to cover the additional costs and continue to compete on pricing. While temporary, the limitation placed on the number of vehicles available could increase vehicle utilization.

The minimum per trip requirement imposed in New York City may also provide some backing for contractors to be considered as employees. While few markets have succeeded in classifying drivers as employees, the change would significantly increase Lyft’s operational costs and could force the company to pass those costs on to riders by charging higher fees. Lyft benefits from contracting drivers who, because of their current classification, are not subject to minimum wage requirements, robust insurance benefits, or, more important, trip-related expenses.

Lyft has faced legal battles related to this issue before. For example, in March 2017, the state of California ruled that while Lyft drivers are still considered as contractors, the drivers who provided Lyft services from May 2012 to July 2016 were to be reimbursed $27 million to cover expenses associated with gas and car maintenance.

In April 2018, the California Supreme Court ruled that contracted drivers of delivery business Dynamex Operations should be considered employees. Additional decisions in this vein in other states or regions might make it difficult for Lyft to continue its business model across its markets, which is heavily dependent on contracting drivers. Yet on federal grounds, Uber and Lyft appear to be safe for now. In a Philadelphia case last year, U.S. District Judge Michael Baylson deemed Uber limo drivers to be contractors under the Fair Labor Standards Act. Without recognition as employees, Lyft or Uber drivers cannot unionize. However, organizations have found loopholes for the next best thing. In New York, the Independent Drivers Guild was created to offer benefits and protections to ride-share drivers outside of unionization. The guild provides representation in legal trials and insurance options. On the legal side, the guild is responsible for giving Lyft drivers the ability to contact Lyft management after deactivation. Previously, drivers who were deactivated without warning due to reports by riders had no way of directly contacting Lyft management. Another guild win is responsible for implementing a tip setting in the app for New York City users.

States and cities have established ordinances for Uber that include guidelines on everything from consecutive driving hours to vehicle inspections. In Illinois, although the state attempted to regulate ride-sharing in 2014, such regulation eventually was left to localities. As a result, Chicago requires Uber and Lyft drivers’ vehicles to be inspected once a year. In New York City, vehicle inspections are required every four months at Department of Motor Vehicles inspection facilities.

Other states have long-term goals to regulate emissions. In California, Senate Bill 1014, which was signed into law in September 2018, requires ride-sharing service providers to take steps to reduce emissions from their contractors’ vehicles and focus on bringing onboard those with zero-emission vehicles.

The more visual effects of bike-sharing--a mass of dockless bikes strewn throughout cities--have led some municipalities to draft quick policies. In the U.S., cities have adopted either a bike-share permit fee based on the number of bikes in a network or a hands-off approach--at least for now. Washington, D.C., has pondered imposing fines on dockless bike-share apps; according to The Washington Post, the fines would be the most extreme in the country at $80,000 per bike annually. Now the city has decided to stay in a trial period, testing out dockless bikes without fees.

In cities such as Los Angeles, scooter-share providers are being forced to send a service team to remove scooters from sidewalks or streets at any time when contacted by the city. Such a measure creates additional maintenance-related costs for companies such as Lyft, Uber, Bird, Lime, and Spin. And Washington is approaching scooter-sharing like bike-sharing--launching a trial period to analyze demand for and possible revenue generated by the city for such a service, in addition to looking at various physical hazards associated with it and how they can be minimized.

Lyft’s minimum requirements to be a driver in the U.S. include being 21 years of age or older, holding a U.S. driver’s license for at least one year, and meeting state or municipal vehicle requirements. Driver screening entails a review of the prospective driver’s driving record and criminal history done through a human resources company. Lyft’s background check looks at the driver’s record over the past seven years. Many states require either an internal background check or fingerprinting. Like Uber, Lyft has complied in markets where fingerprinting is mandated, though with much resistance. Lyft exited the Austin market in 2015 due to mandated fingerprinting but re-entered when Texas ruled for statewide regulation, which does not require fingerprinting.

AV Disruption May Benefit Lyft but Bring Bigger Competitors Lyft appears to be aggressively pursuing the autonomous vehicle route as it understands that self-driving cars may help it expand its margins, since without drivers the company could recognize a higher take rate. While AVs can help current ride-sharing market leaders like Lyft and Uber expand margins, they may also allow larger technology companies to enter the market and threaten the two.

Lyft strengthened Level 5, its AV technology division, in late 2018 by acquiring London-based Blue Vision Labs, which applies augmented reality technology to mapping to help AVs recognize more objects on the road. Lyft is also investing heavily in high-definition maps, which provide much higher accuracy regarding the position of a vehicle on a road or within a lane. In addition, Lyft has opened its ride-sharing platform to partners such as Aptiv, which is currently testing its technology on various vehicles.

Although AV driving provides large potential upsides to the ride-sharing industry, we believe the single greatest existential threat shared mobility investors should be aware of is the risk of a leading AV company entering and disrupting the incumbent ride-sharing industry. Alphabet-owned Waymo, which has tested in over 20 U.S. cities, has already launched a human-backed autonomous ride-sharing service in Phoenix. For Waymo to have a meaningful impact on the world of ride-sharing, it will need to build out a network of its own, which may not be as insurmountable a task as it seems at first glance. We believe investors are probably underestimating the potential for Google to optimize and monetize its Google Maps offering for ride-sharing. Whereas Lyft currently completes 50 million rides per month, Google Maps has over 1 billion monthly active users, a huge pool that could be tapped in order to understand traffic patterns and areas of high demand; this could be compelling to Waymo drivers and someday help Waymo more efficiently utilize its vehicles.

We Assign Lyft an Intrinsic Value of $24 Billion Our fair value estimate for Lyft is $24 billion, which represents enterprise value/net sales multiples of 6, 4, and 3 in 2019, 2020, and 2021, respectively. On an enterprise value/gross billings basis, our valuation represents net multiples of 1.3, 0.9, and 0.6. Our valuation is about 67% above the valuation implied by Lyft's last round of funding. We project that Lyft's net revenue over the next five years could grow at a 40% compound annual growth rate, ahead of the 24% CAGR we assume for Lyft's $500 billion total addressable market. We expect a 26% 10-year CAGR through 2028, resulting in net revenue of $21 billion in 2028, up from $1.1 billion in 2017 and $2.2 billion in 2018.

Our gross revenue estimates and growth rates imply that Lyft has 5% of its total addressable market today but will capture more than 15% of the $500 billion addressable market we estimate by 2023. From there, we model growth for Lyft’s total addressable market at a 13% rate through 2028.

We project that Lyft will remain one of the top players in the ride-sharing market mainly in the U.S. and Canada, with further growth opportunities in Europe and Latin America. Its ride-sharing gross revenue growth likely will outpace the overall ride-sharing market by growing at a 41% five-year CAGR compared with our estimate of 24% for the total ride-sharing market for the same period. We think such growth will be driven by Lyft’s continuing expansion in more markets plus an increasing adoption rate as the company attracts more users. As ride-sharing also represents a substitute for some public transportation, we think it can take revenue from public transportation, which we account for in our projections. Our 10-year gross revenue CAGR for ride-sharing is 26%.

We expect Lyft to increase its presence in the bike- and scooter-sharing market, which we project will be a $9.2 billion market by 2023 (based on gross sales), based on a 12% average annual growth assumption, and a $12.2 billion market by 2028. We think Lyft will gradually take a bigger piece of that pie in the U.S., Europe, Canada, and Latin America organically and through additional acquisitions, which will drive its 10% 10-year CAGR we assume for this business, resulting in micro mobility gross revenue of $5.9 billion by 2028. This is likely to represent only around 6% of Lyft’s total gross revenue.

As Lyft continues to attract more riders and assign drivers to requests more quickly, we think overall vehicle capacity utilization will increase and may accommodate a higher number of vehicles to drive strong gross and net revenue growth, possibly widening its gross margin to 57% during the next 10 years from 38% in 2017. Besides the driver take rate, which is netted out of Lyft’s net revenue, we believe a portion of Lyft’s cost of goods sold is fixed and revenue will grow at a faster pace than these costs (albeit variable costs associated with assets such as bikes and scooters), leading to gross margin expansion. We also project that Lyft will benefit from operating leverage in the years ahead. Given what we assume to be a narrow-moat company with the network effect economic moat source, Lyft might be able to increase revenue at a faster pace than selling, general, and administrative costs, especially in the sales and marketing lines, while also having to spend relatively less on operations and support costs. However, we anticipate that research and development will remain elevated as Lyft is likely to invest in new ventures, resulting in only slight declines in R&D as a percentage of net revenue.

We think Lyft is likely to begin generating adjusted EBITDA in 2021. In our 10-year discounted cash flow model, we assume the company will break even in 2022 and begin generating operating income in 2023 and thereafter. We expect operating margin expansion to 18.5% by 2027.