Ride-sharing services like Uber trumpet that they provide a cheap, easy way to zip around cities anywhere in the world.
That may be true, but that’s because someone else is silently picking up part of the cost, and that can’t last forever. Here’s why: Uber and its rivals are paying for their escalating price wars with money they’ve raised in debt and equity markets. And it’s getting harder to see how they’re all going to be able to pay it back.
Uber’s latest plan is to borrow up to $2 billion from U.S. leveraged-loan investors. While the company’s plans for the cash are unclear, most of its money has ultimately gone toward the same goal, which is to claim market share by undercutting its competitors with lower prices.
While this approach makes sense if the company is able to consolidate enough business, it has caused Uber to burn through cash.
The good news is that people are still extremely willing to lend. Uber is looking at paying a rate of 4.5 percent or less on the loan it may receive, which is lower than average yields on similarly rated new loans that range up to 5.5 percent, according to the Wall Street Journal, which cited sources familiar with the matter and S&P Global Market Intelligence LCD data.
Indeed, investors are generally warming back up to the U.S. market for speculative-grade loans after shunning it earlier in the year. Prices on the debt have risen 6 percent since their lows in February to 91.2 cents on the dollar, according to S&P and Loan Syndications & Trading Association data.
And from an investor’s standpoint, what’s not to like? If companies can keep paying some interest and eventually repay their obligations, their debt holders will do phenomenally well, especially compared with owners of the swelling volume of government bonds that yield nothing or less. The problem, of course, is that some of these borrowers will inevitably be unable to make good on all of their obligations.
Which brings us to the bad news. All of Uber’s warchest has ultimately been aimed at the same goal, which is to build the biggest pool of drivers and riders in every city where the company operates. That isn’t cheap. Uber is spending on bonuses to sign up new drivers, and it subsidizes the price of rides, particularly when it starts service in new cities.
The approach has made Uber a valuable company that has truly changed many people’s daily lives. It also has made it tough to turn a profit. Tech-news outlet The Information recently reported that Uber has roughly 20 percent gross margins in its established markets. That is a slim pool of potential profits before the company has to pay for drivers’ insurance, salaries for employees and other operating costs. Uber posted a loss of $1.7 billion on $1.2 billion in revenue over the first nine months of 2015, according to Bloomberg News.
On Tuesday, Uber’s chief product officer said the cash-torching habits of the ride-hailing industry would change “when the money train stops.” In an interview at the Bloomberg Technology Conference in San Francisco, Jeff Holden highlighted a “very distorted capital market” that won’t last forever. “When the tide goes out, you see who’s been swimming naked.”
Never mind the irony of that quip being a favorite of Warren Buffett, who would find little to love about Uber. Holden also didn’t acknowledge that Uber owes its very existence to this “very distorted capital market.” There’s no way Uber could have started and thrived without the cheap cash it has been able to collect from a growing pool of eager investors , almost no questions asked. If Uber borrows $2 billion, it would take the money Uber has raised to roughly $15 billion. That is far more than Facebook, Amazon, Google, Yahoo and eBay collectively raised before those companies went public.
So that ride home from the bar at 2 a.m. on a Saturday may be cheap now, but it’s coming at a price that may prove extraordinarily steep for Uber in the future.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
©2016 Bloomberg L.P.
This article was written by Shira Ovide and Lisa Abramowicz from Bloomberg and was legally licensed through the NewsCred publisher network.