After posting its Q2 results a few weeks ago, the stock of Uber jumped around 15%. The reason? Uber surprisingly disclosed a positive free cash flow. Not only that, it did so even earlier than expected. But is the business now really structurally and durably generating free cash flow?
The times of seemingly risk-free casino bets on the stock market – mainly with supposedly promising technology stocks – are luckily over. Everything that had something to do with technology, crypto, artificial intelligence or digitalization brought investors often massive profits.
In case they cashed out timely.
What didn’t be of interest to many – especially novice – investors during the boom were fundamental profitability measures of their “investments”. As long as revenues and promises or some figures like “adjusted EBITDA” were growing, they felt on the safe side.
I even came across more fancy figures and ratios I have never heard of before after more than ten years in the market of stocks, e.g. Enterprise-Value-to-Sales-to-Growth (EV-S-G, in the style of PEG or Price-to-Earnings-to-Growth) – let’s keep it maybe for another day…
But finally, the tide has turned.
With rising interest rates and many parts of the world economy being in a recession, common sense and original investing craftsmanship are making a comeback. “Profitability” on an adjusted EBITDA basis is not enough anymore – and rightly so. Charlie Munger, Warren Buffet’s companion, calls EBITDA even “bullshit earnings” (see here or here).
Everybody knows that cash is king. It makes you liquid and flexible. Cash flow is real money pouring into a company. In the end, any serious investor wants to see (free) cash flow for his investments at some point in the future.
There is frequent chatter that several tech stocks have already fallen enough. Are there big bargains to be made, now? One such hotly discussed stock is Uber Technologies (Ticker: UBER, ISIN: US90353T1007).
Uber’s stock is down more than a third from its public offering in 2019 at 45 USD a share. From its all time high in 2021 it even got cut in half.
With the latest publication of results, Uber posted a positive free cash flow. Has Uber finally gotten the curve? Or is it just cutting corners to show a much needed and eagerly awaited “profitability” on a free cash flow basis to calm the minds a little?
There are tools to (legally) show better results than your underlying business in reality has.
We’ll examine in this Weekly.
Some accounting basics
Before we come to Uber, we gobble up and expand on some points from above, first.
EBITDA stands for “Earnings Before Interest, Taxes, Depreciation and Amortization” – hence a lot of stuff that is being left out before the bottom line.
The more capital intensive a business is, the more misleading the profitability based on this accounting figure becomes. That is because capital intensive businesses usually have debt to finance their capital needs (and have to pay interest). The bigger their assets are, the higher the corresponding depreciation and amortization positions (assets get written down in accounting terms).
The problem with EBITDA (and many positions in the profit and loss statement – P&L) is that these are mere accounting figures. Due to their structure, they do not represent the economic reality of a business properly. You cannot buy or pay anything with “earnings”. Buffett, Munger and other famous investors have many times complained about this topic and warned investors to look at cash flow, not earnings.
The P&L tells you only whether the assets on your balance sheet have gained (or decreased) in value. Cash is one such position on the balance sheet. It can also include investments or equipment you bought with real cash way back in the past. That is the case with most businesses.
In a very simplified example to differentiate a profit from a cash flow, image the following:
Think of a personal balance sheet you create once a year. You look at all assets in your home (the home itself, furniture, electronics, paintings, your car, whatever…). At year’s end, some of your assets will be depreciated, because they got older or even worn out. That is being subtracted from your revenue (e.g. your salary) in your profit and loss statement. But it doesn’t tell you anything when you paid cash for your purchases.
Your profit just doesn’t tell you anything about the real cash movements and what you have left over after costs in liquidity. When your TV goes kaput, then your cash holdings don’t get lower with it. You paid let’s say already five years ago for the TV that now depreciated in (accounting) value.
Cash flow is the real cash you brought home minus your direct cash expenditures in the same period.
It does not mean that these P&L figures are useless, however. They are useful for example to determine certain profitability ratios or debt structures of a company – that is not today’s topic. But they are not useful in valuing and assessing the “true” earnings (read: the cash the business generates) from a fundamental point of view, hence the economic reality of the underlying business.
What you need to keep in mind here is that profit (whether EBITDA, EBIT or net profit) is a lousy figure to asses the financial strength and “true” earnings power of a business. Always focus on (free) cash flow.
What has always counted throughout history is pure cash flow. You have to be liquid to survive. Plain and simple. Cash flow is money that comes into a company and generates a positive figure after costs (in simplified terms):
- Operating cash flow (or cash flow from operations – CFFO, as it is called). The amount your business throws off after operating costs (including taxes)
- Free cash flow (FCF) is a step further. It is a figure after investments made back into the business (so called CAPEX, or capital expenditures). Money that is really left over for shareholders, e.g. for dividends or to repay debt
There is a book I read several years ago. It is currently in its forth edition and next year the series will have its 30th anniversary.
It could become a truly timeless evergreen! Every serious analyst should have read it in my opinion.
It really changed how I look at accounting figures of businesses. When a not profitable company suddenly presents wonderful cash flows seemingly out of nowhere, I always am validating a few things.
The good news is, the book is not written for Wall Street pros only. The language is easy as are the discussed real life cases (real financial shenanigans of the past). One just needs some will to work through this stuff, some imaginary power and a few accounting basics. On YouTube, there is a very good video about it summing up the key points.
The book consists of 13 categories where management could be turning some screws. Management could choose to do so on the balance sheet, in the P&L and in the cash flow statement.
It doesn’t have to be necessarily fraud or manipulation, though.
Financial shenanigans can range from loose “interpretations” of accounting rules, over some timely “adjustments” to outright fraud. You can have minor cases where management wants to “prepare” its results just for the release date. This is also what I rather see with Uber’s release (and not a fraud).
If you go beyond only scanning headlines and believing everything that is presented, chances are that you will be able to unmask many of the presented “realities” with some experience. It doesn’t even take that much time, if you have some practice and know where to look.
Actually, I only want to take out one part of the book where the authors talk about “adjusting” some figures to show off a better cash flow than the business truly has. To be more precise, it is the the working capital (WC) section of your cash flow statement where you have some playing ground for “corrections”. But be on guard, this cannot be continued forever, though…
Working capital is capital you need to operate your business (the main parts being inventory, money you are awaiting from your customers and bills you have to pay yourself to your suppliers).
There are four ways to boost your cash flows artificially to be able to show a higher figure than it truly is:
- pay your vendors later (just pay your bills a few days later – suddenly you have a higher cash flow on the specific date needed)
- collect money from your customers quicker (I wrote about Microstrategy doing this obviously last week to avoid a total disaster)
- hold less inventory (less capital tied – that saved you temporarily some expenses)
- have one-time benefits you are pretending to be recurring cash flows
In the case of Uber, we are talking about pushing some expenses into the future – let’s see in the next section.
Uber’s loss-making business suddenly throws off cash for the first time – and earlier than expected
Uber describes itself as a technology platform that operates in 72 countries and more than 10,000 cities. It has three business segments where in each case it connects a delivering and a receiving party with each other:
- mobility (Uber mobility services or colloquially “Uber Taxi” serving “Riders” via ridesharing with its own fleet and Uber Drivers)
- delivery (Uber Eats serving “Eaters”)
- freight (connecting shippers with couriers)
In its annual report, where every company has to write defensively unlike in the ever-promising presentations and pitches, Uber mentions the following interesting aspects.
1) Their business is fragmented, very competitive and has low barriers to entry. Hence more competition could enter relatively easily soon when economic conditions allow or someone with deep pockets decides to do so:
2) Uber will have to invest into its business, hence to keep its expenses rather up. Sure, there has to be a fleet of cars and transporters that has to be kept in good shape. Even in case of leasing, you have to pay periodically cash that is not available for other purposes. Profitability is not expected, at least not in the near term. Higher revenues do not automatically guarantee higher profitability or profitability at all:
3) Uber will need additional capital. Interestingly, they pitch themselves as a capital light business in their presentations. In simple terms, their business is not self-funding and not generating enough cash flow at this stage in the game. Debt and / or dilution of existing shareholders should be expected:
On their investor day in February, Uber presented their expectations for future free cash flow. 2022 should be the year when they break-even. 2024 was supposed to be the year when FCF would be strong with around 4–5 billion USD (that would be indeed strong, if to materialize).
With the latest earnings release a few weeks ago, however, as already teasered, Uber managed to show off a positive free cash flow earlier than the original goal was. Their CEO commented:
Last quarter I challenged our team to meet our profitability commitments even faster than planned—and they delivered, […]Dara Khosrowshahi, Uber CEO, in Q2 2022 press release
Wow, suddenly profitable on a cash flow basis for the first time.
What led to this surprising result? According to Uber, all three segments rose strongly. Total revenue compared to last year doubled in the quarter. It would be logical to assume that with such a strong performance, the operating results and cash flows should grow accordingly. Especially, for a capital-light platform business.
So far, so good. But don’t get fooled by the press release.
What really drove Uber’s cash flow were some well timed moves in their working capital. That’s totally legal.
In their annual report from 2021, we see that the negative cash flow (last row) was already supported by some positive one-time effects that had nothing to do with recurring cash collection from customers for their services. Without these one-offs, operating cash flow would have been more in the red:
Uber has to hold insurance reserves for their business, e.g. in case of accidents:
source: Uber annual report 2021, p. 94
The key term here is “accrued”. In accounting language, accrued means that you have a bill to pay outstanding – hence at a different time (post earnings release). Buy-now-pay-later so to speak. When the pay date is after your earnings release, you have “accrued liabilities” or “accrued expenses”. Because you haven’t paid your bills, you suddenly have more cash on the books.
Is this really cash generated from operating activities?
There comes a time when the bill will become due… Here you can read more about the accounting topic of accrued expenses.
On p. 63 in their annual report, they describe it themselves. It was money, that came from working capital:
I guess, it will not surprise you to read the same explanation in their last quarterly report where they suddenly “achieved” a positive (free) cash flow:
You cannot consume entirely from working capital. When the growth stops, you will have a problem. Had working capital been the same, Uber would have posted again negative cash flows.
More problems and risks with Uber
I wanted to show you that a company can legally manage to show better results and figures than the underlying reality actually is. But there are more potential pitfalls in the case of Uber that would be too long for this article to discuss them in full length. Just in short:
1) Since inception, Uber has accumulated a deficit of 32 billion USD on its balance sheet. That is more than 60% of their current market capitalization and doesn’t speak well about their investment capabilities…
2) Uber actually burned 10.5 billion USD in cash from operations from 2018 until year end 2021. In the same timeframe, their accrued liabilities more than doubled from 3.1 billion USD to 6.5 billion USD. These are bills due, soon.
3) In the current environment of high inflation and a recession, obviously money will have to sit more tightly. Many people will have to think twice were to spend their cash. The services of Uber tend to be more discretionary, hence can be easily cut… What if the recession will be more severe and inflation has not peaked, yet? At least, a company has to be prepared for this scenario.
4) Net debt and interest expenses: Uber has 9.4 billion USD of debt due in the future. Until 2025, they are safe. But in 2025 3.5 billion USD will have to be refinanced. I don’t see them paying that off from cash flow.
5) Dilution of shareholders and stock based compensations: Uber pays its employees and management partly with stocks, like many tech companies do. If the share price dips too low, this type of pay become less attractive. Uber will have to up either the fixed salary or the stock programs at lower prices. The first means less profit, the second means more dilution to existing shareholders.
6) Gasoline prices: Uber is not immune to higher energy costs. If they pass it to customers, less will book a drive.
7) Litigations, government proceedings and regulation: Uber is very controversial regarding working practices and competitive behavior. There are high risks for government intervention. Uber writes in its annual report under risks among others: “litigation and government proceedings including with respect to relationship with drivers and couriers”. The statuses of employees and “independent contractors” is an unresolved topic. Minimum wages and social security payments are looming, too.
8) Balance sheet besides debt: Uber has intangible assets and goodwill of 10.5 billion USD. These are assets that are not easy to value and hence at risk of being impaired. Intangible assets could be customer relations, sales channels, trademarks, etc. In comparison, equity stands only at less than 7.4 billion USD. Their true and material equity is thus negative. This point does not have immediate consequences. But it shows that they operate with lots of maybe-fictitious assets which are hard to value. The balance sheet could be inflated.
So, do we have a management team finally showing operating excellence or rather one twisting and squeezing to show certain financial metrics for a specific date?
You can decide for yourself.
Very good businesses in the long term often do perform very well for their shareholders. Likewise, not so good businesses with week financial metrics can be very profitable investments for a certain time. But in the long run, they are most often not.
Personally for me, the risk reward ratio is not attractive. I see way too many risks and a weak financial profile. Uber for me is still highly speculative. Even their annual report has a whopping 35 (!) pages about risks. That is 5x more than their business description and around one fourth of their annual report in total.
Hence I’ll pass on this one…