“American ride-sharing service Lyft will confirm its initial public offering price on Thursday, having already given an indicative range of $62 to $68 a share that values the firm at between $21 billion and $23 billion. To many investors that will look like an awful lot for a firm that had just $2.2 billion in sales and lost $911 million in 2018, or an average of $1.47 for each ride it provided”, says Russ Mould, AJ Bell investment director.
“As one of two leading players in the US ride-sharing market, alongside Uber, and a firm which is also building a foothold in the scooter-sharing and bike-sharing markets for good measure, Lyft is already rapidly growing its customer base and revenues as it targets the $1.2 trillion that Americans spend on transport every year. The firm’s app also embraces public transport options and Lyft is developing a fleet of autonomous, self-driving cars.
“The company’s long-term potential is therefore huge. But the problem is that right now it loses money hand over fist and the public offering prospectus bluntly warns that ‘we have a history of net losses and we may not be able to achieve or maintain profitability in the future.’ The document outlines the obstacles which could prevent Lyft from making it into the black, such as attracting and keeping new drivers, regulation, competition, whether new platform services prove attractive and a possible expansion beyond the US pays off.
“This leaves investors with a dilemma when it comes to judging what could be a fair valuation for the shares.
“This can be done crudely by looking at revenues on a historic and forecast basis and dividing the projected market capitalisation by those figures, for a price-to-sales figure which can then be compared to the same multiple at other early-stage growth companies.
“More scientifically, investors can look to assess Lyft’s future potential by building a discounted cash flow model, or DCF.
“The idea of a DCF is to establish how much a firm's future cash flow is worth in today's money. This is referred to as the company’s ‘intrinsic value’.
“The four key elements of a DCF are
• A basic operating free cash flow (OpFcF) calculation: OpFcF is operating profit plus depreciation and amortisation plus change in net working capital minus capital expenditure and tax
• Establishing forecasts for OpFcF over the next ten years or longer
• Determining an appropriate weighted average cost of capital (WACC)
• Discounting future OpFcF, for the next 10 years and then out to infinity on a so-called terminal basis, using the WACC to establish fair or intrinsic value for the equity by discounting those future values back to a net present value for today
“This process still includes a lot of ‘ifs’ ‘ands’ ‘buts’ and ‘maybes’. But it at least helps investors to run different scenarios and see how the valuation changes depending upon the core assumptions for the cost of capital (or discount rate), long-term growth rate and the long-term operating margin, for example.
“In this example below, we have assumed that the company’s WACC is 11.75%, based on a risk-free rate of 5.0% (even though the current US Treasury yield is 2.50%) and an equity risk premium of 4.5% (which looks sensible based on history but could be said to be too high right now, given prevailing equity valuations in the US in particular).
|
Example WACC calculation for Lyft |
|
|
Risk free rate |
5.0% |
|
Equity risk premium |
4.5% |
|
Stock beta |
1.50 |
|
Cost of equity |
11.75% |
|
|
|
|
Average debt (cash) |
2,038 |
|
Net interest expense |
0 |
|
Cost of debt |
0.0% |
|
Gearing |
(89.0%) |
|
|
|
|
WACC |
11.75% |
“The model assumes that Lyft breaks even in 2024 and goes on to make a long-term operating margin of 10% - similar to many public transport companies that are quoted at the moment.
“We then assume that the medium-term growth rate flattens out at 15% a year, thanks to the law of large numbers if nothing else, and the terminal growth rate once the firm reaches full maturity is 2% a year, or roughly in line with inflation.
“The results are then added to Lyft’s $2 billion cash pile to get an equity valuation, which is then divided by the number of shares in issue to get to a possible per-share valuation for the stock.
“The series of guesstimates that we have made come up with a figure of around $71.50 a share. (see table below)
“The questions the investor then has to ask are:
• Is a 5.0% risk-free rate a sensible assumption? It looks like interest rates are not getting there any time soon, so a lower number may be appropriate. If so, the equity valuation would be higher, thanks to the lower discount rate this would imply.
• Is a long-term operating margin of 10% appropriate? Some may argue Lyft will never make money or generate cash (in which case the equity is worth no more than the company’s cash pile at the time, unless you add in value for its intellectual property and customer data, which would surely have some worth, too). Is it too high or too low?
• Are the short-, medium- and long-term growth forecasts too aggressive or too conservative?
“All of these can be used to stress test the valuation.
“For example, punching in a 2.5% risk-free rate cuts the WACC to 9.25% and takes the valuation to $115 all on its own (to show the importance of interest rates when it comes to valuing stocks).
“But if you cut the operating margin to 5% from 10% in our original model, then the valuation drops from $71.50 to $55 a share.
“And if you increase the terminal growth rate to 5% a year from 2% in the original model, then the valuation shoots to $101 a share.
“This shows that for all of the maths and science involved, valuing stocks is still an art and that in the case of Lyft there could be considerable upside or downside from that proposed range of $62 to $68 a share.
“Investors must then judge whether the potential rewards outweigh the potential risks. Aggressive, momentum-focused investors may argue that is the case. Value-oriented investors may be more circumspect, especially if they are disciples of Benjamin Graham, whose 1949 book The Intelligent Investor is still one of the most widely acclaimed tomes on investment ever written.
“One of Graham's key tenets was to ensure any portfolio purchase featured what he termed 'a margin of safety’, since the biggest danger to any investor is losing money on a permanent basis.
“Graham sought to do this by paying low prices for good assets and by not paying top dollar. Value-oriented investors will ask themselves whether valuing Lyft at $21 billion to $23 billion at the outset makes any sense at all, especially as the firm does not look likely to make a profit of generate cash for several years to come and any shift from the current bullish sentiment to a more bearish outlook could leave that price tag looking very exposed indeed.”
|
Year |
(1) |
1 |
2 |
3 |
4 |
5 |
6 |
7 |
8 |
9 |
|
$ million |
2018 |
2019 |
2020 |
2021 |
2022 |
2023 |
2024 |
2025 |
2026 |
2027 |
|
Sales |
2,157 |
3,451 |
5,176 |
7,246 |
9,420 |
11,304 |
13,565 |
15,939 |
18,728 |
21,537 |
|
Sales growth |
103% |
60% |
50% |
40% |
30% |
20% |
20% |
18% |
18% |
15% |
|
EBIT |
(978) |
(1,208) |
(1,294) |
(1,087) |
(942) |
(565) |
678 |
1,195 |
1,873 |
2,154 |
|
EBIT margin |
(45.3%) |
(35.0%) |
(25.0%) |
(15.0%) |
(10.0%) |
(5.0%) |
5.0% |
7.5% |
10.0% |
10.0% |
|
Depreciation |
19 |
38 |
66 |
98 |
138 |
179 |
215 |
258 |
310 |
372 |
|
Capex |
(69) |
(86) |
(155) |
(217) |
(283) |
(339) |
(407) |
(478) |
(562) |
(646) |
|
Net working capital |
(22) |
(35) |
(52) |
(72) |
(94) |
(113) |
(136) |
(159) |
(187) |
(215) |
|
Tax |
(1) |
(60) |
(65) |
(54) |
(47) |
(28) |
(170) |
(299) |
(468) |
(538) |
|
OpFcF |
(913) |
(1,179) |
(1,190) |
(898) |
(663) |
(188) |
995 |
1,473 |
2,089 |
2,418 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Growth rate terminal |
2.0% |
|
|
|
|
|
|
|
|
|
|
Discount rate |
11.75% |
|
|
|
|
|
|
|
|
|
|
NPV per forecast year |
(1,055) |
(953) |
(643) |
(663) |
(188) |
995 |
1,473 |
2,089 |
2,418 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
OpFcF discounted to 2028E |
|
|
|
|
|
|
6,272 |
|||
|
OpFcF terminal value to infinity |
|
|
|
|
|
|
22,157 |
|||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2028 E |
Infinity |
|
Discounted sum |
|
|
|
|
|
6,272 |
22,157 |
|||
|
Net debt / (cash) |
|
|
|
|
|
(2,038) |
(2,038) |
|||
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity Value |
|
|
|
|
|
8,309 |
24,195 |
|||
|
Number of shares in issue (million) |
|
|
|
|
|
338 |
338 |
|||
|
Equity Value Per Share ($) |
|
|
|
|
|
24.58 |
71.58 |
|||
