With so many money-losing, growth tech start-ups going public in 2019, some might wonder how their valuations get so high.
Lyft (LYFT went public in March, pricing shares at $72 — a total valuation of roughly $20 billion. Uber will hit the public market soon, and is seeking a valuation of $100 billion. Pinterest began trading last week, and is currently valued at $14.11 billion.
One analyst has a price target for Lyft of $80. But Lyft had a net loss of $911 million in 2018, a 32% increase over 2017’s net loss of $688 million. Yet the market — and analysts — say it is valued anywhere between $56 and $80 a share.
So, how are companies actually valued?
The average investor may think Lyft’s valuation range is insane. And he or she just may have a point. Eric Schiffer, CEO of the Patriarch Organization, a venture capital and private equity firm that invests in digital media companies, recently told TheStreet, “The valuation at this [share price on first trade] level makes no sense.”
And even compared to other tech stocks like Netflix (NFLX – Get Report) , Lyft’s valuation is outsized. While Lyft’s market cap is currently $16.84 billion, WedBush analyst’s price target of $80 represents a total equity value of $23 billion, which values Lyft at 10.5 times its 2018 sales. (We can’t look at price-to-earnings, because there are no earnings yet.) Netflix, while it’s turned a net profit in the past few years, is valued for explosive growth, like Lyft, with a current trailing 12-month price-to-sales ratio of 9.88 times.
In order to understand how Lyft is valued, we have to understand how valuations work.
How Valuations Work
Valuation experts predict a company’s worth based on the cash it could generate into the future. That means the price an investor pays to own one share today reflects the expected cash flow the company will generate as far into the future as we can reasonably predict. Its price is essentially based on the “long term,” a phrase especially important for Lyft.
The most intrinsic and frequently used valuation method is discounted cash flow, or DCF. Analysts project free-cash-flow, or FCF, for each year usually six years out.
While the most popular profitability figure is “earnings per share” (formula: net income less preferred dividends, divided by shares outstanding) the figure used to calculate DCF is FCF. That’s net income plus interest expense, plus non-cash expenses like depreciation and amoritization of assets, minus capital expenditures, minus changes in working capital. This tells us how much pure cash a company generated in a given time period.
After FCF is projected for one year, that number is discounted, essentially reduced, by weighted average cost of capital, or WACC, a company’s cost of debt (percent interest) and cost of equity, which is a whole other conversation. After all, a dollar tomorrow is worth less than a dollar today.
In financial markets, cash flows are discounted by an investor’s opportunity cost. The WACC is the opportunity cost of buying shares in a particular company. There are initially five years of these projected discounted free cash flows. At the sixth year, analysts apply a standard growth rate of FCF they think is likely for this company.
After applying the FCF growth rate, analysts use that long-term growth rate for year six’s FCF for perpetuity. FCF will theoretically grow at that rate, discounted by a constant WACC. We get a seemingly inflated number out of this. That’s our terminal value.
Another way to arrive at a company’s terminal value is by using the exit multiple method. To do so, you find an appropriate multiple of year-six EBITDA (earnings-before-interest-tax-depreciation-amoritization) that fits the company’s growth profile. The discounted terminal value plus the discounted cash flows for years one through six equals the enterprise value, or EV. Subtract net debt (debt minus cash) from EV, and we get the total equity value. Divide that by shares outstanding and we get the share price.
Analysts will also compare their company to other companies with similar growth rates, cost structures and profit margins, usually in the same or similar industries. Then analysts compare the multiples of similar companies to the company they’re covering, to figure out what multiples are appropriate. That’s called relative valuation.
How Lyft Is Valued
So if Lyft is so unprofitable, how can anyone possibly value the shares at a positive number? And it’s not even as if Lyft will be EBITDA positive soon, let alone see FCF. WedBush analyst’s say Lyft’s 2020 EBITDA will likely be negative $1 billion.
Step one: Think long term. “These are really long plays, if you think about the growth prospects of these companies,” Alejandro Ortiz, principal analyst at Sharespost recently told TheStreet.
Secondly, as mentioned earlier, valuations are run through periods of six years, but sometimes they’re run through periods of 10 years. Some analysts may be attempting to project 10 years into the future before arriving at a terminal value. People do expect Lyft to generate cash flow within the next 10 years, and then to sustain a mature growth rate of that cash generation. And there are some bulls out there.
“There is a path to EBITDA positive [for Lyft] by 2022, 2023,” Santosh Rao, head of research at Manhattan Venture Partners told TheStreet.
So let’s talk about Lyft’s business.
“There is some margin to cut” on expenses, Rao adds, mentioning that costs of goods sold, much comprised of insurance expenses, could soon abate. Plus, “sales and marketing is a big expense,” which was 37% of revenue in 2018. Marketing expense will comprise far less of Lyft’s revenue in the future, as it will ultimately reach a rider base and won’t need to spend so much on marketing. Of course, by that time, its revenue growth will have slowed considerably.
Meanwhile, revenue growth is accelerating, as the ride-sharing market is expanding rapidly. Guggenheim analysts think the ride-sharing market will be $120 billion in 2025. With Lyft and Uber competing for share, Lyft is solidly the second-place company in the market, behind Uber.
As for other costs Lyft will need to control, Rao did stress that “the big issue is the take rate.” Maybe Lyft can increase its take rate, but since “a large portion of [Lyft’s revenue growth] has come from take-rate expansion, we worry that it could be hard to raise fees or cut driver pay in a competitive category,” Guggenheim said. Lyft may have to take the cost-controlling route. That, combined with the broader ride-sharing market’s expansion, could prove significant in Lyft’s path to profitability. Rao says capital expenditures will abate after Lyft’s scooter and bike investments made through at least 2023.
As for Lyft’s multiples, D.A. Davidson & Co. analysts, who have a $75 price target, have Lyft’s enterprise value at 3.4 times expected 2020 sales. That’s still a relatively high multiple, since it uses a much higher sales figure than 2018’s.
