The whole problem with a business model throwing off large losses is that the business can’t handle bad news very well. Lyft (LYFT) faces that exact situation with COVID-19 crushing business while facing a potential shutdown in its key California market. My investment thesis remains negative on the stock despite Lyft still trading far off the 2020 highs.
Source: Lyft website
The only real good news from the Q2 report is that Lyft didn’t see losses balloon when revenues plunged. The rideshare company saw revenues collapse by 61% to $339 million, but adjusted EBITDA losses were only $280 million. The company had over $500 million in lost revenues from last Q2 and far more below original expectations for the quarter, yet the adjusted EBITDA loss was only down $76 million from the prior year.
Source: Lyft Q2’20 presentation
While this does speak to the flexibility of the business, it also further highlights the ultimate limitations: limited leverage with scale. A lot of the expenses are marketing to riders and paying drivers. When riders decline 60%, so do costs. The flip side is that those costs will return as riders return to the network.
In the quarter, the contribution margin dipped to 34.6% from 46.0% last Q2 and 57.3% in the prior quarter. The whole problem with the business has been the low contribution margin as the majority of revenues go to drivers while Lyft has built a substantial infrastructure to support the rideshare business.
Imagine creating a business where the service is far better than legacy options, but the company now has a substantial infrastructure to support and charges less than the legacy services. In addition, the service remains under attack in California where the company is headquartered. Lyft and competitor Uber (UBER) might be forced to suspend services due to California court decisions to require the rideshare companies to reclassify drivers as employees with benefits. President John Zimmer was clear on the Q2 earnings call that this would lead to suspended services on August 21 in the state:
On Monday, the Superior Court of California granted a preliminary injunction motion filed by the state, which would force Lyft and Uber to reclassify drivers as employees in California. That injunction has been stayed until August 20, and we may appeal this ruling and request to further stay. If our efforts here are not successful, it would force us to suspend operations in California.
Again, the problem here is that Lyft spends billions in quarterly operating expenses to build the platform infrastructure at the expense of contributing to drivers’ income. The traditional taxi service didn’t offer this level of sophistication, but the rideshare companies failed to obtain higher fares for the higher quality service, causing this ultimate problem of being able to scale effectively.
Wait For A Catalyst
The company is now guiding towards reaching EBITDA positive by the end of 2021 with fewer riders. The guidance is definitely a step in the right direction as running a business with a previous $4.6 billion revenue target for 2020 without reaching an EBITDA positive number was truly disappointing.
The stock is down about 50% from the February highs, but Lyft still offers limited value. The market cap is still $9 billion and the company won’t reach meaningful profits until 2023 when revenues top $6 billion.
The ultimate risk is a world of AVs where the likes of Waymo (NASDAQ:GOOG) (NASDAQ:GOOGL) or Tesla (TSLA) again pressure the margins of the rideshare business by undercutting traditional trips with drivers. These firms could add a massive layer of competition to the sector where Alphabet and other tech giants have much stronger balance sheets to compete.
Lyft continues to have an intriguing delivery platform. The stock isn’t appealing until the company can figure out a better way to monetize the platform via premium services not so reliant on a driver costing over half of the fare. Like Uber, the company has to figure out how to pay for all of the marketing and technology spend before capturing a vast majority of the rideshare market.
The key investor takeaway is that Lyft continues to offer limited value with a business that doesn’t scale correctly. All while the business model is under attack in California and faces extreme competition in the future. At some point that Lyft figures out a catalyst to profitable growth, the stock could become a buy. Until then, avoid Lyft even 50% below the recent highs.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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