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DiDi's IPO: Windfall for VCs but Bum Deal for Investors?
COVID-19 and China
Vehicles on road near buildings. Photo by Eepeng Cheong on Unsplash

Uber, which filed its S-1 in early April 2019, was expected to raise approximately USD 10 billion in a deal that could lift its valuation to USD 100 billion. Uber is currently aiming for USD 84 billion, or USD 91.5 billion on a fully diluted basis, though that number could change depending on demand. Its rival Lyft (NASDAQ: LYFT) is already traded in the public market since this March.

We expect the third ride-hailing public company to be the Beijing-based service provider DiDi Chuxing. The company is attempting to leverage its ride-hailing business and to tap into other growth opportunities from what we estimate to be a USD 422.2 billion addressable market by 2023. In our view, DiDi’s core competency of network effect could position the company to become profitable in the future.

We present the 44-page report featured DiDi, including a number of strong indicators of the company:

Significant addressable market: We believe that DiDi’s total addressable market comprises the global taxi, ridesharing, and bike sharing industries. Taking DiDi’s potential international food delivery plan into account, we also consider the share that ride-hailing companies can take from public transport. After that, we estimate DiDi's total addressable market to be USD 422.2 billion by 2023, growing at a 12% CAGR from 2017 to 2023.

Strong network effect: In our view, DiDi’s core competence of network effect could position the company to become profitable in the future. Here is how it works: a large supply of drivers enables more rides to be completed, which attracts more riders, making the entire platform more valuable for both sides in a virtuous circle. Each incremental rider and driver, in essence, creates a network effect.

However, we doubt whether DiDi can afford the high subsidy levels: Uber spent USD 1.2 billion in R&D expenses and USD 2.5 billion in sales and marketing expenses in 2017, representing 29.78% and 62.58% of the company’s net loss, respectively. DiDi, however, spent much more subsidies for drivers and riders in 2017 and 2018, accounting for 724% and 207.34% of the company’s net loss, respectively.

Self-driving cars have the potential to disrupt the market: overall, we see an upside potential to revenue and margins if self-driving cars become possible in the future. Although riding in self-driving cars would lead to a decreasing fare per ride, we believe it would eventually translate to an increase in total miles traveled and a decrease in overhead costs in drivers. Thus, increased net margin will offset the shrinking fare to drive profitability.

New competitors and authorities pose challenges: There are also risks, such as increased regulations and competition from companies with heavy-asset business model and OEMs. In addition, two safety scandals gave DiDi a tainted reputation and the PR pressure is likely to persist in the short run. A series of scandals and missteps have caught up Will and Jean, who was criticized for their failure to take the responsibilities after the DiDi Hitch killing issues. DiDi has failed to give out a strategic response with the speedy reaction for lack of PR talents. It’s time to slow down and chose a balance management style for CHENG Wei (Will) and LIU Qing (Jean).

DiDi is Expanding its business scope globally, in a modest way: DiDi invested USD 100 million in Lyft and USD 350 million in Grab, in 2015. DiDi also was involved in Ola’s USD 500 million investment in 2015. DiDi acquired 99 in a USD 1 billion deal in early 2018. In July 2017, DiDi injected USD 2 billion into Grab, along with SoftBank.

We estimate DiDi’s fair value:  The company once planned to go public during 2019 but remains low-profile for a very long time since last August. DiDi is now the second most valuable company globally, following Uber which has a valuation of USD 76 billion. However, such a high valuation will only make sense when DiDi grows at a double-digit rate or even more. If DiDi does not fit the bill going forward, it will raise concerns from investors. We project strong gross bookings for DiDi at a 25% 5-year CAGR through 2023, resulting in net revenue of USD 27.6 billion in 2023 (equivalent to USD 157.8 billion gross bookings in 2023). Based on our estimation and public data, we estimate DiDi to have a market capitalization of USD 69.6 billion by the end of 2019 in our bear case scenario, which is approximately 35% above the USD 51.6 billion valuation implied by Uber’s prospectus.

Our methodology: we analyzed DiDi's key operational data, management guidance and outlooks, interviews with experts in the industry, and DiDi’s former employees. We broke down DiDi's businesses, the costs, and revenues of its core ride-hailing business, the competitive landscape the company is facing, the future bets the company is making, and how all of these tie into DiDi's high-growth story.

Early investors who firmly believed in DiDi's vision and seemly unlimited growth opportunities used to see a clear path to exit before the company's IPO, since rounds of financing are pushing up the valuation. However, it might take years for us to tell whether it would be a windfall for its early investors and VCs like Matrix China (invested in Kuaidi), Softbank and Tencent or it is a bum deal for investors to buy DiDi’s shares on the public market.

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