PAY – The “Uber” Strategy for Licensed Taxis

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SEE LAST PAGE OF THIS REPORT FOR IMPORTANT DISCLOSURES

Howard Mason

203.901.1635

hmason@ssrllc.com

September 16, 2015

Re: PAY – The “Uber” Strategy for Licensed Taxis

“Uber has got quite a healthy valuation and you see medallion prices dropping in certain parts of New York. I actually think it is very short sighted … that [Uber] experience, from a technology point of view, is relatively easy to create in taxis … Any place where you see taxi fleets you’re going to see Verifone.” PAY CEO Paul Galant, March 2015

  • Verifone (PAY) and Creative Media Technologies (“CMT”) enjoy, with similar market shares, a license duopoly in equipping yellow and boro (green) cabs in New York with in-car payment terminals. Both offer open, cloud-based APIs allowing third-parties permissioned access to these terminals to, for example: (i) read the metered rate and transport payment credentials[1]; (ii) improve fleet management (by, for example, checking that boro taxis do not pick up in the yellow zone below W110th and E96th streets); (iii) enable app-based booking and dispatch via “e-hail” systems such as Uber; and (iv) prospectively use GPS and passenger information to personalize advertising messages on in-car digital media (i.e. terminal screens and, increasingly, taxi-top displays as they are upgraded to digital from static media).
  • PAY has developed its own native apps, including the “hail-and-pay” Way2Ride app which does for licensed taxis what uberX does for private-cars (except that there is no surge pricing since it charges the metered rate plus a nominal booking fee) and which was officially launched by the NYC taxi-system last Thursday after a pilot. While Way2Ride so far has little consumer adoption (with the TLC[2] reporting that from Jun-2013 through Nov-2014 e-hails accounted for only 0.39% of yellow-cab pickups), the taxi payments processing and media business at PAY, anchored by the NYC market, is large generating ~$120mm in annualized revenue (our estimate and out of firm-wide revenue of ~$2bn) and accounting for ~10% of firm-wide revenue growth in 2014[3].
  • We expect this contribution to increase as the taxi-solutions business grows low double-digits[4] for the foreseeable future (versus high single-digits for firm-wide revenue). A key driver is the new e-hail capability of the Way2Ride app which will replace phone-dispatch for taxis where street-hail is less practical than in NYC (just as mobile order-ahead is replacing phone-in orders at QSRs). This is increasingly a table-stakes capability for fleet-owners to reduce the risk of driver attrition to Uber and gives PAY an edge in pricing power in cities where it already operates[5] and in expanding its fleet-footprint both in the US and globally. Already, we estimate that near-half of taxi-solutions revenue is from value-added services, as opposed to core payments processing, albeit largely driven by digital-media revenue rather than app-based streams.
  • While PAY’s open API means that third-party apps can provide hail-and-pay capabilities (as, indeed, Hailo did in NYC but pulled out of the US in October 2014), its advantage with fleet-owners over Uber is a commitment to work only with licensed taxis and not open its app to private-cars. This allays a key concern of fleet owners that, in adopting e-hail apps, they are trading control for distribution – more specifically that open apps can steer taxi-customers (where they earn only a nominal booking fee of $2 in the case of Uber) to private-cars (where they earn a cut of the farebox equal to 20% in the case of Uber). Indeed uberT, Uber’s hailing app for taxis, uses the opportunity of interacting with taxi customers to market uberX, Uber’s hailing app for private-cars, as the “low-cost uber … with rates cheaper than a NYC taxi”.
  • We see PAY’s payment-terminal business as enabling incumbent taxi systems to compete against disruptors such as Uber through app-and-wheel strategies in a similar way that, as discussed in our note of September 6th titled “PAY – The ‘Apple’ Strategy for Merchant Devices”, PAY enables incumbent physical retailers to compete against digital players such as Amazon through app-and-mortar strategies. The resulting secular expansion of PAY’s addressable market supports long-run revenue growth in the high single-digits, and after operating and capital leverage, EPS growth in the mid-teens. As these secular effects become more visible relative to the short-run changes in revenue-timing associated with the EMV-upgrade cycle in the US, we expect the stock to trade at a 10% earnings multiple to the S&P500 versus the current discount (see Chart).

Chart: NTM Forward P/E for PAY (red) versus S&P500 (blue)

Overview

This note, “PAY – The ‘Uber’ Strategy for Licensed Taxis” is a companion-piece to our note of September 6th titled “PAY – The ‘Apple’ Strategy for Merchant Devices” with both focusing on the secular opportunities for the company in enabling incumbents, whether physical retailers or registered taxis, to respond competitively to digital disruptors through app-and-mortar and app-and-wheel strategies respectively. As shown in the preferences below, PAY is one of our favored names.

Traditionally, the defining characteristic of the vehicle-hire business, from the early use of Venetian gondolas[6] in the eleventh century until the official launch of the Uber app in June 2010, is that curbside negotiation of rates is impractical and dangerous. The result is that rates either have either been regulated (as is the case with the meter-rates of street-hailed taxis) or negotiated in advance through a booking process (as is the case with private cars). Having been established to regulate rates, taxi-licensing organizations, such as the Taxi and License Commission (TLC) in New York and the Public Carriage Office in London, extended their mandates to include rate-monitoring, safety, and service. Licensed taxis may typically not overcharge or refuse service, for example, and in the case of London black-cabs must be operated by drivers demonstrating an encyclopedic knowledge of local streets referred to as “The Knowledge.”

Mobile apps such as Uber undermine a key element of the taxi-licensing framework by enabling practical negotiation of rates, given pick-up and drop-off locations, as part of a near real-time electronic hailing process. A key issue for regulators, as well as drivers and fleet-owners, of registered taxis is whether this constitutes pre-booking (in which case private cars can participate in Uber) or street-hailing (in which case participation by private-cars violates taxi regulations at least in New York)? On September 9th, Queens Supreme Court Justice Allan Weiss ruled[7] that e-hailing is not the same as street-hailing so validating Uber’s use of private-cars. This introduction of private-cars into near real-time hailing fundamentally changes the economic protections afforded to registered taxis by the licensing process.

Specifically, the taxi-licensing authority loses its ability to control the supply of drivers that can service street-hail demand albeit with some latency[8]. Absent municipal involvement, perhaps motivated by a desire to manage traffic congestion, the only limit to this supply is the ability of Uber and other e-hail app providers in recruiting drivers; in NYC, for example, there are now more than 19,000 Uber-affiliated vehicles versus just over 13,500 yellow cabs. The resulting loss of scarcity value likely explains why yellow-cab medallion prices have fallen meaningfully more than taxi-revenues and the focus on Mayor de Blasio’s decision[9] last Wednesday to drop plans for a cap on the number of Uber-enabled vehicles in the City. The latter also illustrates the advantage Uber derives from cheap capital for lobbying in almost unlimited quantities relative to the resources of local fleet-owners.

Without legal or municipal protection, fleet-owners of licensed taxis need to mount a competitive response to Uber. As discussed below, Verifone is a table-stakes element of this after New York taxis announced last Thursday the system-wide launch of its integrated hail-and-pay app, Way2Ride which does for registered taxis what uberX does for private-cars (except that there is no “surge-pricing” during busy or wet periods in Way2Ride which follows metered rates aside from a nominal and flat booking fee).

Uber – Category Killer for On-Demand Transportation

The core conflict in the market for on-demand transportation is between, on the one hand, companies like Uber seeking to build a consumer brand (starting with the app-based booking and dispatch of passenger cars but already extending to delivery vehicles) and steer consumers to service-providers that maximize platform economics; and, on the other, service-providers such as medallion fleet-owners in New York City seeking to maximize their own economics and, in particular, maintain price protection and limit driver-supply. uberT, Uber’s ride-hail app for taxis, provides an example: Uber collects only a $2 booking fee (rather than 20% of the fare as with uberX its ride-hail app for private cars) but, having persuaded some taxi-drivers to participate, uses the opportunity of interacting with taxi customers to market uberX as the “low-cost uber … with rates cheaper than a NYC taxi”.

The early wins have gone to Uber first because of cheap capital (it has raised $2.2bn over the last 14 months, on negative earnings of $150mm in 2014H1 with the latest $1bn round in June at a valuation of $51bn[10] or 25x expected 2015 revenue of $2bn up from $400mm in 2014[11]). Uber has used the funds to lobby for favorable treatment, drive down consumer prices by 20% in key cities, offer guarantees for new drivers and drivers who participate only in Uber, and commit to invest $1bn each in China and India by end 2016Q1[12]. A result is that Hailo has withdrawn from North America and the $150mm funding round by Gett in August 2014 looks light.

The broader picture is that investors are betting Uber can establish itself as the go-to consumer brand and secure wheels-on-the-street leadership, leaving fleet-owners of registered taxis with no choice but to participate, and hence further engaging network effects; these network effects are already in evidence in certain customer segments including US business travelers among whom Uber accounted for over one-half of ground transportation receipts in July[13]. Collectively, fleet owners understand the threat: that if Uber is able to brand the taxi-booking experience, it can steer customers to private-cars. But, individually, they can reduce driver attrition to Uber by participating in uberT, Uber’s ride-hail app for registered taxis. The catch is that Uber takes the opportunity to market uberX, its ride-hail app for private cars, as the “low-cost uber … with rates cheaper than a NYC taxi”.

A second advantage enjoyed by Uber is that incumbent taxi-fleets have been slow to respond with service improvements as a result of the endowment effect of ascribing more value than warranted to regulatory protection. The result of this complacency has been striking: in NYC, the Taxi and Limousine Commission (TLC) reports 19,000 Uber vehicles[14] versus 13,500 yellow cabs which, for the year through May 2015[15], have seen a 10.9% decline in daily trips to 424,437 and 6.4% decline in daily farebox totals to $7mm. The urgency of a competitive response is further indicated by a 25% decline in medallion values[16] since the June-2013 peak, driver-attrition to Uber, and a Court ruling on September 9th that e-hailing is pre-booking (so allowed for private-cars) and not a street hail (restricted to yellow and boro’ taxis).

Verifone as Uber for Licensed Taxis

Fleet owners in NYC acted last Thursday with the formal system-wide launch of “hail-and-pay” capabilities provide by Verifone (PAY); PAY’s app does for taxis what uberX does for private-cars. It is an important win for PAY whose taxi-solutions business, anchored by the New York market, generates annualized revenue that we estimate at $120mm (out of a firm-wide total of ~$2bn) and contributed over 25% of firm-wide revenue-growth in 2014. We note that, given exclusive licenses to accept in-taxi payment, Verifone (PAY) and Creative Media Technologies (CMT) are the only vendors[17] that can app-integrate hail-and-pay; PAY’s Way2Ride app (previously enabled for payment only, not e-hailing) was selected along with CMT’s dual approach using its RideLinQ app for payment integrated with a third-party app from Arro[18] for e-hailing. (Uber enables e-hailing for taxis through uberT. However, Uber solutions cannot accept in-app payment, or even digitally access the metered rate, without integrating via an API with the licensed payment apps of PAY and CMT; in practice, Uber has not accessed the APIs so that, unlike with uberX for private-cars, passengers must pay the driver at the end of an uberT taxi-trip using a card or one of the two licensed apps).

Beyond the passenger convenience of integrating hail-and-pay for taxis in a single app, PAY was almost surely selected because it has aligned with exclusively with taxis. CEO Paul Galant has emphasized this on a number of occasions saying, for example, that “we deal with registered taxis, the yellow cabs, the green (i.e. boro) cabs; we typically don’t touch anyone who does not have a medallion[19]” and adding, more pointedly, that “we also don’t have the legal issues, the breaking the covenant of how the transit authorities and the commissions deal with those. We’re dealing with a population of drivers that are doing it by the rules.” After the experience of Hailo, which adopted a similar positioning with London black cabs and violently[20] lost their support after applying for a license to open its service to private-cars, we expect PAY to maintain a closed-system for registered taxis. The risk is that registered taxis continue to lose share so that the payment processing currently handled by PAY migrates to Uber’s payment processor (PayPal’s Braintree). The opportunity, as CEO Paul Galant puts it, is that fleet-owners approach PAY and say “help us build Uber-like capabilities that consumers can use”.

Verifone’s Value-Added Taxi Solutions

PAY has been clear that the taxi business works economically on processing revenues alone, but that value-added solutions and particularly digital media provide positive optionality; in practice, we estimate that these value-added solutions generate about half of the annualized $120mm revenue for the taxi-solutions business as follows. The average daily farebox for yellow cabs in New York is ~$7mm translating to payments-processing revenue for PAY of ~$40mm given its 50% share of market (in a duopoly with CMT) and assuming an average processing fee of 3%. Even allowing for a combined contribution of $20mm from other North American and from overseas, this suggests PAY is making approximately one-half of revenues from value-added services over and above core payments processing. While app-based streams (such as PAY’s share of the booking fee for e-hails on Way2Ride) will emerge over time, fleet-management solutions and digital media currently represent substantially all of the value-added solutions revenue for now.

The backbone of PAY’s digital media business is the VNET media platform which displays content such as local news, weather, traffic, and public service messages along with paid advertising and coupons, and is deployed in taxis, at gas-dispensers, and in retailers participating in Verifone’s PAYmedia couponing program and LiftRetail suggestive-selling program (for basket-level targeting of media content at convenience stores). The obvious advantage of these deployments is that customers are captive particularly in the case of a taxi journey which PAY reports lasts an average 18 minutes among PAY-equipped vehicles. The obvious opportunity is to target media content more precisely based on taxi-location and any passenger-information that can be inferred from interaction between the Way2Ride app (which will have personally-identifying information as a result of payments registration) and the in-car hailing or payment systems.

PAY monetizes VNET as it is engaged by advertisers (typically through ad agencies since it does not design third-party media content) to display their advertisements. Unfortunately, PAY does not break out the revenue from its digital media business but we believe it is growing rapidly; one indication of this is that the rent expense for non-cancelable operating leases (which is paid to fleet owners in return for the right to place advertising in or on taxicabs) has grown at 15% annually since 2012 and stood at $36.4mm in 2014. We expect this growth to continue as PAY improves the effectiveness of VNET advertising through adding capabilities to customize advertisements based on GPS location and personally-identifying information from customers using the Way2Ride app. As CEO Paul Galant puts it “these screens have paid out very handsomely in New York [and] they will pay off more handsomely over time”.

Final Page

  1. Including paying with American Express membership-rewards points launched in October 2013
  2. NYC Taxi and Limousine Commission – http://www.nyc.gov/html/tlc/downloads/pdf/ehail_q5_report_final.pdf
  3. In its 10K, PAY reported a $14.8mm increase in Services net revenue from North America taxi solutions with firm-wide revenue up $167mm to $1.87bn.
  4. The North America segment, currently contributing substantially all taxi-solutions revenue, grew 14% in the June-reported quarter.
  5. PAY reports that its taxi payment solutions are currently deployed in New York City, Philadelphia, Boston, Chicago, Las Vegas, Miami, Baltimore, Washington D.C. and Fort Lauderdale and that it has recently won mandates in Istanbul and Cancun.
  6. http://ed.ted.com/lessons/corruption-wealth-and-beauty-the-history-of-the-venetian-gondola-laura-morelli
  7. http://www.crainsnewyork.com/article/20150909/BLOGS04/150909863/judge-rules-on-taxi-industry-lawsuit-compete-with-uber-or-die
  8. Of course, near real-time is not real-time so there will be a segment of customer preferring a traditional street-hail over an e-hail for its immediacy provided licensed cars are available; in busy or wet periods, the advantage of a street-hail over an e-hail diminishes.
  9. http://www.nytimes.com/2015/07/23/nyregion/de-blasio-administration-dropping-plan-for-uber-cap-for-now.html
  10. http://www.wsj.com/articles/uber-valued-at-more-than-50-billion-1438367457
  11. The WSJ has reported that Uber made over $400mm in 2014 generating losses of ~$150mm in the first half in part because of discounts to new passengers and rewards to new drivers.
  12. http://www.wsj.com/articles/uber-to-invest-1-billion-in-india-1438314294
  13. https://www.certify.com/PR-2015-07-16-Certify-Releases-Q2-2015-Report-on-Business-Expense-Trends
  14. http://www.nytimes.com/2015/07/17/nyregion/city-hall-and-uber-clash-in-struggle-over-new-york-streets.html?_r=0
  15. http://www.wsj.com/articles/rough-road-ahead-for-new-york-citys-yellow-taxis-1437698764
  16. To $767,000 for an independent unrestricted medallion and $925,000 for a corporate unrestricted medallion as of June 2015
  17. As of September 2014, these licensed apps are interoperable so that a consumer using PAY’s Way2Ride can pay in taxis with a CMT in-car terminal and a consumer using CMT’s RideLinQ app can pay in taxis with PAY terminals.
  18. http://www.crainsnewyork.com/article/20150827/BLOGS04/150829899/meet-the-taxi-industrys-last-best-hope-to-survive-uber-age
  19. PAY CEO Paul Galant in May 2015.
  20. http://www.bbc.com/news/technology-27517914
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