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April 27th, 2017

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What the Saudi $3.5 billion stake in Uber means for the unicorns

Megan McArdle

By Megan McArdle Bloomberg View

Published June 3, 2016

Uber has accepted a giant investment from Saudi Arabia's sovereign wealth fund. This $3.5 billion dwarfs most private equity investments, and brings Uber's fundraising total to $11 billion. The fund will be taking a board seat alongside other digital and finance luminaries.

Let's look at a few of the questions this instantly raises.

What will this mean for Uber? Is there a downside to taking this money?

The company has already come in for some criticism. The optics are terrible: a cosmopolitan company accepting money from a country that won't let women drive. But color me skeptical that this criticism will matter much. Travis Kalanick, Uber's CEO, has time and time again proved himself spectacularly uninterested in optics unless they affect his bottom line. And I doubt that many consumers will remember or care that Saudi Arabia has invested in Uber. Six months from now, the sum total of people who think about this investment will consist of:

1. Uber employees

2. Financial analysts

3. People currently writing columns about the investment.

Few people are going to say "Well, I'd like to take an Uber, but gee, not until women can drive in Riyadh." The small number of consumers who do won't affect the company's bottom line.

Meanwhile, Uber has another $3.5 billion dollars that it can spend on sustaining below-market fares in an attempt to crush its competition out of business in as many cities as possible, and thereby reap the gains of a winner-take-all market. This worries Timothy B. Lee, who writes on the Vox website that blowing a lot of investment capital on price wars doesn't actually do much to increase the net productivity of the global economy. It worries other people who think that winner-take-all markets are terrible, and fear that someday we'll all be renting water and air by the hour from Travis Kalanick.

These things do not worry me overmuch. Brutal price wars aren't exactly what you think of when you imagine productive investment, but to the extent that a single global ride-sharing service is a lot more efficient than dozens of local ones (entirely possible), the brutal price wars might actually result in productivity increases.

Meanwhile, if we do end up with Uber owning the global market, I suspect that we (and Kalanick) will find that this position isn't quite as powerful as it sounds. The most efficient scale of national telephone service provision in the 20th century was probably a single provider, but that didn't result in the ultra-powerful AT&T being able to do whatever it wanted, under threat of shutting down communications; it resulted in the company becoming a tightly regulated utility.

However, since the barriers to entry for building a ride-sharing app are considerably lower than the barriers to entry for building out a national telephone network, I'm skeptical that Uber will ever end up with anything like that much market power.

Why is Saudi Arabia doing this? My initial theory was "because the money is running out." The the New York Times says the sovereign wealth fund has until now not been known for venture-capital investing. Now it's buying one of the biggest-ever stakes in a unicorn farm. On its face this looks like a "reach for yield" -- taking on higher-risk investments to avert catastrophic downsides.

Saudi Arabia's current budget is estimated to require an oil price of about $100 a barrel to break even. We can't rule such prices out in the future of course, but fracking makes them less likely: There's now a lot of expertise and capital floating around, so the minute prices shoot skyward again, we can expect new capacity to come online.

(This was roughly the problem Saudi Arabia faced in the mid-1980s, when OPEC's initially successful supply restrictions encouraged both cheating by members and investment in new drilling capacity outside of OPEC countries.)

In such financial straits, investors are often motivated to "reach for yield."

But then I talked to Omar Al-Ubaydli, an economist and program director at the Bahrain Center for Strategic, International and Energy Studies and a research fellow at the Mercatus Center in Virginia. He pointed out that while $3.5 billion is a lot of money for us, and for Uber, it's almost pocket change for the Saudi government. He sees this as an investment in moving the Saudi economy beyond oil -- a well-documented priority.

"The gulf economies are very strange," says Al-Ubaydli, himself a Bahraini national. The Gulf States have historically had only two major domestic sources of income: oil and religious pilgrimage.

The gulf states are now trying to change that, and Al-Ubaydli suggests that putting money into Uber, and taking a board seat, gives them a leg up at building a stronger private sector through similar decentralized applications, allowing Saudis -- particularly women, who are less mobile for cultural and legal reasons -- to begin to move the country beyond its dependence on oil revenue.

It's an odd thought, trying to build up the private sector with a targeted investment from the state wealth manager. But given the strange nature of gulf economies, there's little alternative.

"The normal principles you're used to deploying in a traditional economy don't work," Al-Ubaydli says. "I agree it's a bit ironic, but trying to shift an economy that's so dependent on oil, you have to think outside of the box."

What does this mean for the rest of us? Well, for starters, you can enjoy your lusciously cheap fares for a while longer, courtesy of Saudi oil wealth, especially if you live in an area where Uber is fighting a strong competitor.

I'm pretty skeptical that this is going to revive the fortunes of the "unicorns" (startups valued at more than $1 billion). Those valuations have taken something of a hit in recent months, as investors started looking hard at which companies really had the cash flows, or market potential, to justify that kind of price. Uber is, pardon me, the uber-unicorn, and I've heard some suggestion that this huge investment might put a bit of juice back into the unicorn bloodstock auctions.

But Uber is unique among unicorns. First of all, it has more potential for disruption of an economically central activity than most of the other unicorns, which is why it's been able to raise so much money. Its business model doesn't necessarily translate to a lot of other businesses, or at least not so profitably. Also, there aren't all that many Saudi wealth funds floating around; the fact that one very rich nation was willing to make one very big investment in one spectacularly successful startup does not mean that others are going to follow suit.

The Saudi investment does raise questions about why so much capital is being poured into Uber's price wars, instead of into actually designing and building new stuff. The uncomfortable possibility is that there just aren't that many good, productive ideas about new stuff to design and build. If true, that's a problem. But not one that the Saudi investment will either exacerbate or solve.


Previously:


05/27/16: Hillary's server doesn't look like honest mistake
05/09/16: Welcome to the modern economy, where increasingly, everything not compulsory is forbidden
05/09/16: The four horsemen of the Republican apocalypse
04/21/16: Parents could go bankrupt simply trying to look adequate
04/18/16: Your assessment of the 2016 election is way off
04/13/16: Those tax 'loopholes' were created for a reason
04/01/16: Enlightened crybabies: Campuses can't become one big 'safe space'
03/16/16: A 'cashless society' is great until it's not
03/15/16: President Trump's revolution? Fear not
03/14/16: Trump's clumsy pivot to the general election
03/08/16: Trump too poor to stage a third-party run
03/07/16: We can all relate to Trump's policy tactics
02/25/16: Twitter can only lose when it polices abuse
02/09/16: Rubio faces the risk of going off script
02/08/16: Sanders and Clinton get substantive, and go wrong
02/03/16: 6 takeaways from an exciting night in Iowa
02/02/16: Trump fans should know he'll offend them next
01/04/16: Obama: Dreamer or irresponsible luftmensch?
12/21/15: Sheltered students go to college, avoid education
12/17/15: Trump disproves liberal and conservative myths
10/28/15: Preschool Helps Kids. Sometimes. Briefly.
10/26/15: If you like truth, don't watch the movie 'Truth'
10/21/15: Turns out timeless cliches and the Beatles understood the 2016 election season before the rest of us did
02/09/15: Reading the tea leaves for 2016 gets you nowhere
02/02/15: Hillary's late start won't stop punches

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Megan McArdle is a Bloomberg View columnist who writes on economics, business and public policy. She is the author of "The Up Side of Down." McArdle previously wrote for Newsweek-the Daily Beast, the Atlantic and the Economist.

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