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As California’s AB5 Becomes Law, Uber’s Path to Profitability Just Got More Complicated

Uber Technologies (NYSE: UBER) was one of the most anticipated IPOs of last year. Many investors felt that the company's strong position in the ride-hailing industry would turn into meaningful returns on the stock market. However, things haven't gone that way, at least not yet. At writing, Uber's stock is down by 18% from its $45 IPO price. One reason behind this lackluster performance has been the red ink on Uber's bottom line.

Although few people expected the ridesharing giant to turn a profit in its first year as a publicly traded company, the pace at which Uber has been losing money is dizzying. During the third quarter, Uber's net loss was $1.2 billion, and that was significantly better than the company's $5.2 billion net loss recorded during the second quarter. Unfortunately for Uber, a new California law dubbed AB5 makes it harder for the company to classify its drivers as independent contractors, and its road to profitability isn't getting any easier.

Image source: Getty Images.

What AB5 is all about

Gig workers -- i.e., independent contractors like Uber drivers -- aren't entitled to receive many of the benefits full-time employees enjoy. These benefits include paid time off, sick days, a minimum wage, and unemployment insurance, among others. However, California's AB5, which was signed into law last September and took effect Jan. 1, makes it harder for Uber to classify its drivers as independent contractors. AB5 outlines three conditions that companies must meet to classify those working for them as independent contractors:

  • The worker must be free from the direct control of the company.
  • The worker must perform tasks that are outside the company's core business.
  • The worker must be "engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed."

Uber, as well as its rival Lyft (NASDAQ: LYFT) and other companies in the gig economy such as GrubHub (NYSE: GRUB), have vehemently opposed this law. After all, for Uber, having to reclassify its drivers as fully fledged employees would mean these drivers are entitled to the benefits being an employee typically comes with. Providing such benefits to thousands of contractors-turned-employees would drastically increase Uber's expenses.

Profitability is nowhere in sight for Uber

During Uber's third-quarter earnings conference call, CEO Dara Khosrowshahi announced the company's plans to become profitable by 2021. However, that comes with a major caveat: Khosrowshahi was only referring to Uber's earnings before taxes, expenses, depreciation, and amortization (EBITDA) being in the green. The company has no timeline (that we know of) for when it will record a net profit.

And with AB5 taking effect, the company's expenses will likely rise, which could make it even more difficult for Uber to become profitable. Note that other states, such as New York (New York City is Uber's largest ridesharing market), have been exploring the possibility of enacting similar laws. New York City even imposed some restrictions on the company, including a minimum driver wage. In other words, the regulatory landscape isn't getting any easier for Uber, and that may well affect the company's ability to become profitable.

Will Uber turn things around?

Despite all the problems Uber is facing, some may argue that given its leading position in the ride-hailing market -- as well as its food delivery app Uber Eats -- the company could well turn things around. However, Uber is losing money at a fast clip, and given the worsening regulatory conditions, Uber likely won't be consistently profitable anytime soon. For those reasons, I think it's best to stay on the sidelines for now, especially as there are plenty of exciting growth stocks to consider buying.

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Prosper Junior Bakiny has no position in any of the stocks mentioned. The Motley Fool recommends Uber Technologies. The Motley Fool has a disclosure policy.


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