Cram Up and Uber's Competitive Advantage

Welcome to the twenty-sixth Pari Passu newsletter,

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Today, we will learn more about:

1. Cram Ups

2. Uber’s Competitive Advantage

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Cram Ups

In a cram down, a bankruptcy court ignores objections from a class of creditors and approves a plan of reorganization (typically filed by the debtor). In a cram up, the roles are reversed. Instead of the bankruptcy court imposing a cramdown on the debtor's behalf against a class of creditors, junior or subordinated creditors typically force terms of a reorganization on other, more senior creditors that may be holding up the reorganization. Suppose enough junior-class creditors agree to the terms set by a company seeking refinancing. In that case, they can force holdouts to be bound to the agreement, cramming up the refinancing. Senior creditors are forced to accept the terms, even if they are not as good as the original deal or if they continue to object. For this to happen, the bankruptcy court must find that the terms of the POR are fair and equitable. Cram ups are particularly useful for junior creditors who are dealing with a secured creditor who wants a quick sale of assets to recoup their investment and end the bankruptcy process quickly. This would result in enough proceeds to satisfy their own debt, but can reduce or negate a significant recovery for junior creditors.

Indubitable Equivalent Cram Ups and Requirements

Indubitable equivalent cram ups utilize section 1129(b)(2)(A) of the Bankruptcy Code. This section details the allowance of the confirmation of a POR over the objection of a class of secured creditors.

Section 1129(b)(2)(A)(i) outlines one set of requirements for the approval of a POR by a bankruptcy court over the objections of an impaired class. Under this section, for a POR to be confirmed, the secured creditors must:

1. Retain their liens. This means that they will not lose their legal right to the collateral or assets which secure the debt that they are owed.

2. Receive deferred cash payments

   1. If the total amount due to the creditors is less than the value of the collateral, the deferred cash payments will have a present value equal to the amount due. This means that the creditors will receive the full amount owed to them over time.

   2. If the value of the collateral is less than the total amount due to the creditors, the deferred cash payments will have a present value equal to the value of the collateral. The creditors will receive payments equivalent to the collateral's value over the payment period.

However, debtors seeking to utilize this bankruptcy code section may encounter difficulties. The statute stipulates that secured creditors must maintain their liens, which can make it difficult for a reorganized debtor to use its assets as collateral for its working capital needs. This type of indubitable cram-up is similar to a reinstatement cram-up, with a key difference being that the terms of the debt will typically be amended. An alternative section in the bankruptcy code that can be utilized for a cram up section 1129(b)(2)(A)(iii), which states that a bankruptcy court may approve a POR if it provides a secured creditor with the "indubitable equivalent" of its secured claim. "Indubitable equivalent" is not explicitly defined in the bankruptcy code, but court precedent and legal scholars have arrived at a rough definition of "the unquestionable value of a lender's secured interest in the collateral."

DBSD Cram Up

DBSD was a satellite communications company that filed for Chapter 11 bankruptcy in 2009. During the bankruptcy proceedings, DBSD sought to implement an indubitable equivalent cram-up plan to restructure its debt and emerge as a reorganized company. Before filing for bankruptcy, DBSD had a $51 million first-lien working capital facility with a 13-month term. A working capital facility provides short-term financing to help cover a company's operational and day-to-day needs. The first-lien status of the loan means that the lender had the priority claim on any assets or collateral the loan was secured by. In this case, the lien was on substantially all of DBSD's assets, meaning it had priority over almost all other creditors in the event of a bankruptcy filing.

During the bankruptcy case, one of DBSD's second-lien noteholders purchased the first-lien claim from the original holder. This purchase granted the lender enough voting power to acquire a blocking position for any DBSD Chapter 11 plan. Typically, for a plan to be accepted by a class of creditors, it must be approved by a majority in number and two-thirds in dollar amount of claims. Essentially, this purchase gave the creditor enough power to reject any plan of reorganization put forward by the debtor.

The Plan of Reorganization

DBSD’s POR proposed that this first-lien creditor would receive the "indubitable equivalent" of its claim in the form of an amended loan facility. This means that instead, the original loan agreement would be modified to allow the debtor to continue to operate and fulfill its debt obligations while providing equivalent value to the lender. In DBSD's case, the proposed loan had a four-year term and payment-in-kind ("PIK") interest at 12.5%. PIK interest is when the interest on a loan is added to the principal, compounding over time, and paid at a later date rather than cash. This is often useful when a company needs to restructure or amend its debt terms but does not have the cash flow to make the interest payments. Typically, in restructuring cases, it is assumed that when the principal becomes due, the company will be out of its financial distress and able to either pay off or refinance the loan. Just like the original first-lien loan, the new loan facility between DBSD and the first-lien creditor would be secured by substantially all of the reorganized company's assets.

The Result

The POR was approved by the second-lien creditor class and the unsecured creditors' committee (which represents the interests of all unsecured creditors) but was objected to by the first-lien creditor. The bankruptcy court concluded that the plan provided the first-lien creditor with the indubitable equivalent of its claim. As a reminder, section 1129 establishes that if the total amount due to a creditor is less than the value of the collateral, the deferred cash payments must have a present value equal to the amount due.

Following this requirement, the court explained that:

1. The first-lien creditor's claim was comfortably over-secured because the value of the collateral given to the creditor in the POR vastly exceeded the face amount of the claim.

2. The 12.5% PIK interest rate was appropriate for the four-year amended loan facility, given the prevailing low-interest rates on treasury securities.

This is a great example that shows how the use of cram ups can facilitate a restructuring process and prevent one party to destroy value just to maximize their returns.

Uber’s Competitive Advantage

Today, we are going to learn about the four types of competitive advantages through Acquired’s June 2023 interview with Uber CEO Dara Khosrowshahi.

Khosrowshahi, previously the CEO of Expedia Group, took the top spot after Travis Kalanick’s dishonorable departure from the company he founded in 2017. Khosrowshahi spearheaded Uber’s transformation from the scandal-embroiled, hemorrhaging startup to the profitable (on an adjusted EBITDA basis), dominant American rideshare player that it is today. Some of the initiatives he has taken to do this include divesting all business dimensions besides rides and eats, adopting country-specific operating models, and optimizing Uber’s take rate to improve the driver and courier experience.

Concept Overview

A competitive advantage is a strategic process or position owned by a company that allows it to produce its products or deliver its services better than its peers. The four types of competitive advantages include price, lead time, variety, and quality. Most successful companies can only hold a competitive advantage in one of these types; this is quality in the case of Uber today. Trying to outpace competitors in more than one of these categories generally translates to doing neither well (take Jet.com, for example). Amazon is arguably one of the few companies that compete across multiple competitive advantages, which include lead time and variety (along with service and price in certain business lines). You can read more about Amazon in last week’s newsletter here.

Price

Uber does not seek to compete on price and claims that it does not control prices internally. Khosrowshahi explains that when the economy is on an upswing, it becomes difficult to recruit drivers and couriers, causing the acquisition cost to increase. Simultaneously, however, demand for transportation and meal delivery increases, causing the cost of service to increase. Thus, prices are pushed higher. When the economy is in a downturn, more drivers and couriers seek work on the platform, flooding the supply base, and decreasing acquisition costs. Meanwhile, demand decreases, easing service costs and pushing prices lower. In the words of Jonathan Hall, Uber’s Chief Economist, the marketplace, not Uber, sets the price for rides and eats based on the supply of labor and the demand for transportation and meal delivery.

If you are wondering why your typical Uber ride has become more expensive, Khosrowshahi asserts that this is because of economic dynamics, like inflation, increases in the cost of labor, and greater demand. If Uber were to initiate fare increases, more drivers and couriers would come to the platform. Demand for rides and eats would decrease at a higher price, causing drivers to complete fewer rides and deliveries in their hours worked. Drivers would then leave the platform, pushing fares back down to their original rate. The same works in reverse. Any internal Uber pricing initiative will be overridden by the invisible hand of the market.

In regards to price, Khosrowshahi also discusses his quest to drive Uber’s take rate down following the oversupply of drivers that he inherited as CEO (fun fact: this promotion was made by the recommendation of Spotify founder, Daniel Ek). The take rate is the amount of money that Uber earns from a ride or meal delivery transaction, which currently sits at 20% and 30%, respectively. As Expedia’s CEO, he took the take rate down from 25% to 17%, in comparison to Booking.com’s take rate of just 15%. He explains that this taught him to ensure that all operations are incredibly efficient, automate as much as possible, and eliminate fraud. He urges operators to avoid using the take rate as a means of delivering on the bottom line, as this is purely a means of temporarily inflating margins. It is unsustainable quarter-over-quarter and makes you too vulnerable to competitors, who will attract drivers with any lower take rate.

Lead Time

Similar to price, lead time is determined by driver and courier supply, not by Uber internally. Thus, beyond attracting and retaining quality drivers, it is not something that Uber attempts to compete upon. Uber’s supply acquisition cost outpaces its demand acquisition cost, and Khosrowshahi describes that Uber’s growth is supply-led. This means that attracting and retaining reliable drivers is what will drive customers to Uber’s platform in the long term. Khosrowshahi also asserts that as an open platform, Uber will not cap the supply of drivers and couriers, even if the decision not to do so makes working for Uber less attractive to them.

However, Khosrowshahi repeatedly focuses on the importance of improving the driver experience. During the pandemic, Uber’s volume of rides fell by 85%. Khosrowshahi explains that Uber’s focus on bringing drivers back to the platform helped it outpace Lyft and reverse the loss in market share that it incurred prior to the pandemic. Today, Uber is the world’s largest earner platform and generally matches 1:1 in many taxi markets, which have a total of 4.5mm drivers. In markets where Uber has mixed demand (an UberX request can return an UberX car or a taxi), the marketplace is more liquid, and lead times generally decline.

Variety

Khosrowshahi speaks at length about the competitive advantage of variety in the context of UberEats vs. DoorDash. DoorDash is the dominant player in the meal delivery market, which Khosrowshahi attributes to its early decision to cater to the suburbs and expand restaurant selection (variety). In contrast, UberEats focused primarily on the urban customer and restaurants that would deliver food quickly (lead time). Uber’s urban biases, fueled by its reliance on cities for Uber rides, blinded them to the overall market, in which the suburbs constitute a larger portion of the meal delivery market than urban areas. Khosrowshahi claims that this decision has largely been corrected now by focusing more on rides in urban areas, eats in suburbs, and building out the selection, rather than the speed or price, within their restaurant portfolio.

Some of Uber’s latest expansions in terms of variety of rides include taxis, two-to-three wheel options, Uber for Business, and Uber Health. Uber’s divestments demonstrate that the company does not seek to compete on variety. Two-to-three-wheel options include the divested bike and scooter options, as well as Uber motorcycles and recent forays into custom autonomous vehicles. Uber for Business provides a platform for corporations to manage business travel and meal programs. Uber Health provides non-emergency healthcare transportation in an effort to reduce barriers to care, decrease healthcare costs, and improve outcomes.

Quality

Khosrowshahi comments that determining what was truly core to Uber’s operation was the focus of his CEO pitch to Uber’s Board. Refining the quality of these selected dimensions is what ultimately drove Uber from losses exceeding $2.5bn to something closer to profitability and is the competitive advantage that it competes upon today.

Once UberEats got to scale, Khosrowshahi merged the functional teams for the rides and eats applications, creating a seamless and consistent user experience and more freedom for drivers. Today, the rides app is the most successful customer acquisition tool for UberEats, converting more customers and costing one quarter of what Uber pays to advertise on Meta’s and Google’s platforms. Khosrowshahi carefully considers how much space on the rides app should be deployed to eats initiatives in order to preserve the quality of the rides experience while leveraging this customer acquisition channel. Regulations for couriers are much more lenient than those for drivers. The crossover between rides and eats has also allowed UberEats to build a larger courier supply base and quickly increase the number of partner restaurants, further improving the quality of the customer and restaurant experience. Khosrwshahi also states that in light of legislation surrounding the gig economy, he feels a certain “duty of care” to consider the drivers that are making a living by spending hours on his app every day. UberEats allows drivers to start working and be paid very quickly. The faster that this happens, the faster that an UberEats courier will be converted into an Uber driver. This is important for Uber’s supply-led growth.

Today, Uber partners with 5.6mm drivers and 1mm restaurants. Khosrowshahi asserts that his biggest focus is quality at scale and comments that the future of Uber depends on building the best platform for earners. This quality extends to all types of transportation, including taxis in the near term and freight in the far term. On-the-ground operating teams make plans at the city level to ensure high-quality service in times of exceptional demand, and Khosrowshahi has made strides to build profit pools outside of the US. This is particularly the case in countries in which Uber’s standard operating model is illegal, like Germany, Spain, and China. Instead of trying to change legislation to accommodate Uber in these countries, Khosrowshahi has shifted his business model, reflecting a desire to build trust and a perception of quality surrounding the Uber brand. This paves the way for Uber to influence policymakers in these countries as operations in these countries grow.

Today, UberX accounts for 50% of growth. Uber’s taxi, two-to-three wheel options, Uber for Business, and Uber Health account for 35% of growth. International countries account for 15% of growth. Uber’s future will depend heavily on its ability to maintain and deliver quality across its total addressable market and appease shareholders through its financial performance and its navigation of regulation and competition.

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