Critics who question the value of private equity funds point to how they can sometimes inflate their internal rate of return with numbers that don’t accurately show how their underlying investments are performing. While that could certainly dull the allure of PE investments, a similar problem could be seeping into the public markets through start-ups going public.
The problem can be traced to Uber, Lyft, and many other disruptive companies starting to enter the US public equities market. Saddled with financial statements that show historic monetary losses, they have come up with “unusual alternatives for measuring their performance” in a thus-far vain attempt to win over investors, reported The Wall Street Journal.
“The ride-hailing rivals have struggled after debuting on the public markets with the two largest-ever 12-month losses for American start-ups preceding an IPO,” the Journal said. Uber reportedly posted a US$3.7-billion loss in the 12 months running up to March, while Lyft sustained a loss of US$911 million last year. Uber fell around 11% two trading days after its May 10 debut, while Lyft has fallen around 30% since its launch in March.
According to the Journal, both companies provide financial measures that they say better gauge their performance — but also ignore significant expenses. Uber’s “core platform contribution profit” shows that it made US$940 million last year, in contrast to a US$3-billion operating loss shown by conventional measures. Similarly, Lyft’s “contribution” profit shows that it netted US$921 million last year.
Some companies have managed to come back after stumbling in their IPOs. And firms other than Lyft and Uber have also presented unconventional metrics that they say better indicate the health and potential of their business — although not everyone is convinced.
“The early investors are trying to find some sucker who will buy the stock in the public market,” forensic accountant Howard Schilit said to the Journal, accusing firms of creating “nonsensical” fact patterns to sell the deals.
Still, some investor groups may be willing to give the benefit of the doubt. Venture capitalists and entrepreneurs who place a premium on fast-growing start-ups may turn a blind eye to certain upfront expenses. They say marketing costs, for instance, might push companies into debt at the outset, but could be instrumental in landing highly profitable customers in the long haul.
According to Howard Silverblatt, a senior index analyst at S&P Dow Jones Indices, members of the S&P 500 Index used adjusted profit measures to report 2018 earnings that were US$19 a share higher than if they had used standard accounting practices. The gap represents twice the average increase of the past 10 years; taking the record back to 1980 shows similarly large instances of flattered performance, but only during recessionary periods when large write-offs are typical.
Investors must keep their eyes on that growing gap, Silverblatt warned. “These are real expenses and could be indications that companies are running into difficulty,” he said.
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