The Uncomfortable Truth About Going Public With a Money-Losing Business:

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TO HELL WITH PROFITABILITY

WeWork (also known as The We Company) is planning to go public. The co-working giant has filed paperwork confidentially with the SEC to conduct an initial public offering in the near future.  The company was most recently valued at $47 billion following a SoftBank investment, which would likely make it the second largest IPO this year after Uber. In an email to the staff, WeWork CEO Adam Neumann wrote: “As one of the world’s largest physical networks, it is our responsibility to help lead the way and set the global example for people and corporations on how we should take care of each other and of our planet.”  That responsibility is real costly. WeWork is yet another business with “eye-watering losses.” The startup lost $1.93 billion on $1.82 billion in sales last year — losses so bad that ratings agencies have given it a “junk” credit score because its growth has been predicated on heavy borrowing. It is yet another unicorn ready to make its public market debut despite never having turned a profit.  Just yesterday, I wrote about how it seems that investors are willing to overlook profitability so long as there’s a promise for long-term growth. I asked the following question, “Do you buy the long-term growth story that founders are selling — or do you see a day when all of this outrageous spending comes crashing down?”

  Here’s what Techwaysout readers had to say:

Dominic: Investors should perhaps wake up to the reality that most of these loss-making companies are more similar to restaurants than they are to Amazon.com. I am especially interested in seeing how Lyft will play out over the next couple of years since they seem to be in a double bind. To continue growing, they will need to continue losing more money on rider and driver subsidies. To turn a unit profit, they will need to increase prices, which will have a negative impact on growth. Unless they can figure out driverless cars, or experiment and build other more profitable businesses on top of their platform, I don’t see any path to profitability.

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Len: I believe deep pocket investor money that fuels the Valley will dry up rapidly and with severe consequence when the Bull that feeds their investing confidence becomes the Bear that eats the unicorns.

Bonnie: No, I don’t buy the fake “long-term growth strategy” that greedy founders & early investors are hawking. To prove my point, I’m tracking the pre-IPO share costs from Equidate and comparing them with the strike price and post-IPO share cost. Fear of Missing Out and the media’s frenzied articles about newly-minted millionaires in the Bay Area have artificially spurred greed, and my data and research prove it. I consciously choose to use products and services that are developed and owned by entrepreneurs who demonstrate ethical, economic and principled virtues.

Blake: The only way that many of these companies are going to become profitable is to raise prices.

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A LOT! That’s much easier to do, once you have driven out of business the higher-priced competitors that you undercut in price in the first place to get your market share. Caveat emptor!.

Andrew: Credit, credit, credit. Too abundant and too cheap for too long. This can get ugly … real quick. Look at what happened in Q4 last year when the Fed hiked rates. They used to say cash flow covers a multitude of sins… now it appears to be cheap, abundant capital. Is that sustainable? Probably not.

Larry: There is one thing about the growth which investors are betting on that hasn’t really been thought about. I don’t think there is much debate about the fact that equities are overweighted in most portfolios because the prolonged, largely artificial low interest rate environment forced investors to seek returns from somewhere other than fixed income (or similar) instruments.  But if the growth that is being projected by all these high flyers actually occurs, an almost certain consequence will be inflation. Rising inflation brings rising interest rates and portfolios will be likely to shift again. That shift will mean that equities will sell off and stock prices will naturally fall. So, by betting on so much growth, these investors are essentially setting their stock portfolios up to fail.  Then, we’ll start looking at “fundamentals” again. Just like what happened two decades ago….

Adam: As a value investor working for a startup in San Francisco, here’s my take. Today, we’re witnessing this incongruous environment because Silicon Valley and Wall Street aren’t speaking the same language. Most in the Valley see themselves as optimistic futurists, able to create and/or predict the future, creating immense societal impact, which doesn’t always translate to earnings. Wall Street, as we know, is a less forgiving environment, valuing financial forecasting and predictability above all else. Societal implications are an afterthought.

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Cryptocurrency is one example, with Wall Street taking a cautious stance amid gradual adoption, while Silicon Valley continues to double and triple down on it, even as the price swings

What separates the contenders from the pretenders in the recent IPO environment, the latter being appealing to both the Valley and the Street, is their unit economics.  There has to be an inflection point when a company swings to profitability, typically by wielding pricing power in a winner-take-all market, or at least continues inching closer to it. If you don’t have that, you don’t have a business. Plain and simple.  There continue to be far too many comparisons to Amazon, simply because they weren’t profitable for so long. Often, these comparisons are misplaced or sleight of hand. They’re excuses for not being able to grow profitably or having poor unit economics.

Summary

So to answer your question, I buy the growth story as long as they understand and control their unit economics. Some have a strong grasp of this. Many do not.

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