The last time a fast-growing, lossmaking tech company tried this hard to persuade Wall Street to judge it by its own measure of profits, things didn’t end well.
Ahead of its 2011 initial public offering, local marketing company Groupon notoriously conjured up something it called “adjusted consolidated segment operating income” — a measure of profitability that excluded a number of costs, such as spending on marketing. Judged by this yardstick, its $413m after-tax loss the year before it went public became a $60m profit.
Groupon’s growth spurt turned out to be a flash in the pan, and its shares are now worth only 18 per cent of the IPO price.
Lyft isn’t Groupon. But the ride-hailing company, which is expected to kick off a wave of big tech IPOs when it goes public next week, still wants investors to focus on its own, non-standard measure of performance. It is a reminder of how far some of today’s most valuable private tech companies still have to go to prove they are sustainable businesses.
The very first mention Lyft makes in its listing prospectus of last year’s after-tax loss ($911m) also points to what it calls the positive “contribution” from its operations: $921m.
This turns out to be close to the company’s gross margin, or the amount left after deducting direct costs from revenue. The fine print reveals that certain costs have been excluded, such as stock-based compensation and changes to its insurance reserves. At 43 per cent, the contribution margin last year was less than a percentage point away from the company’s gross margin, though future periods may diverge more.
Lyft isn’t alone in getting this far in the development of its business without needing to live up to Wall Street’s normal measures of performance. It is among a group of highly valued tech companies that have enjoyed ready access to cash in the private markets, supporting their heavy cash burn rates and protecting them from the scrutiny of public market investors.
There are consequences to this, besides the ability of some private tech companies to get to huge scale without making a profit.
One is the lower returns venture capital investors are likely to see from the round of mega-IPOs of which Lyft is a part. The large amounts of cash these companies have raised privately risks diluting early investors. Google’s stock market value at the time of its IPO, for instance, was around $23bn — roughly what Lyft hopes to achieve next week. But Google only raised $20m in start-up financing: Lyft has amassed almost $5bn.
One venture investor not involved in Lyft estimates that early investors will get back between five and eight times their investment — a big gain, but not the kind of blowout that VCs expect from their top-performing investments.
Another consequence of the large amounts of cash sloshing around in the private market is that companies have been able to pursue business strategies they couldn’t have contemplated in other times.
In this regard, ride-hailing is Exhibit One. Between them, Uber and Lyft have raised more than $17bn in equity, yet it isn’t clear what a “normalised” ride-hailing market will look like.
Plan A, as pursued by Uber, was to use its mountain of cash to subsidise fares, grabbing an unassailable lead in a business with strong network effects and blowing rivals out of the water.
It might have worked. But Uber’s many slips gave Lyft a new lease of life: it claimed a 39 per cent share of rides in the US last December, up from 22 per cent a year before. The estimate comes from a research company owned by Rakuten, one of Lyft’s biggest investors. But if this is even close to reality, it points to a market that is still experiencing huge swings in customer loyalty.
With so much growth (Lyft’s revenues were up 103 per cent last year) and market share seemingly up for grabs, it makes perfect sense to keep rolling the dice, spending heavily while the market is still forming. Lyft’s main challenge will be to persuade public market investors to keep the faith.
Hence the appeal to “contribution”, which at least points to an anchor of economic logic. Each ride taken by a Lyft passenger contributed, on average, $1.71 to paying its overheads in the fourth quarter of last year. The company has also been claiming a steadily larger slice of each fare.
There is a long way to go to prove that this can lead to a profitable business. There are hints of slowing growth in rider numbers, and keeping pace with bigger rivals in new areas like driverless car technology will keep operating costs high. New businesses, like electric scooters, will dilute the revenue per ride figure. Most importantly, it is unclear if ride-hailing will turn into a winner-takes-most market.
Next week, amid the usual hype generated by a Wall Street IPO, it will be easy to believe that the tech world’s best-known unicorns are finally fulfilling their promise. In reality, though, it is only the beginning.
