Insights on VC Pricing: Lessons from Uber Technologies Inc (UBER), WeWorks and Peloton Interactive, Inc. (PTON)!

 

3. Blurry Business Models and Flaky Earnings Measures
Most of the companies that have gone public this year have entered the public markets with large losses, even after you correct for what they spend to acquire new users or subscribers. For some investors, this, by itself, is sufficient to turn away from these companies, but since these are young companies, pursuing ambitious growth targets, neither the negative earnings, nor the negative cash flows, is enough to scare me away. However, there are two characteristics that these companies share that I find off putting:

– Pathways to Profitability: As money losing companies, I had hoped that Uber, WeWork and Peloton would all spend more time talking, in their investor pitches, about their existing business models, current weaknesses in these models and how they planned to reduce their vulnerabilities. With Uber and Lyft, the question of how the companies planned to deal with the transition of drivers from independent contractors to employees should have been dealt with front and center (in their prospectuses), rather than be viewed as a surprise that no one saw coming, a few months later. With WeWork, their vulnerability, stemming from a duration mismatch, begged for a response, and plan, from the company in its prospectus, but none was provided. In fact, Peloton may have done the best job, of the three companies, of positioning themselves on this front, with an (implicit) argument that as subscriptions rise, with higher contribution margins, profits would show up.

– Earnings Adjustments: As has become standard practice across many publicly traded companies, these IPOs do the adjusted EBITDA dance, adding back stock-based compensation and a variety of other expenses. I have made my case against adding back stock-based compensation here and here, but I would state a more general proposition that adding back any expense that will persist as part of regular operations is bad practice. That is why WeWork’s attempt to add back most of its operating expenses, arguing that they were community related, to get to community EBITDA did not pass the smell test.

In summary, it is not the losses that these companies made in the most recent year that are the primary concern, it is that there seems to be no tangible plan, other than growth and hand waving on economies of scale, to put these companies into the plus column on profits.

 

4. Founder Worship and Corporate Dictatorships
Some time in the last two decades, newly public companies and many of their institutional investors seem to have lost faith in the quid quo pro that has characterized public companies over much of their history, where in return for providing capital, public market investors are at least given the semblance of a say in how the company is run, voting at annual meetings for board directors and substantive changes to the corporate charter. The most charitable characterization of the corporate governance arrangement at most newly minted public companies is that they are benevolent dictatorships, with a founder/CEO at the helm, controlling their destiny, and with no threat of loss of power, largely through super-voting right shares. In fact, most of the IPO companies this year have had:

 

– Shares with different voting classes: With the exception of Uber, every high profile IPO that has hit the market has had multiple classes of shares, with the low-voting right shares being the ones offered to the market in the public offering and the high voting right shares held by insiders and the founder/CEO. It is also revealing that Uber was also one of the few companies in the mix where the founder was not the CEO at the time of the IPO, after the board, pressured by large VC investors, removed Travis Kalanick from atop the company in June 2017, in the aftermath of personal and corporate scandals.

– Captive boards of directors: I am sure that the directors on the boards of newly public companies are there to represent the interests of investors in the company and and that many are well qualified, but they seem to do the bidding of the founder/CEO. The WeWork board seems to have been particularly lacking in its oversight of Adam Neumann, especially leading up to the IPO, but it is probably not an outlier.

Complex ownership and corporate structures: When private companies go public, there is a transition period where shares of one class are being converted to another, some options have forced exercises and there are restricted share offerings that ripen, all of which make it difficult to estimate value per share. It does not help when the company going public takes this confusion and adds to it, as WeWork did, with additional layers of complex organizational structure.

In many of the companies that have gone public this year, it is quite clear that the company’s current owners (founder and VCs) view the public equity market as a place to raise capital but not one to defend or debate how their companies should be run. Put simply, if you are public market investor, these companies want your money but they don’t want your input. When faced with that choice with Alibaba, I characterized this as Jack Ma charging me five-star hotel prices, when I check in as an investor in his company, but then directing me to stay in the outhouse, because I was not one of the insiders.