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Investors don't care that fast-growing companies are hemorrhaging money
By John D. Stoll
This article is being republished as part of our daily reproduction of WSJ.com articles that also appeared in the U.S. print edition of The Wall Street Journal (April 27, 2019).
Snap Inc. posted a $310 million loss on $320 million in revenue Tuesday, but you would have never known it from the stock market.
As the social media company's shares were rising that day, my colleague Christopher Mims, wondered on Twitter:
"Has there ever been a time where this many companies lost this much money and everyone acted like it was completely normal?"
This could be asked every day. Ride-hailing company Uber Technologies Inc., aiming to pave the way for an initial public offering, said Friday it lost at least $1 billion in the initial three months of 2019. Work-place messaging company Slack Technologies Inc. published its IPO paperwork saying it lost $140 million in the last fiscal year, equal to the prior year, when revenue was 82% lower.
Many an executive and investor has winced as shares of a solidly profitable Blue Chip gets pummeled because guidance was tweaked or earnings-per-share didn't quite satisfy analyst consensus. 3M Co. is earning decent money, but shares plummeted Thursday after it reported slower sales, job cuts and a weaker outlook.
Nary a quarter goes by when a management guru or money manager doesn't blame the market's myopia as the reason a research-and-development department was chopped or a marketing budget was slashed.
In Silicon Valley, meanwhile, the red ink flows. A stable of so-called unicorns and decacorns (startups valued at billions or tens of billions of dollars) are going public this year. As they do, eye-popping market capitalizations are assigned to companies whose plan for profitability is hard to discern beyond their willingness to spend and spend and spend on growth that promises a profit...someday.
"Despite everything written about short-termism, we're seeing that as long as these companies have a compelling growth story, investors are actually telling them to not focus on short-term performance," Jay Ritter, an IPO expert at the University of Florida, said.
The lesson here is one that has been with us since the Dutch invented the public company 400 years ago: Growth sells.
There's a lot of handwringing over what feels like a relatively free pass handed to Elon Musk at Tesla Inc. or Dara Khosrowshahi at Uber Technologies Inc. Yes, they are peddling money-losing cars or running an unprofitable ride-hailing service. But investors love what they are selling.
Look at a company like Lyft Inc., an Uber competitor worth about $26.5 billion when it went public last month. The stock fell as much as 23% during initial weeks of trading. Still, nearly all major analysts covering the stock have overweight, outperform or buy rating on Lyft. Their $80.70 average price target represents a 44% premium over Thursday's low.
Lyft lost nearly $1 billion in 2018, and could have been far closer to profitability if it cut down on subsidies designed to steal riders from Uber, or had it dialed back technology investments. However, if Lyft did this, it wouldn't just be crushed by Uber -- it would just be another taxi company and not a candidate to enjoy the spoils of the expected dominance that app-based mobility services could enjoy.
Not all sectors work like this. If an unprofitable restaurant chain tried to build an IPO on a promise to add more stores, the market would scoff, Mr. Ritter says, because no one will believe that you can make money on 150 restaurants if you can't do it with 100.
What makes tech companies different? The belief that their product has a much brighter future where revenues will eventually rise to cover an astronomical cost base, and that they'll eventually be freed of the cutthroat competition that forces them to buy market share.
If this feels like a remake of a movie you've seen before, that's because in some ways it is. More than 600 companies staged initial public offerings in 1999 and 2000, just prior to the dot-com bubble bursting. Only 14% of those companies were profitable, according to Mr. Ritter's research.
The percentage of money-losing tech startups filling IPOs was nearly the same in 2018, but Mr. Ritter says there is less reason to panic these days.
Why so calm? Fewer startups are going public -- the median age of an IPO'd tech company is 12 years old, compared with four in 1999; and about 80% of startups are bought by bigger companies or other investors, compared to about half 20 years ago. That means many of the companies actually making it to public markets are fairly well capitalized and already have a proven business idea.
Jeff Bezos, the Amazon.com Inc. founder who weathered the dot-com bubble, said his company delivered a case study in how patience can pay off. Shortly after his company surpassed $1 trillion in market value, Mr. Bezos told the Economic Club of Washington, how he turned an online bookseller into a tech conglomerate.
"People always accused us selling dollar bills for 90 cents and said 'look anybody can do that and grow revenue,'" he said. Mr. Bezos remembered when former NBC anchorman Tom Brokaw asked him if he could even spell profit. Mr. Bezos responded, "P-R-O-P-H-E-T."
"It's a fixed cost business and so what I could see from the internal metrics at a certain volume level we would cover our fixed costs, and we would be profitable," he said.
Airbnb, a decade-old company that allows users to book lodging, often in other people's homes, is one of those companies looking like a candidate as the next Amazon. It has grown bigger than most hotel chains and is expected to file an IPO by 2020 with a valuation in excess of $30 billion.
Unlike many Silicon Valley peers, the company says it is profitable. But before it was ready for prime time, it endured years in what Airbnb co-founder Joe Gebbia calls "the trough of sorrow." This is a period when a startup founder considers an idea worth funding even before there is a sizable market for it.
The moral of Airbnb's story: Don't go big too early. Irrational exuberance is no match for the trough of sorrow.
Little-known YogaWorks Inc. is one of many companies learning this the hard way. It billed itself as fast-growing wellness company in preparation for a $40 million IPO in August 2017. It had 50 studios that offered affordable classes for novices to master yogis. It looked like a reasonable bet for investors watching the popularity of Lululemon Athletica Inc. yoga pants and no-frills gyms like Planet Fitness Inc.
The California-based chain was bleeding money, though, and investors were selling the stock at a 50% discount by Christmas. Executives plowed ahead, adding about 20 more studios in high-rent cities like Boston and Washington. By May 2018, having racked up $25 million in losses on $56 million in revenue since its IPO, the company backed off the costly acquisition spree to focus on improving performance at existing locations and MyYogaWorks.com.
Is it too late? All the humbled company can hope is that every downward-facing dog has its day.
Write to John D. Stoll at email@example.com
Corrections & Amplifications Slack Technologies Inc. lost $140.7 million in the prior fiscal quarter. An earlier version of this article incorrectly stated that the loss took place in the first quarter. (April 26, 2019)
(END) Dow Jones Newswires
April 27, 2019 02:47 ET (06:47 GMT)
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