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Opendoor Follows WeWork Into Non-GAAP Land

What’s a profit? A recent ill-tempered television appearance by the co-founder of home-flipper Opendoor Technologies Inc., Keith Rabois, showed just how far we have drifted from a common understanding of earnings.

Rabois, a Miami venture capitalist, was irritated by his interlocutor’s (not unreasonable) suggestion that Opendoor is loss-making. Net losses total $1.7 billion since inception, according to the latest accounts, and the quarter that just ended will likely be ugly due to falling house prices.

But on a “per home basis”  — also known as “contribution margin,” which excludes groupwide costs such as marketing and technology development — Opendoor has consistently made money for years, Rabois argued. (1)The clash reflects the extraordinary proliferation of alternative financial performance measures during an era of “free money,” when investors were focused on top-line growth over bottom-line earnings.

Because Opendoor is far from alone. Non-standard financial metrics are widespread in private equity buyouts and among startups that report losses under normal accounting, but they are also used by almost all S&P 500 companies. UK annual reports include 16 such figures on average, according to a survey by the UK’s Financial Reporting Council. One of the favorites is adjusted earnings before interest, taxation, depreciation and amortization, aka “Eventually busted, interesting theory, deeply aspirational.” Which numbers should investors actually rely upon? It’s increasingly hard to know. While these alternative figures can provide a more complete and meaningful picture than a regular profit and loss statement, they’re not recognized by generally accepted accounting principles (GAAP) or the International Financial Reporting Standards used outside the US.

Not surprisingly, they tend to make earnings appear higher than they otherwise would and can even magically turn an accounting loss into an adjusted profit. Remember WeWork’s infamous community-adjusted ebitda, which stripped out swathes of the office provider’s expenses?

The use of these metrics partly reflects how accounting standards haven’t kept pace with changes in the economy, especially the importance of intangible assets. But the danger is investors place too much trust in flattering numbers. Alternative performance metrics aren’t audited as closely. In a recession, the worst offenders might discover that a large “total addressable market” (TAM) and an adjusted profit soup don’t pay the bills.

“Both private and public companies are taking astonishing liberties by misrepresenting their profitability. Some definitions of adjusted ebitda and adjusted earnings are simply farcical,” says Stephen Clapham, founder of research and training firm Behind the Balance Sheet.

Some top managers appear to have recognized that the market mood-music has changed, and therefore so must they. Uber Technologies Inc. boss Dara Khosrowshahi told employees in May that free cash flow, not adjusted ebitda, must be the priority. The ride-hailing company has lost $32 billion since inception, so a pivot was long overdue.

I have no issue with companies that exclude genuinely one-off charges or neophyte companies drawing attention to their unit economics. Healthy contribution margins imply the business should generate cash once it has scaled up and fixed costs weigh less heavily. Banning disclosure of non-GAAP information might even harm investors: Those overly focused on Amazon.com Inc.’s bottom line in its early days probably missed out on its astonishing rise.

But there’s often too big a gulf between adjusted and bottom-line earnings. Sports betting firm DraftKings Inc. says that in all states where its platform has gone live, it will be “contribution profit positive” this year — defined as gross profit minus advertising expenses. Yet on an adjusted ebitda basis, the company expects to lose around $800 million while the net loss is likely to be around $1.4 billion, according to the Bloomberg-compiled analyst consensus. 

One challenge for investors is that alternative financial indicators aren’t commonly defined, making companies harder to compare. And though it can be helpful to view the same numbers that inform management’s decision-making, flattering adjustments can lead them astray.

Consider loss-making mobile-games company Skillz Inc., which claimed last year to be profitable on an adjusted ebitda basis, when adjusted for the cost of acquiring new customers. Yet user acquisition marketing expenses were almost two-thirds revenue that year. When Skillz sought to reduce marketing spend in recent months, its revenue plunged, and so has the stock. (Skillz has said the metric helps investors understand “the value of existing users on the system.”)

Adjusted ebitda is especially problematic because companies have huge discretion about what to include. Last week, Singapore-based Grab Holdings Ltd.  vowed to break even on an adjusted ebitda basis by the latter half of 2024, but its definition includes more than half a dozen add-backs. This isn’t unusual.

Removing stock-based compensation expenses from ebitda calculations is widespread because, in theory, it’s a non-cash charge. Rabois called stock compensation a “fake” expense.

In reality, though, this employee pay is a real cost to the business because existing shareholders are diluted. Often the company repurchases equity to lower the share count and if the stock prices falls, the business either has to give more cash to employees to offset their lost earnings, or issue even more stock, as property listing platform Zillow Group Inc. recently said it would do.

In the wake of Enron and the dotcom bust, regulators adopted stricter rules on non-standard financial measures. Such metrics mustn’t now be given undue prominence compared to GAAP figures (bigger fonts are banned!), and companies must at least show how they’ve been derived.

It would be helpful, too, if regulators better defined non-standard financial measures to aid comparability. I’d like to see European financial regulators follow the US SEC’s example by publishing the letters they write to companies querying accounting adjustments.

With luck, the end of the free money era will also mark the end of the adjusted profit free-for-all. But I wouldn’t count on it.

More From Bloomberg Opinion:

• Recession Alert? Corporate Giants Are Massaging Their Earnings: Shuli Ren 

• Tech Shares Are Crashing, So Kiss Your Bonus Goodbye: Chris Bryant

• What Comes After a Week That Shook the World: John Authers

(1) Opendoor was profitable on a GAAP basis in the first quarter of 2022.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Chris Bryant is a Bloomberg Opinion columnist covering industrial companies in Europe. Previously, he was a reporter for the Financial Times.

More stories like this are available on bloomberg.com/opinion

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