March 15, 2019

Breakingviews: Lyft makes flattering “contribution” to accounting

by Breakingviews.

Lyft is making an optimistic tweak to the accounting lexicon. The ride-hailing firm has inserted the concept of “contribution” into its initial public offering prospectus. It’s a metric that’s supposed to represent a steady-state level of profitability, excluding the costs associated with growth. Lyft’s take on it, though, is for a world that doesn’t exist.

The problem for Lyft, its larger rival Uber Technologies and the likes of trendy office-space provider WeWork is that profit by any standard measure is absent. That makes valuation a crapshoot and deters some investors. Even adjusted EBITDA, which involves usually flattering tweaks, is deep in the red, to the tune of $944 million for Lyft last year on revenue of $2.2 billion.

All these companies spend heavily to increase market share and enter new areas. Investors know growth costs money. Yet it makes sense to try to understand what the mature economics of a business might be. That’s what Lyft’s contribution is trying to get at. WeWork came up with what it called community-adjusted EBITDA to express something similar: This is how profitable we would be if we stopped trying to grow and let our business cruise.

Lyft’s contribution has some problems, though. First, the usual definition is revenue less all variable costs – it’s a measure of marginal operating profitability. The Lyft version starts with ride revenue – which already removes the drivers’ take – and backs out insurance, payment-processing fees, other direct costs of rides, but essentially nothing more.

It excludes sales and marketing expenses, for instance, the company’s second-largest cost line and surely necessary in competitive markets where customer churn is inevitable. Little wonder the company pegged its 2018 contribution margin at a healthy 43 percent.

Second, there’s a philosophical problem when it comes to valuation. Lyft may target a public market capitalization of perhaps $25 billion, according to Reuters sources. That’s the kind of eye-watering multiple of sales that only rapidly expanding companies attract. Switching off growth in the foreseeable future, even in return for profit, would knock that down sharply.

Monitoring contribution may help Lyft’s bosses maintain cost discipline, up to a point. They should, however, recognize that the metric is overly generous, even compared to WeWork’s community-adjusted EBITDA. IPO investors should probably ignore both of these numbers altogether.

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