They have accomplished an amazing feat: losing tons of money year after year during the Good Times in what were profitable industries.
By Wolf Richter. This is the transcript from my podcast last Sunday, THE WOLF STREET REPORT:
What do the companies Wayfair, Zillow, Uber, Lyft, WeWork, Carvana, Tesla, Airbnb, Casper Sleep, Zume, and many others have in common in addition to their current or former status as unicorns with huge valuations?
There is one fundamental thing they all have in common: Supported by what seemed to be an endless flow of investor money, they barged into profitable industries, such as retailing furniture, house flipping, real estate brokerage, taxi operations, serviced temporary offices, selling used cars, manufacturing new cars, retailing mattresses, pizza delivery, and the like, and they disrupted them by throwing around often billions of dollars that they obtained in wave after wave from investors.
And in these profitable industries, they accomplished an amazing feat: they managed very successfully to lose a running ton of money, not just the first year or two while getting their feet on the ground, but year after year, in many cases for over a decade, without hopes of ever making a profit as defined, not by their own home-made metrics, but by Generally Accepted Accounting Principles, or GAAP.
And in the process, they turned themselves into money-sinkholes, supported and subsidized by investors’ willingness to throw good money after bad, right into that sinkhole. That’s how these companies disrupted: They turned classic profitable business models – from house flipping to used car sales – into endless cash-burn machines. And it took a lot of genius to accomplish that.
These are not teeny-weeny startups. Many of these companies have been around for over a decade, have thousands or tens-of-thousands of employees, and they’re still losing a running ton of money each year even during the Good Times, that are now over.
Whereas the companies that have been in these industries before them – often small operations, such as house flippers or taxi companies, furniture stores, or used-car dealers … they have to make money to stay alive – and if they start losing money, they’re gone.
Even before the crisis, publicly traded US companies were a money-losing bunch. As stocks reached an all-time high in January and February during the end of the Good Times, nearly 40% of the listed US companies had lost money in the prior 12 months, according to the Wall Street Journal back then. Outside of post-recession periods where companies always book big losses or go bankrupt, that is the highest percentage since the 1990s.
OK, IPOs are essentially dead so far this year. And those that flew out the IPO window last year already ran into trouble. The entire IPO market came unglued in the second half. This was well before the Covid-19 crisis.
But three-quarters of the IPOs last year were money losing companies – including Uber and Lyft. In 2018, 81% were money losing companies. It matched the 81% money-losing-companies record set in the year 2000, the peak of the dot-come bubble that then collapsed. Both those years, 2018 and 2000 share the all-time record for money-losing IPOs.
So what are we really looking at here with Wayfair, Zillow, Redfin, Compass, Uber, Lyft, WeWork, Carvana, Tesla, Airbnb, Casper Sleep, Zume, just to cite a few?
These are companies that have an app – OK, anyone can have an app these days – and they’re doing what other companies have been doing for a long time profitably, except these new entries are losing a ton of money doing it.
Let’s start with Wayfair. Wayfair is an online furniture retailer. I’ve used it, and it was OK. I’ve used other furniture retailers, and they were OK too. The thing that makes Wayfair unique is that its losses have nearly doubled every year. They’re rising on an exponential curve: from $77 million in losses in 2015 to $194 million in losses in 2016, to $245 million in 2017, to $504 million in 2018, to nearly $1 billion in losses in 2019.
I dread to see what 2020 will look like. It’s going to be a doozie. During the stay-at-home phase of our economy, consumption has shifted to the internet, and Wayfair sales will likely rise sharply in the current quarter, but the losses will make our ears ring – because Wayfair operates on the principle: the more it sells, the more it loses.
A regular furniture retailer has to make money long term. They cannot lose money year after year. But Wayfair can. By the time 2020 is accounted for, it will have lost over $3 billion since 2015. A furniture retailer like this should be worthless, and when it runs out of money, it would need to file for bankruptcy, like JCPenney did on Friday.
But these companies are different from JCPenney in that investors keep throwing good money after bad at them. They keep funding the losses of these companies when they raise more capital by selling more shares or issuing bonds. And by being able to raise more money, and by having a super-inflated share price, these companies see that they have the investors’ approval to just keep burning their cash.
Then there are the house flippers and real estate brokerages. Both, house flipping and real estate brokerage, are profitable businesses, if done right.
A friend of mine is a house flipper. He’s got some employees, and he’s using some contractors, and he is buying run-down homes, rehabs them thoroughly, and then sells them at a profit. The real value he adds – not just to the house but to the neighborhood, is the rehab. His business survived the housing bust. It was tough, and he had to find renters for some of the homes, but he got through it. And he’s likely to get through the next crisis – because in the good times, he makes lots of money. That’s how that works.
Zillow and Redfin are now also into house flipping. And even during the best of times, they lost a ton of money doing it. But investors loved them for it. Losing money for these investors is a badge of honor. Both of these companies have been around for many years.
Redfin, which is also a real estate brokerage, lost money every single year over the past five years. Over the past three years, during the Good Times, its losses have doubled each year.
Zillow became a house flipper in early 2019. And since then, its quarterly loss has more than doubled. This was during the Good Times, before the Crisis.
Uber, the global taxi operation, with some side hustles in e-scooter rentals, food delivery, and freight, has lost $18 billion over the past five years. That was during the Good Times.
Carvana is an internet-only used car dealer. Selling used cars is very profitable. It’s profitable even during tough times. But not at Carvana. Over the past five years, during the Good Times, its losses surged year after year. It lost $37 million in 2015; and by 2019, its annual loss had ballooned to $364 million. The more it sells, the more it loses.
And on and on and on.
All these companies disrupted existing industries with reckless losses. And investors rewarded them by given them more money, rather than cutting them off until they come to their senses or file for bankruptcy.
If a company that has been in business for years and has thousands of employees and hundreds of millions or billions of dollars in sales, and it cannot make a decent profit during the Good Times, it doesn’t have a functional business model.
Having a functional business model means conducting business in a profitable way over the long term. This means that during the Good Times, the company must make a solid profit, and during the bad times it might have to scramble.
But these companies lose money hand over fist even during the best of times. They’re designed that way, and executives are rewarded that way, and investors want it that way. They disrupt existing industries by not having to stick to the principle that a business has to be a self-sustaining enterprise.
The easiest thing in the world is to run a money-losing business, where bigger losses are better. As long as investors are willing to pay for it. The hard part is bamboozling investors into paying for it.
The only way they disrupt is by having temporarily changed the logic of business – that a successful business is now a cash-burn machine, and the more cash it burns the better. And it took a lot of genius to accomplish that.
The genius lies in bamboozling public and corporate investors into enthusiastically and unquestioningly going along with this, and making them believe in this new religion. And that works for a while. But in the end, there is the harsh reality of business, as the dot-com crash has shown when most of these companies disappeared, and as the current generation of unicorn busts is beginning to show, and as this crisis is beginning to show.