Business models ultimately are about generating cash. Adjusted EBITDA margins sounds like a nice metric, but I also want to know what’s the cash generated from your customers? Is cash generated going up when Revenues scale up or is each additional dollar of Revenue ‘invested’ back into growing Revenues with little likelihood of ever returning any cash? I look closely at the the rolling 24-month financial forecast and how the Revenue converts to cash. Is there a large spike due to cutting costs or a significant price increase? That’s great but is it a wish vs. an assumption based on what’s probable.
Amazon was clever in how they built/are building their businesses. One of their Key Strategies or Winning Moves was figuring out how to dominate a sector or segment and drive profits/cash that could be used to invest in the next segment it planned to dominate. It dominated books, diapers, investing in cloud computing and now is investing billions into streaming content. Cash generated from each segment goes to fund other ventures. Wall Street now understands Bezos and his plans. But most of these businesses today heading for IPOs do not have that type of plan or any other viable Winning Move. The Wall Street Journal has a good article (see link below) on how the Tech unicorns are raking in big cash but losing money. “The IPO class of 2019 is notable for big valuations, diverse business models and little or no profits.”
How Tech Unicorns Are Raking In Cash but Losing Big Money
Uber, Lyft, Palantir, Slack, Pinterest, Postmates and Cloudflare are all expected to IPO in 2019. While all have decent key operating metrics, little or none are profitable. Lyft and Uber either have to be incredibly lucky in betting on new transportation models such as a platform for driverless cars or need strong pricing power to increase the true Enterprise profitability. Maybe, over the next five years they can double prices and scale profits. Who really knows? Lyft lost $800M last year and Uber is losing almost $800M a quarter. Despite these ugly losses it’s expected that both Lyft and Uber will be valued a 10X multiple to Revenue.
We’re seeing Netflix flex its brand muscles by implementing price increases -which are expected to continue- but we are also seeing real competition such as Hulu, AT&T and of course Amazon. Competition puts a brake on a brands ability to extract more via price increases, so we’ll have to see how that plays out for Netflix.
Cash was King: Cash generated from Operations is now King or Queen
Don’t get me wrong: growth is never easy and turbo-charged growth is even more difficult. But unless you have a strategy to exit via an IPO with lots of funding in place it’s impossible to sustain growth without profits and ultimately cash. The number of companies who will IPO is extremely small in any one decade- less than 5,000 companies went IPO in the US so far this century- so it’s important to build a company that has a business model that generates cash- or will generate cash in the medium term. When I look at a company’s financial forecasts, I want to know how it’s growing cash, what the financing strategies are and how its brand is growing so it can have some pricing power. Unless your company is a type of moon-shot enterprise- some biotech/biopharma are- it’s hard to justify valuations or the business model unless you can realistically generate profits and cash. I may sound too cautious but most of these businesses mentioned in the WSJ above are built for IPOs andtaking advantage of the longest bull market in history. The timing of these Unicorns is exquisite-maybe even lucky. However, they will need lots of luck to navigate the next 10 years. Luck does not justify 10X Revenue valuations. Many will have lots of cash on hand to fund the expected burn but the old cliché that said cash was king is no longer valid: cash generated from Operations is now the new King or Queen.