Last week it was reported on Bloomberg that Uber’s head of finance, Gautum Gupta, revealed on a conference call that Uber had losses of $1.2 billion before interest, taxes, depreciation and amortization in the first half of 2016. That obviously is an incredible amount of money for a private company to lose in just half a year and understandably made many investors question how sustainable Uber’s business model is. In the article it stated that “subsidies for Uber’s drivers are responsible for the majority of the company’s losses globally” and that “bookings grew tremendously from the first quarter of this year to the second, from above $3.8 billion to more than $5 billion”. In addition, net revenue, under GAAP, grew “about 18 percent, from about $960 million in the first quarter to about $1.1 billion in the second”. So Uber continues to grow at a rapid pace but is having to spend large amounts of capital to expand. In other words, Uber’s expenses are growing faster than its revenues. But are those subsidies to drivers truly expenses or are they actually strategic investments?
50 years ago GM was the largest company by revenue in the US according to Fortune Magazine. Imagine in the summer of 1966 GM announced that it wanted to expand its global reach and was going to build several new factories in order to meet its predicted production goals. GM would have booked the capital it spent on the new factories not as an expense but as an investment. GM’s management would have viewed these new factories as a strategic investment with the belief that it would pay off in the future with higher earnings. From an accounting perspective, this means that instead of charging this expense, say $100 million for the sake of argument, in a single quarter GM would capitalize this expense and amortize it over a 10 or 20 years. The difference between charging the $100 million investment all at once compared to capitalizing the investment is that current period earnings are much higher because the cost of the new factories is rightfully spread across the useful life of those factories.
Now fast forward 50 years and analyze Uber under a similar framework. To expand its market share, Uber doesn’t need to invest in a new factory, it needs to invest in new drivers. By having more drivers on the road, Uber can increases the number of bookings that happen each day which ultimately increases revenues. However, unlike when GM would invest in a new factory, Uber’s investment in new drivers is treated as an expense from an accounting standpoint instead of as an investment. And don’t get us wrong, every dollar that Uber has spent on subsidizing driver’s shouldn’t be considered an investment but at a minimum some of that capital spent is an investment. So how do you define an investment? In theory, capital spent that creates long-term value for a company should be capitalize and recorded as an asset regardless of whether the asset is tangible, like building a new factory, or intangible, like expanding the number of Uber drivers on the road. The key phrase in that previous sentence is “long-term value” and generally if an investment creates value for more than a year or has a useful life longer than a year, than it should be treated as an investment. So going back to Uber, using this intangible-adjusted framework, any capital spent on a new driver today who ends up driving for more than a year should be treated as an investment, not an expense. The depreciation schedule for Uber’s investments in new drivers would obviously be much faster than the depreciation schedule used for GM’s new factories. Also, a factory would still have some salvage value at the end of its useful life while Uber’s new drivers probably wouldn’t. However, the fact that an investment has a fast depreciation schedule and salvage value of $0 doesn’t change the fact that it should still be treated as an investment in the first place. For investors, it is impossible to know what percentage of these subsidies should be treated as an expense and what percentage should be treated as an investment because Uber is a privately held company. And even when Uber goes public investors still won’t have access to this type of information unless Uber chooses to share it because unbelievably accounting standards don’t force companies to share this type of strategic investment information. This is one of the main reasons, according the Baruch Lev in his new book “End of Accounting”, that company reported financial data is increasingly becoming irrelevant to investors. Uber’s investment in new drivers is as strategic as GM’s investment in new factories was 50 years ago. The difference for investors is how accounting standards force companies to book these investments.