The We Company, the parent of WeWork, uses a cash-flow metric called the “contribution margin,” which showed that its core services were profitable, Bloomberg Tax reported on Tuesday (Dec. 3). The contribution margin — also used by Lyft and Peloton — ignores fixed and startup costs, and highlights core service revenue.
The use of the metric raised red flags from analysts, though, and got the attention of the Securities and Exchange Commission (SEC). The SEC is now reviewing WeWork’s reporting of financials and disclosures.
Using this cash-flow metric, WeWork was able to deduct about $900 million in leasing costs and building expenses from the revenue it took in from members and services. The company used generally accepted accounting principles (GAAP) to essentially turn a $1.9 billion net loss into a $142 million profit.
The metric generally comprises the selling price per unit, less per-unit variable costs. It ignores fixed costs, however, expenses a business would have to pay regardless of generated revenue, Bob Pozen, former vice chairman of Fidelity Investments told Bloomberg. Pozen now lectures at the MIT Sloan School of Management.
The contribution margin could be helpful to executives as a way to cut expenses, or to show revenue growth. Yet, for WeWork, it was the primary measure of profitability, Pozen said.
Recent IPOs — Uber, Lyft, Peloton — included the contribution margin in earnings statements and investor presentations. Lyft’s use of a contribution margin flipped a $463 million loss into a $479 million profit. Peloton turned a $50 million loss into a $42 million profit.
Bloomberg Intelligence Analyst Jeffrey Langbaum said startups seek avenues to showcase what the profits would be if there were not growth-related expenses.
“They are hoping to point investors to metrics that show the underlying health of the business, while setting aside expenses that they think will scale over time or moderate over time,” said Tom White, a tech analyst for D.A. Davidson Companies.
The SEC’s enforcement arm is also examining the company’s disclosures to investors amid reports of conflicts of interest and questionable fundraising practices, which are also under scrutiny.