Tuesday, November 9, 2021

Tesla's Trillion Dollar Moment: A Valuation Revisit!

I have been writing about, and valuing, Tesla for most of its lifetime in public markets, and while it remains a company that draws strong reactions, it is also one that I truly enjoy valuing. It has been a while since my last valuation of the company, which occurred in January 2020, and given how much the landscape has changed since, partly as a result of the company's own actions and partly because of how COVID has upended its competitors in the automobile business, it is time to revisit the company and reassess its value, especially as the company’s market capitalization crosses a trillion dollars.

Tesla: The Back Story

I first valued Tesla in 2013, as a "luxury automobile company" and  I have valued almost every year since. If you are interested, you can see my valuations from 2014,  2016 and 2017. If you review those valuations, you will notice that in each valuation, my story for the company expanded, and my valuations increased, but the market price for the company jumped even more, leading me to conclude in each of them that it was not a company that I would invest in. While these valuations led me to different assessments of value, there were common themes across time:

  1. At its core, Tesla has been an automobile company: In my 2016 post on Tesla, I described it as the ultimate story stock, driven less by news about its most recent financial performance, and more by news that alters its story trajectory. I would be lying if I said that I have had clarity about Tesla's story over the last decade, because it has so many tangents, distractions and shifts along the way, flirting with narratives about being a battery company, an energy company and a technology company. In 2021, looking at the company, I feel more convinced than I was a few years that it is, at its core, an automobile company, and while it will continue to derive revenues from batteries and perhaps even software, its pathway to becoming a trillion dollar market cap company still runs through the "car company" story.
  2. Tesla has disrupted and reinvented the automobile business: Putting any company into the automobile business handicaps it, when it comes to value, for a simple reason. The automobile business has been in trouble for quite a while, struggling with anemic revenue growth in the aggregate, and abysmal profit margins, with even the very best in the group struggling to earn returns that match, let alone beat, their costs of capital. As I have valued Tesla over the years, I have come to the realization that it is the most 'uncar-like" automobile company in the world, and its uniqueness shows up on two dimensions. The first is on profitability, where its operating cost structure, unconventional distribution model (which bypasses dealerships), and capacity to augment revenues with related products and services, has given it an opening to deliver much higher margins than any automobile company in history. The second is on investment and capital intensity, where it has managed to take what critics pointed to as weaknesses (unwillingness to build large and expensive assembly plants ahead of time, to meet future demand) and made them into strengths. Put simply, the company has been able to scale up more quickly, while reinvesting less in capacity, than any other automobile company.
  3. Tesla positioned itself well for structural shifts in the economy: Tesla's success over the last few years has also been fed by three other external forces. The first is in the government and business response to climate change, and the resulting policies favoring electric cars over gas-powered, cars. It is undeniable that Tesla, especially in its early years, was a beneficiary of tax credits and other benefits meted out to electric car makers and buyers. The second is the rise of ride sharing, with a host of companies around the world upending the status quo in car service. While Tesla has not directly benefited yet from this trend, it has opened up possibilities for the future, built around self-driving cars, that have added to the company's allure. The third is the rise of ESG as an investing force, and the resulting shift away by investors from all things fossil-fuel related, has benefited Tesla, at the expense of the legacy automobile companies.
  4. Tesla is built around an outsized personality: When valuing publicly traded companies, I seldom talk about its top management explicitly, since the numbers reflect what they bring to the firm. That rule does not work with Tesla, since its founder and CEO, Elon Musk, has many qualities, but being self effacing is not one of them. Tesla and Musk are locked at the hip, and it is almost impossible to have a view on one, without having a similar view on the other. Put simply, I am still to meet an investor who loves (dislikes) Tesla as a company, and dislikes (loves) Musk. On the plus side, Musk is a visionary and out-of-the-box thinker, and an evangelist for his visions, who draws true believers to his cause. On the other side of the ledger, he is unpredictable and prone to distractions that draw attention away from the company, and his impulses have created costs for the company and its investors. While his net effect has clearly been a net positive for investors in Tesla, over the last decade, it is worth remembering that you are getting a package deal, when you invest in the company.
  5. Tesla draws extreme reactions: I have never valued a company, where there is as much divergence in views about the future, cross market players, that I have seen with Tesla and Musk. There are some who see Elon as the ultimate con man, and Tesla as a shell game, and many in this group have spent the last decade making Tesla one of the most shorted stocks in history. There are others who view him a savior, and map out pathways for Tesla to become the most successful company of all time, and many of them have bought shares in the company, and held through good and bad times. 

My two most recent valuations were in June 2019 and January 2020, and I am going to go back to them, not just because they are recent, but because they led to investment decisions on my part. 

  • In June 2019, Tesla had hit a rough spot, partly due to concerns about production bottlenecks and debt, and partly due to self inflicted wounds. Musk's tweets about going private, with funding secured, contributing to a sell off, driving the stock down to $180 ($36 in today's split adjusted terms). I valued the company, with conservative assumptions about growth and margins, and incorporating my concerns about managerial missteps, at about $190: While the buffer (between value and price) was small, I did buy shares in the company.
  • Between June 2019 and January 2020, the stock went on a tear, as the stock price more than tripled, and I revisited my Tesla valuation. With a more expansive view of future growth and profitability, I revalued Tesla in January 2020 and more than doubled my valuation, though that still left me well below the market price. I sold my shares then, and I know that many of you have pointed out how much money I have lost as a consequence of that sale, as the stock price has increased almost ten-fold since then, and I will come back and talk about my regrets, or absence thereof, towards the end of this post.

Tesla: The Numbers

    It has been roughly 22 months since my last valuation of Tesla, and it is astonishing how much change there has been, not just in the company, but also in the macro environment that it operates. In this section, I will start by chronicling the astonishing rise of Tesla in public markets in the last decade, follow by looking at the company's operating details and close by examining how the company has found a way to turn the COVID crisis into an opportunity.

Stock Prices and Market Cap

    To put Tesla's explosive performance in the last two years in perspective, I will look at its market performance since its entry into public markets. The graph below contains Tesla's stock price, adjusted for stock splits, going back to 2010, and ending in November 2021:

While the graph illustrates the surge in the stock price, the table embedded in the graph conveys the rise  more vividly, by listing Tesla's market capitalization in millions of dollars. In sum, the company's market cap has risen from $2.8 billion in August 2010 to more than a trillion dollars in November 2021, and along the way, it has not only made Elon Musk into the wealthiest man in the world, but also enriched those who bought into his vision early, and stayed invested in the company. 

Revenues and Earnings

    While the initial rise in Tesla's market capital was driven by the promise of the company, and detractors were quick to note Tesla's paltry revenues and big losses, the company's more recent financials reflect how it has acquired substance over time. In the graph below, I report on Tesla's quarterly revenues, gross profits and operating profits going back to 2013:


Tesla's quarterly revenues have risen from negligibly small values at the start of the last decade to almost $14 billion in the third quarter of 2021, making it the 20th largest automobile company in the world in 2020 (in revenue terms). The company spent much of the last decade losing large amounts each year, but it now not only generates an operating profit, but a healthy one at that, with a pre-tax operating margin of close to 15% in the third quarter of 2021.

The COVID Effect

    While Tesla's resurgence has been building for a while, its growth has clearly exploded in the last year and a half, a period where our personal and business lives have been upended by COVID. During this most trying of times for all businesses, and especially for those in manufacturing, Tesla has not just survived, but thrived, gaining market at the expense of its rivals and accelerating towards profitability. To understand why, I would point you to a series of posts that I did during 2020 about how COVID was playing out in markets, and the winners and losers. In particular, I noted to the following aspects that made the COVID crisis different, from prior crises:

  • Risk capital stayed in the game: The most striking feature of last year's crisis was how quickly markets came back from the savage sell off between February 14 and March 23 of 2020, and I argued that the biggest reason for that come back was the resilience of private risk capital. Instead of withdrawing from markets, as in prior crises, venture capital investing, initial public offerings and investment in the riskiest segments of both stock and bond markets continued, and actually increased, through 2020, and those trends have continued this year. 
  • Flexibility over Rigidity: While the overall market quickly recovered, the recovery was uneven, and the crisis left behind winners and losers. In this post, I argued that one of the key dividing lines between the two groups was flexibility, with companies with more flexible investing, financing and dividend policies winning out over companies with more rigidity on those dimensions. To be specific, service/technology companies gained at the expense of manufacturing & natural resource firms, debt-light firms won at the expense of those with much bigger debt burdens and firms that paid large dividends lost value, relative to firms that did not.
  • Young beat old: Another factor differentiating winners and losers during 2020 was that, unlike prior crises, young companies (early in their life cycles) benefited at the expense of mature and aging companies (with far more of their value coming from investments in place).
I summarized the transfer of wealth in a table in my final update:

As you can see young, high growth companies, with little debt and no dividends, benefited at the expense of older companies, with more debt and dividend commitments.  You could argue that if central casting were creating the perfect COVID winner, it would look a lot like Tesla, a young, adaptable company in a sector filled with companies with expensive manufacturing facilities, large debt burdens and legacy dividend policies. In fact, many of what many (including me) considered to be Tesla's weaknesses (make-shift manufacturing, seat-of-the-pants financing) in the pre-COVID age became strengths during COVID. While conventional automobile companies shuttered and scaled down manufacturing, Tesla continued to make and sell cars through the pandemic, and it is inarguable that it has come out of this crisis, far stronger than it was going into it. The table below breaks down the Tesla's performance from the last quarter of 2019 to the third quarter of 2021:

Tesla: The COVID Quarters
Focusing on the key financials of the company and looking at Tesla's performance through the COVID quarters, there are trends that stand out. 
  • The first is that the company stumbled briefly on revenues in the second quarter of 2020, as COVID restrictions kicked in, but saw a surge in growth in the quarters since, with growth rates significantly higher than in the pre-COVID years. 
  • The second, and more significant, is that the company seems to have turned the corner on profitability, with margins not just improving, but dramatically so, with gross margins moving towards 30% and operating margins exceeding 14% in the most recent quarter.
In brief, if there Tesla's growth was lagging, leading into 2020, and there were worries about its capacity to be profitable, the COVID quarters seem to have removed both concerns.

Tesla: Updated Story and Valuation

    I have long argued that the three most freeing words in investing and valuation are "I was wrong", and with Tesla, I have had to say those words repeatedly over the last decade. Through its lifetime, I have under estimated Tesla's value, and while COVID may have given the company an assist, my updated valuation will reflect what I have learned, since January 2020, about the company.

Story Components - Revisiting the Past

   Over the years, I have tried, not always successfully, to navigate between the extremes on Tesla, and tell a story that reflects the company's strengths and weaknesses. Not surprisingly, that story has changed over time, as the company, the business and the world have all changed. In the table below, I list the stories that I have told, with end-year revenues, operating margins and valuations for equity, for each one, in 2013, 2017, 2019 and 2020:

Over time, as you can see my story for Tesla has become bigger (in what I see both as its potential market and the revenues from it) and I have adapted my story to reflect the company's capacity to reinvest far more efficiently than the typical automobile company that I used in my very first valuation. 

    To see how much I was off the mark with my September 2013 valuation, I decided to compare my predicted revenues and operating income with the actual revenues and operating income from 2013-14 to 2020-21:

This may surprise you, since my 2013 valuation seems, at least in hindsight, to be hopelessly pessimistic, but I actually over estimated Tesla's revenues and profitability in the years since; the actual revenues in 2020-21 came in almost 24% below my prediction and my predicted margin of 8.52% was 0.75% higher than the actual margin posted by the company in that year. That said, I assumed in the 2013 valuation that, by 2021, Tesla's growth would be plateauing, and the company would be moving towards being a profitable, luxury car company. Instead, the company seems to be just getting started, redefining itself as a mass market company, with much bigger ambitions. I know that for some, my shifting stories and valuations are a sign of weakness, both in my analytical capabilities and in the very idea of intrinsic valuation. For me, and this may be just my delusions talking, an unwillingness to change your valuation stories and inputs, especially in a company that delivers as many twists and turns as Tesla, is a far greater sin.

Updated Story and Valuation
    Whatever your priors were on Tesla coming into COVID, it is difficult to argue with the fact that the company has benefited from the economic changes it has wrought, and that its story has become bigger. The question of how big is what will determine value, but rather than give you my assessment at the start, I want to try an experiment. Ultimately, whatever story you tell about Tesla has to show up in five inputs that drive its value: (a) Revenue growth, or what you see as end revenues for the company in steady state, (b) Business profitability, reflecting what you see as unit economics, and captured in the pre-tax operating margin, (c) Investment efficiency, measuring how much investment will be needed to get to your estimated end revenues, (d) Operating risk, incorporated into a cost of capital for the company and (e) the chance that the company will not make it, gauged with a probability of failure. If you are willing to go along, with each input, I will lay out the choices (as objectively as I can) and I would like you to take your pick, given what you believe about the company. As you make these choices, though, please do not open the spreadsheet that I will provide at the end, to convert your choices into value, since that will create a feedback loop that can feed your biases.
  1. Revenues: I do believe that Tesla has come out COVID with the potential for far more revenues than it did, going in. In particular, as the automobile market increasingly shifts to electric cars, Tesla will hold a strong competitive advantage in that portion of the market, and have the chance to be a market leader. To get a sense of what this will mean in terms of revenues by 2032, consider the following choices:

    Note that if your story draws primarily on Tesla remaining an auto company, revenues of $400 billion will translate into about ten million cars sold in that year, more than ten times the number of cars the company sold in 2020-21. If you believe that there are other businesses that Tesla will enter, you can augment your revenues with the added sales in those other businesses, keeping in mind that most of these businesses have far less revenue potential than the car business.
  2. Profitability: The biggest eye opener for me, during COVID, has been the surge in profitability at Tesla, with the operating margin nearing 15% in the third quarter of 2021. While that number is volatile and there will be ups and downs, it looks like the electric car business has far better unit economics than the conventional automobile business. Notwithstanding Tesla's first mover advantage, this margin will come under pressure not only from increased competition from electric car offerings from existing automakers and new entrants (Neo, Rivian etc.), but also from having to cut prices to increase market share in Asia, where car prices tend to be lower than in the US and Europe. Laying out the choices in terms of profitability:

    As you make this choice, recognize that Tesla is already approaching peak level gross margins for a manufacturing company, with its 30% gross margin in the last twelve months.
  3. Reinvestment:When I first valued Tesla in 2013, it had one plant in Fremont that produced all of the cars that it sold. At the time, one of my concerns was that the company would need massive reinvestment in assembly plants to ramp up even to luxury car revenue levels, and that this reinvestment would create significant cash burn. In the years since, Tesla has not only added capacity in lumps with assembly plants/giga factories in Storey County (Nevada), Buffalo (New York), Shanghai (China), Berlin (Germany) and Austin (Texas), but has spent far less than I originally estimated that they would have to invest. That said, if you are projecting that Tesla will sell 8, 10 or 12 million cars a year, a decade from now, it will need to reinvest in additional capacity. I use the sales to capital ratio as my proxy for investment efficiency (with higher values implying more efficiency investing), and the choices are below:
    To the extent that the company has the excess capacity to cover growth for the next few years, I will allow for a a higher sales to capital ratio in the early years, but move it towards a more sustainable number thereafter. 
  4. Risk: When I valued Tesla last in early 2020, I used a cost of capital of 7%, reflecting a risk free rate of 1.75% and an equity risk premium of 5.2% for mature markets. In November 2021, the risk free rate is down to 1.56% and equity risk premiums have drifted to 4.62%, and the cost of capital for the median firm had drifted down to about 5.90%. The choices you have on cost of capital are structured around those market realities:
    The other risk measure that will affect value is the likelihood of failure, a number that has varied over Tesla's history, partly because it used to lose money and partly because of a choice it made to borrow money in 2016. In making this assessment now, recognize that Tesla now has a cash balance that exceeds its debt due and is making money, at least for the moment.
  5. Management: Taking to heart how closely Tesla and Elon Musk are connected, one of the concerns with Tesla has always been the sheer unpredictability of Mr. Musk. The Musk effect on value can be positive, neutral or negative, depending on your priors:

    While Musk has been better behaved and more focused for the year and a half, with the exception of indulging in tweeting about cryptos, he seems to have reverted to bad habits in the last two weeks, seeking guidance from his Twitter followers on whether to sell a significant portion of his Tesla shares and indulging in a back-and-forth with senators about the billionaire tax.

I made the choices just as you did, and in the most upbeat of my forecasts, I aimed for revenues of roughly $400 billion (about ten million cars, augmented by revenues from ancillary businesses) in 2032, operating margins of 16% and a sales to capital ratio of 4.00 for the next five years (making Tesla far more profitable and investment efficient than any large manufacturing company in the world). With a cost of capital of 6% (close to the median company) and no chance of failure, it should come as no surprise that my estimated value of equity for the company has increased more than six-fold since my last valuation, to about $692 billion for equity in the aggregate, and $640 billion for equity in common stock.

Download spreadsheet

There are very few companies in the world that I would value at more than half a trillion dollars, and with Tesla, I get there almost entirely based upon its potential for growth and profitability. That said, though, the value per share that I get of $571, even in this most upbeat of scenarios, is less than half the current stock price, leaving me with the conclusion that the stock is over valued. Rather than take issue with my valuation, put your inputs into the attached spreadsheet and estimate your value of equity for the firm.

What’s your story?

    Given my choice to sell shares in Tesla at precisely the wrong time (in January 2020) and my history of undershooting on value for the company, I am the last person you should be relying on for your Tesla investment judgments. There are multiple caveats that go with my valuation, and it is possible that you are able to find a story that yields a valuation not just higher than mine, but also higher than the stock price. Alternatively, you might be one of those who believes that much of what we have seen as improvements in the last two years at Tesla are a mirage, and that I am being delusional in my assumptions. While I welcome debate and disagreement, I have found that, with Tesla, it is easy to get off on tangents and argue about what ultimately become distractions, and I would posit that almost any disagreement that we have about Tesla ultimately becomes one about how much revenues the company can generate from the businesses you see it operating in, and how profitable it will be as a company. 

  1. Revenues: In making my revenue estimates, I have assumed that Tesla will get a predominant portion of its revenues from selling cars, partly because of its history and partly because its alternative revenue sources (batteries, software etc.) are not big revenue items. It is possible, though, that there are new businesses with ample revenues that Tesla can enter, that can create new and substantial revenue streams. It is also possible that the electric car business will resemble technology businesses in their winner-take-all characteristics, and that Tesla will have a dominant market share of that business. In either case, you will have to find ways to get to revenues far greater than my already-daunting number of $414 billion in 2032. (Just for perspective, the total revenues of all publicly traded automobile companies, globally, in 2020-21 was $2.33 trillion and this would give Tesla roughly one sixth of the overall market.)
  2. Profitability: The other key driver of Tesla's value is its operating margin. While I think that my estimate of 16% is already at the upper end of what a manufacturing company can generate, there are a couple of ways in which Tesla might be able to get even higher margins. One is to enter a side business, perhaps software or ride sharing (with automated driving cars), that has much higher margins than the auto business. The other is to benefit from technological advantages to reap the benefits of economies of scale in production; this would require gross margins to continue to climb from less than 30% to much higher levels. 

You can check this for yourself, but the other assumptions about reinvestment and risk don't have as big an impact on value, and I have computed Tesla's equity value (in common stock) as a function of targeted revenues and operating margins.

As you can see, there are pathways that exist to get to the current stock price and above, but they require that you enter rarefied territory with Tesla, assuming that it will have more revenues than any company (not just automobile) in history, while delivering operating margins similar to those delivered by the largest and most successful technology stocks, none of which have the drag of substantial manufacturing costs. 

Tesla: The Pricing Game

     If you are holding or buying Tesla, finding a story to justify its current market capitalization will require a real stretch, a story that will require the company to not just be successful but a one-of-a-kind company. That said, I believe that Tesla is a "trade", not an "investment", and  that perspective provides answers to four questions that you may have about the stock.

  1. How do you explain the current stock price? For much of the last decade, Tesla skeptics have struggled with explaining why the stock is priced at the levels that it is, by the market. Put simply, they have wondered how a company with little revenue and big losses acquires a market capitalization of hundreds of billions of dollars. I have never tried to explain what other people pay for a stock, but the answer may lie in the fact that those trading Tesla are pricing it, based on pricing variables (mood, momentum), rather than on fundamentals (earnings and cash flows).  
  2. Why does the price change so much on news stories? Tesla has always been a company, where small and sometime trivial news stories cause big price changes. Take the news story a couple of weeks that Hertz was considering ordering 100,000 cars from Tesla. Given that the current market cap of Tesla reflects an expectation that the company will sell 10 million cars or more in a few years, the Hertz order, by itself, will have a tiny impact on value, and certainly far less than the hundred billion dollar jump in Tesla's market capitalization, after the news. However, if you view Tesla as a "story stock", the Hertz news story can be viewed as a sign that the company has made the transition from being a second car for the wealthy to a much wider market, potentially leading to a higher pricing.
  3. Does price affect value? Much as I would like to argue that intrinsic valuations are about cash flows, growth and risk, and are therefore insulated from market dynamics, the truth is more nuanced. The ten-fold surge in the stock price since last January did have an effect on my valuation, pushing me towards more upbeat and bigger stories, even though I still found the company to be over valued. If stock prices drop by 50% in the next few weeks, my assessment of value may be lower, as a consequence. In sum, it is almost impossible to value companies in a vacuum, where what the market is doing can be ignored.
  4. If I think the stock is over priced, why not sell short? To the question of why, if I believe in intrinsic value, I am not selling short on Tesla, it is because I believe that, at least in the short term, momentum beats fundamentals, and I have no desire to be caught in the whiplash effect. 
If you are a Tesla trader, I wish you the best, but I do hope that you don't delude yourself, if successful, with tales of fundamentals. You were on the right side of momentum, and whether this was a function of luck or skill, I will leave it for you to decide.

Conclusion

    In the last year and a half, I have heard from many of you about my decision to sell Tesla, and while I am thankful for your concern about my investment performance, there are a few of you who have asked me whether I was sorry that I had sold Tesla, just ahead of its  run-up in the last year and a half. I would be lying if I said that I did not think about the money I could have made, by holding on, when the stock crossed a trillion-dollar market cap, but those second thoughts have been fleeting and I have no regret. Like everyone else, I would rather make money on my investments, than lose money, but I would also rather leave money on the table and have an investment philosophy, flawed though it may be, than make money, and end up without a core set of beliefs about markets. I can say with certainty that I will be back valuing Tesla some time in the future, either because it has crossed a new threshold or because it is in the news. This company is far too interesting to ignore!

YouTube Video

Spreadsheets

  1. Automobile Sector in November 2021
  2. Tesla: November 2021 Valuation




Monday, October 25, 2021

The Billionaire Tax: The Worst Tax Idea Ever?

If you have been tracking the torturous workings of the infrastructure bills working their way through Congress, consideration is now being given to a "billionaire" tax, focused on a extraordinarily small subset of Americans, and intended to raise tens, perhaps even hundreds, of billions of dollars in revenues, to cover the costs of the bill. I am constantly amazed by the capacity of legislatures to write bad tax law, but this one takes the cake as perhaps the worst thought-through and most ineffective attempt ever, at rewriting tax code. That is a little unfair, I know, because the details are still being hashed out, and it is conceivable that the final version will be redeemable, but given that the clock is ticking, I am not hopeful!

The Billionaire Tax: History and Proposal

    To get a sense of why we are discussing a billionaire tax, you have to start with a historical context, beginning with a recognition of increasing wealth inequality and the perception (real or otherwise) that the wealthiest were not paying their fair share of taxes, continuing with promises made during  the most recent presidential campaign and culminating in the last few months of legislative slogging to get a passable bill.

The Rise of Populism

    For much of this century, the big story in economics and politics has been increasing inequality, with the spread in income and wealth between the richest and the rest of society widening over time. The graph below, from the Pew Research Center, is a good starting point, since it highlight the shift in the share of aggregate US income flowing to upper, middle and lower income households.


While economists and politicians continue to debate the causes and consequences of this inequality, that income inequality is magnified when you look at the wealth levels different income groups, with the lowest income households falling even further behind. A rising stock market has augmented the wealth inequality, since the wealthiest hold the preponderance of equities in the market. 

In conjunction with this widening inequality, the perception is building that the wealthy don't pay their fair share in taxes, even though the question of whether they are depends upon the prism you look through. If you focus just on federal tax dollars paid by each group, the wealthy are actually paying a larger share of federal taxes collected than ever before in history, undercutting the claim that they are welching on their tax responsibilities. 

The pushback from progressives is that this graph misses key components, including other taxes collected by the government (payroll taxes, Medicare taxes, estate taxes etc.), and that it is the tax rate that is paid, not dollar taxes, that better measures fairness. In 2018, for instance, the federal effective tax rates paid by different income groups were as follows:


Clearly, while the richest are paying a higher percentage of income in taxes than the poorest, the argument made by some is that they are paying a lower percent of their taxes than they were 40 or 50 years ago (which is true) and that they can afford to pay more (which is debatable).

Elections and Infrastructure Legislation

    To understand why the billionaire tax proposal has become one of the center pieces of the revenue side of the infrastructure bill, we have to retrace the path taken during the 2020 presidential election. During the presidential campaign, President Biden promised repeatedly that he would not raise taxes on anyone making less than $400,000 a year in income, effectively locking out 98.2% of income tax payers from any proposed tax increase. In conjunction, he also argued that the top 1.8% of the populace were not paying their fair share of taxes, and that corporations were also paying too little, and that any rewrite of the tax code would force them to pay their "fair share". In keeping with these two promises, the version of the big infrastructure bills that was initially promoted by the administration raised a significant portion of revenues from changes in tax rates for the wealthiest individuals (by raising the marginal tax rate from 37% to 39.6% for those in the $400,000 plus income range and by adding a surtax on capital gains for those making more than a million dollars in income) and by raising corporate tax rates from 21% to 28%.  After months of back and forth between members, the House Ways and Means Committee approved tax provisions on September 15 that included many of these proposals, raising the corporate tax rate from 21% to 26.5%, while putting limits on interest tax deductions, and the individual tax rate to 39.6% (for income) and 25% (for capital gains). 

Breaking the Logjam?

    The proposals to raise revenues, from the While House and the House committee ran aground, because of objections on raising tax rates from Senator Sinema last week, leading to a rethink of the revenue side.  As higher tax rates were taken off the table, the congressional committees had to look elsewhere, and the billionaire tax proposal seems to be gaining traction, as the replacement. Since almost everything we know about the proposals comes from unofficial sources or news leaks, and talks are still continuing, everything could change in the next couple of days, but here is what the proposals look like on Monday, October 25:

  1. Targeted Taxpayers: The tax will be targeted at individuals who own more than $1 billion in assets or have had income of more than $100 million for three consecutive years. That is pretty elite company, and it is estimated that less than 1000 taxpayers in the United States would be affected.
  2. Taxable Items: The tax would apply to a wide array of assets, including stocks, bonds, real estate and art. I am assuming that closely held businesses are not covered by the tax, or if they are, they will be dealt with differently, but since the proposal is still in the process of being written, we just don't know.
  3. The Proposal: The changes in values of these assets will be subject to tax, even though the individuals continue to hold them, making this a tax on "unrealized" capital gains. There is talk that taxpayers will be allowed to deduct "unrealized" capital losses as well, though the details remain fuzzy. 
  4. The Tax Rate: It is not clear what tax rate would apply on these changes in value, i.e., whether it would be an extension of the capital gains tax rate to these unrealized capital gains, or some other rate, and also whether the tax rate will be the same for all assets, irrespective of liquidity.
In conjunction, corporations will also face a corporate minimum tax rate, putting a floor (at least in theory) on how low they can make their effective tax rates. I will leave it others to discuss that aspect of the tax code, which at least has a defensible basis, but I find the billionaire tax to be problematic at multiple levels.

The Worst Tax Code Change Ever
As I noted earlier, there may be changes that happen between now and when this gets voted on that help make it better, but as it stands, this is an extraordinarily bad tax proposal, and for many reasons:
  1. Micro targeting: Since very few of us to like paying more in taxes, but don't seem to mind seeing others paying more, the political payoff from targeting very few taxpayers is that you minimize the backlash. I know that each of us probably has a billionaire that we hate, and may take secret pleasure in watching that billionaire pay more, but if you view the prime role of taxes as generating revenues for governments, it is dangerous to focus raising tax revenues from this small a number. As a general rule, taxes that are broad based and affect most people are more likely to deliver predicted revenues than those that affect a narrow subset of the population, and the billionaire tax is about as narrowly focused as tax law gets. You may have little sympathy for the seven hundred or so billionaires affected by these taxes, but you should also recognize that these individuals also have the most resources to find ways to minimize the impact of these laws. In fact, not only is an army of tax lawyers, accountants and investment vehicles being created while the law in being written, but I would not be surprised if they are providing input on its actual form. As a final note, as some readers have pointed out, it is worth remembering history. In 1969, Congress added an alternative minimum tax to the code, ostensibly to force less than 200 families that were not paying federal taxes, to pay taxes. Fifty two years later, that abomination stays in the code and ensnares millions of taxpayers, a lesson that what starts as "targeted at a few" very quickly becomes a loose cannon, affecting many more. 
  2. Taxing capital gains (and losses): The basis used for computing taxes can have implications for revenues from the tax code, and that basis can range from sales (with value added and sales taxes) to salary/wage income, to capital gains. Rather than get into moralistic arguments about whether salary income is more virtuous than capital gains income (or unearned income, as its critics like to call it), I will focus on tax revenue reality. Taxes based upon revenues/sales will yield more predictable revenue for the government than taxes based upon salary income, and taxes based upon salary income will yield more stable revenues than taxes based upon capital gains. Capital gains come from stock price changes, which are far more volatile, than income earned by taxpayers, and that income, in turn, changes more on a year-to-year basis than the value of the assets they own. Without passing any judgment on which approach is better, consider tax revenues collected by California, a state that not only taxes all capital gains as ordinary income, but is also more dependent on capital gains than almost any other state, with tax revenues collected by Florida, a state without taxes on individual income:
    Federal Reserve Data Base (FRED)

    California's tax revenues are significantly more volatile than Florida's tax revenues, and capital gains are a big reason why that is the case.  If you are in finance, and you were measuring the risk of different tax revenue sources, capital gains tax revenue would have a "higher beta" than "income tax revenues or sales tax revenues. It is true that prudent governments can find ways to put aside big portions of the capital gains tax revenues, in years of plenty, to cover shortfalls in years where capital gains tax collections are low, but when was the last time you saw prudent governance?
  3. Including "unrealized" gains: The new feature of this law is its attempt to tax unrealized capital gains on assets. The problem with taxing "unrealized" gains or income is that since they are unrealized, and taxes have to be paid with cash, the question of how to come up with the cash becomes an issue, making it a central challenge for any plan, built around it. In fact, there are two practical problems with the proposal, at least as described in the press. 
    • Liquidity questions: If the billionaire tax is going to apply on assets like real estate and fine art, and not just on stocks and bonds, the idea that you can sell some your holdings in the open market and get the cash that you need to pay taxes does not apply as easily, since these non-traded assets are often illiquid and cannot be sold off in small parts. It will also mean that taxpayers who own non-traded assets will need appraisers to revalue these assets every year, great for the appraisal business, but almost guaranteed to create a hotbed of litigation around the appraised values.
    • Losses and Gains: After a decade of rising stock and bond prices, I guess that many have forgotten that not only can what goes up come down, but also that you can have extended periods where assets stagnate or drop in value. While there is airy talk of being allowed to claim unrealized losses as deductions, how exactly would this work? Put simply, if stocks are up 20% in 2021 and down in 2022, would taxpayers get refunds on their taxes paid in 2021? It is also not clear what the tax code writers are assuming about what the market will do over the next decade, when they estimate that this tax will deliver about $200 billion in revenues, but are they assuming that the good times will continue? Stock and bonds have a really good run, but history suggests that there will be not just bad times, but extended bad times for markets:
      Damodaran Online

      There may be no revenues at all from this tax code change, if the market has a decade like the 1970-1979 or 2000-2009, and if that happens, what are the contingency plans for the expenditure that is being funded by these revenues? 
  4. With side effects for other tax revenues: There is another point that I still have not seen a response to, and that is the effect that this billionaire tax will have on revenues from other parts of the tax code, particularly estate taxes. If paying the billionaire tax changes the tax basis for assets, as it should since they are being marked to market, and taxed, that will also mean that when these stocks are inherited, and ultimately sold, there will be less capital gains taxes collected. Even if this proposal is an attempt to get around the inheritance step-up windfall, it is a ham handed and a selective one that does not fix the core problem. If all that the billionaire tax code change is doing is moving forward the collection of taxes to earlier, rather than later, there is a time value benefit to the government, but it has to be a net benefit. In other words, the lost future taxes will have to be netted out against the $200 billion that it is expected to bring in revenues over the next decade.
  5. It is a wealth tax, albeit on incremental, not total wealth: For a few years, progressives led by Senator Warren have argued for a wealth tax, and its pluses and minuses have been debated widely. The administration is trying hard to avoid using the words "wealth taxes" to describe this proposal, but that is sophistry. Janet Yellen's claims notwithstanding, this is a wealth tax, albeit on incremental wealth, rather than total wealth. Put simply, this proposal is biased towards people with inherited wealth, invested in non-traded assets and mature businesses, and against people invested in publicly traded equities in growth companies, many of which they have started and built up. If that is the message that the tax law writers want to send, they should at least have the decency to be up front about that message, and to defend it.
Side Costs
If the history of tax law is that there are always unintended consequences, the problem with this law is that the consequences are entirely predictable and mostly bad, and you and I, even though we are not in the billionaire club, will face them. 
  1. Price Effects: If there is a billionaire tax on unrealized gains, some or even many of these billionaires will have to sell portions of their asset holdings to pay taxes dues. There is no way that an Elon Musk would have been able to pay taxes on the unrealized gains on his Tesla holdings in 2020, without selling a portion of his holding. While there may be enough liquidity in a stock like Tesla to absorb that selling, there are other assets where the liquidity effect is going to be larger and more permanent. 
  2. Founder/Managers: One reason that investors prefer companies that have founders with substantial stock holdings running them is because they believe that there is less of a conflict of interest in these firms, than in those run by professional managers with little or no shareholdings. If this proposal is pushed through, and especially if the tax rate is set at capital gains levels, founders will have no choice but to reduce holdings over time, both to pay taxes and to shift to less traded assets.
  3. Public to Private: As I said earlier, I am not sure how privately held businesses will be treated, for computing the billionaire tax, but if there is indeed a carve out for these businesses, I will predict that there will be more companies where rich founders will choose to take the company private again.
For those who view the tax code as an instrument to deliver pain, the only consolation prize will be that punishment is being meted out to those who "deserve" it the most, but I am afraid that it is a booby prize. With the billionaire tax, the intended targets will pay far less in taxes than you think they should and now that the door to unrealized profits being taxed has been opened, how do you know that you are not next on the target list?

Conclusion
I understand that those working on these tax code changes face a tough task, given the constraints that they have on them (not raising tax rates, not taxing people who make less than $400,000), but these are constraints that they imposed on themselves, either because too much was promised on campaign trails or because they are working with paper-thin majorities, where one hold out can stop the process. The problem with the billionaire taxes is that it will be ineffective at collecting tax revenues, and I am willing to wager that a decade from now, we will find that it collected only a small fraction of its promised revenues. Good intentions about creating a better social safety net cannot excuse the writing of tax laws that are inefficient at collecting revenues, ineffective even in their punitive intent and potentially dangerous for the rest of us, in terms of side costs. 

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Tuesday, October 19, 2021

Triggered Disclosures: Escaping the Disclosure Dilemma

In a post a few weeks ago, I argued that the disclosure process had lost its moorings, as corporate disclosures (annual filings, prospectuses for IPOs) have become more bulky, while also become less informative. I argued that some of this disclosure complexity could be attributed to the law of unintended consequences, with good intentions driving bad disclosure rules, and that some of it is deliberate, as companies use disclosures to confuse and confound, rather than to inform. For those of you who agreed with my thesis, the end game looks depressing, as new interest groups push for even more disclosures on their preferred fronts, with the strongest pressure coming from the environmental, social and governance (ESG) contingent. In this post, I propose one way out of the disclosure dilemma, albeit one with little chance of being adopted by the SEC or any other regulatory group, where you can have your cake (more disclosure on relevant items) and eat it too (without drowning in disclosure). 

The Disclosure Dilemma: Disease and Diagnosis

    For those of you who did not read my first post on disclosures, let me summarize its key points. The first is that company disclosures have become more bulky over time, whether it be in the form on required filings (like annual reports or 10K/10Q filings in the US) or prospectuses for initial public offerings.  The second is that these disclosures have become less readable and more difficult to navigate, partly because they are so bulky, and partly because disclosures with big consequences are mingled with disclosure with small or even no consequences, often leaving it up to investors to determine which ones matter. The net effect is that investors feel more confused now, when investing in companies, than ever before, even though the push towards more disclosures has ostensibly been for their benefit.

    As we look at the explosion of disclosures around the world, there are many obvious culprits. The first is that technology has made it possible to collect more granular data, and on more dimensions of business, than ever before in history, and to report that data. The second is that interest groups have become much more savvy about lobbying regulatory groups and accounting rule writers to get their required data items on the required list. The third is that companies have learned that converting disclosures into data dumps has the perverse effect of making it less likely that they will held accountable, rather than more. That said, there are three other reasons for the disclosure bloat: 

  • The first is the prevailing orthodoxy in disclosure is tilted towards "one size fits all", where all companies are covered by disclosure requirements, even if they are only tangentially exposed. Though that practice is defended as fair and even handed, it is adding to the bloat, since disclosures that are useful for assessing some firms will be required even for firms where they have little informative value. 
  • The second is the notion of materiality, a key component of how accountants and regulators think about what needs to be disclosed.  Using the words of IFRS (1.7), ‘Information is material if omitting, misstating or obscuring it could reasonably be expected to influence decisions that the primary users of general purpose financial statements make on the basis of those financial statements, which provide financial information about a specific reporting entity’. As we will argue in the next section, this definition of materiality may be leading to too much disclosure for backward looking items and too little for forward looking items.
  • The third is that the disclosure rule writers happen to be in the disclosure business, and since more disclosure is good for business, the conflict of interest will always tilt toward more rather than less disclosure. No matter how many complaints you hear from accountants and data services about disclosure bloat, it has been undeniable that it has created more work for accountants, appraisers and others in the disclosure ecosystem.
It is quite clear, though, that unless we break this cycle, where each corporate shortcoming or market upheaval is followed by a fresh round of new disclosures, we are destined to make this disclosure problem worse. In fact, there may come a point where only computers can read disclosures, because they are so voluminous and complicated, perhaps opening the door for artificial intelligence or matching learning into investing, but for all the wrong reasons.

Escaping the Disclosure Trap

    There is a way out of this disclosure trap, but it will require a rethink of the status quo in disclosures. It starts first by moving away from "one size fits all" disclosure rules to disclosures tailored to companies, a "triggered" disclosure process, where a company's value story (big market, lots of subscribers) triggers disclosures on the parameters of that story. It extends into materiality, by reframing that concept in terms of value, rather than profits, and connecting it to disclosure, with disclosure requirements increasing proportionately with the value effect. Finally, it requires creating a separation between those who write the disclosure rules and those who make money from the disclosure business.

One size (does not) fit all!

When disclosure laws were first written in the aftermath of the great depression, they were focused on the publicly traded firms of the time, a mix of utilities, manufacturing and retail firms. At the time, the view that disclosure requirements should be general, and apply to all companies, was rooted in the idea of fairness. In the decades since, there have been exceptions to this general rule, but they have been narrowly carved out for segments of firms. For instance, oil companies are required to disclose their ownership of "proven undeveloped reserves", in addition to details about quantity, new investments and progress made during the year in converting those reserves. The disclosure rules for banks and insurance companies require them to reveal the credit standing of their loan portfolios and their regulatory capital levels to investors and the public. These exceptions notwithstanding, disclosure laws written to cover concerns in one sector (such as the use of management options at technology firm or lease commitments at retail and restaurant companies) have been applied broadly to all companies. It is time to rethink this principle and allow for a more variegated disclosure policy, with some disclosures required only fir subsets of companies. Since the next big bout of disclosures that are coming down the pike will be related to ESG, this discussion will play out in a wide range of ESG data items. For instance, while it makes sense to require that fossil fuel and airline companies report on their carbon footprints and greenhouse gas emissions, it may just be a time consuming and wasteful exercise to require it of technology companies.

From earnings-based to value-based materiality

I do not think that you will find many who disagree with the premise that any information that has a material effect should be disclosed, but there is disagreement on what comprises materiality. I believe that the "materiality principle", as defined by accountants, is diluted by measuring it in terms of impact on net income and the fact that accountants tend to be naturally conservative in measuring that impact. Simply put, it is safer for an accounting or audit firm to assume that a disclosure is material, and include it in reports, even if it turns out to be immaterial, than it is to assume that it is immaterial, and be found wrong subsequently.  One solution to this problem is to redefine materiality in terms of effects on value, rather than earnings, thus accomplishing two objectives. First, it will reduce the number of noise disclosures, i.e., those that pass the materiality threshold for earnings, but don't have a significant impact on value. Second, since value is driven by expected cash flows in the future and not in the past, it will shift the focus on disclosures to items that will have an impact on future earnings and cash flows, rather than on past earnings or book value.

Triggered Disclosures

At first sight, the requirements to make disclosures slimmer and more informative may seem at war with each other, since disclosure bloat has largely come from well-intentioned attempts to make companies reveal more about themselves. Triggered disclosures, where disclosures are tailored to a company's make-up and stories, are one solution, where contentions made by a company trigger additional disclosures related to that contention. Thus, a company that claims that brand name is its supreme competitive advantage would then have to provide information to not only back up that claim, but also to allow others to value that brand name. 

Disclosure Illustration: Initial Public Offerings
    
It is difficult to grapple with disclosure questions in the abstract, and to illustrate how my proposed solutions will play out in practice, I will focus on initial public offerings, where there is a sense that the disclosure rules are not having their desired effect. In my last post, I noted that prospectuses, the primary disclosure documents for a companies going public, have bulked up, contrasting the Microsoft and Apple prospectuses that came in at less than a 100 pages in the 1980s to the 400+ page prospectuses that we have seen with Airbnb and Doordash in more recent years. At the same time, applying a disclosure template largely designed for mature public companies to young companies, often with big losses and unformed business models, has resulted in prospectuses that are focused in large parts on details that are of little consequence to value, while ignoring the details that matter.  Since companies going public often do so on the basis of stories that they tell about their futures, and these stories vary widely across companies, this segment lends itself well to the triggered disclosure approach. To do so, I will draw on a paper that I co-wrote with Dan McCarthy and Maxime Cohen, to provide details. In that paper, we argue that a going-public company that wants to build its story around certain dimensions (a large total addressable market or a large user base) will trigger disclosure of a more systematic, business type-specific, collection of “base disclosures” that are required to understand the economics of businesses of that type, whatever type that might be.

Total Addressable Market (TAM)
Companies going public have increasingly supported high valuations by pointing to market potential, using large TAMs as one of the justifications. These TAMs are often not only aspirational, but also come with very little justification and no timeline for how long it will take for the existing market sizes to grow into those TAMs. For instance, the graph below shows the TAMs that Uber and Airbnb claimed in their prospectuses at the time of their initial public offerings.
Uber and Airbnb Prospectuses
Is Uber’s total addressable market really $5.2 trillion? I don’t think so, but you can see why the company was tempted to go with that inflated number to push a “big market” narrative. To prevent the misuse of TAM as little more than a marketing ploy, companies that specify a TAM should also have to provide the following:
a. TAM, SAM and bridges: Companies that specify a TAM should also specify the existing market size (i.e., the serviceable addressable market or SAM), as well as additional “bridges” so that investors can understand the evolution from SAM to TAM (e.g., an estimate of how many individuals would be interested in the company’s product before considering price). Investors who may be skeptical of a lofty TAM could still look to SAM as a more achievable intermediate metric.
b. Market share estimates: As long as companies do not have to twin TAM with expectations of market share, there is little incentive for them to restrain themselves when estimating TAM. We would recommend requiring that companies that disclose TAM figures couple them with forecasts of their market share of those TAM figures. For companies that are tempted to significantly inflate their TAMs, the worry that they will be held accountable if their revenues do not measure up to their promises, will act as a check.
c. Ongoing metrics or measures: Companies usually provide TAM, SAM, and variants thereof on a one-shot basis, disclosing these figures in their pre-IPO prospectuses and then never again. We believe that investors should be given these measures on an ongoing basis. This will help on two levels. First, it will allow investors to see how well the company is adhering to its prior disclosures and forecasts and provide investors with updates if conditions have changed. Second, companies that know they will be held accountable to their IPO disclosures after they go public will be more incentivized to make those disclosures realistic and achievable. 

To the extent that investors will continue to assess premiums for companies that have bigger markets, the bias on the part of companies will still be to overestimate TAM. That said, these recommendations should help rein in some of those biases.

Subscription-Based Companies
A subscription-based company derives its value from a combination of its subscriber base (and additions to it) and the subscription fees its charges these subscribers.  Consequently, the value of an existing subscriber can be written as the present value of the expected marginal profit (subscription fee net of the costs of servicing that subscription) from the subscription each year, over the expected life of the subscriber (based upon renewal/churn rates in subscribers), and the value of a new subscriber will be driven all of the same factors, net of the cost of acquiring that subscriber. The overall value of the company can be written in terms of its existing and new subscribers:


Companies that sell a “subscriber” story have the obligation, then, to provide the information needed to derive this value:
  1. Existing subscriber count: Observing the total number of subscribers in each period (e.g., month or quarter) allows us to track overall growth trends in the number of subscribers, and to understand how revenue per subscriber evolves over time, because revenue is disclosed.
  2. Subscriber churn: To value a subscriber, a key input is the renewal rate or its converse, the churn rate. Holding all else constant, a subscription business with a higher renewal rate should have more valuable subscribers than one with a lower renewal rate. It would stand to reason that any subscription-based company should report this number, but it is striking just how many do not disclose these measures or disclose them opaquely. For example, while the telecom industry regularly discloses churn figures, Netflix has not disclosed its churn rate in recent years. 
  3. Contribution profitability: For subscribers to be valuable, they need to generate incremental profits, and to estimate these profits, you need to know not just the subscription fees that they pay, but also the cost of servicing a subscription; the net figure (subscription fee minus cost of service) is called the contribution margin. Many subscription companies explicitly disclose contribution profits (e.g., Blue Apron, HelloFresh, and Rent the Runway), but many others do not (e.g., StitchFix). In the absence of explicit contribution profit data, investors often resort to simple proxies for it, such as gross profit, but these proxies are imperfect and noisy.
  4. Subscriber acquisitions & drop offs: To move from the value of a single subscriber to the value of the entire subscriber base, we must also know how many subscribers are acquired over time, not just the net subscriber count. Put differently, if a company grew the overall size of its subscriber base from 10 million to 12 million subscribers in a year, it is quite different if that net growth came about because the company acquired 10 million customers that year but then lost 8 million of them, versus if the company acquired 2 million customers and lost none of them. Acquisition (or equivalently, churn) disclosures are what allow us to piece this apart.
  5. Cost of acquiring subscribers (CAC): Subscription-based companies attract new subscribers by offering special deals or discounts, or through paid advertising. While the cost of acquiring subscribers can sometimes be backed out of other disclosures at subscription-based companies (such as subscribers numbers, churn and marketing costs), it would make sense to require that it be explicitly estimated and reported by the company.
  6. Cohort data: While many subscriber companies are quick to report total numbers, only a provide a breakdown of subscribers, based upon subscription age. This breakdown, called a cohort table, can be informative to observe retention and/or monetization patterns across cohorts, as noted by Fader and McCarthy in their 2020 paper on the topic. Many subscription-based firms, including Slack, Dropbox, and Atlassian, now disclose cohort data, and the figure below shows one such chart for Slack Technologies:
    Source: Slack Technologies Form S1
By breaking down cohort-specific retention and monetization trends, a cohort chart offers investors visibility into retention and development patterns as a function of subscriber tenure (e.g., does the retention rate get better or worse as subscribers get older), and trends across time, as subscribers stay on the platform. 

Transaction-Based Companies
The guiding principles driving our disclosure recommendations for subscription-based businesses largely extend to transaction-based businesses, with the primary difference being that subscription revenues are replaced with transaction revenues, a number that is not only more difficult to estimate, but one that can vary more widely across customers. The value of the customer base at transaction-based businesses is driven off the activity of these customers, translating into transaction revenues and profits. 


As with subscriber-based businesses, this framework can only be used if the company provides sufficient data from which one can estimate the inputs. Deconstructing this picture, many of the key disclosures track those listed for subscription based companies, including contribution profitability, customer acquisition costs and cohort data. In addition, there are three key additional pieces of information that can be useful in valuing these companies:
  1. Active customer count: We replace the notion of a subscriber with that of an “active” customer, which is more suitable for transaction-based businesses. After all, a customer in your platform who never transacts is not affecting value, and one issue that transaction-based companies have struggled with is defining "activity". Wayfair, Amazon, and Airbnb, for example, define an active customer to be one who has placed at least one order over the past 12 months. In contrast, Lyft, Overstock, and many other companies define a customer as active if they placed an order in the past 3 months. 
  2. Total orders: In transaction-based companies, the average purchase frequency of active customers can change, often significantly, over time. We need to know the total orders because this further allows us to decompose changes in revenue per active customer into changes in order frequency per active customer and changes in average order value. While some transaction-based businesses disclose this information, including Wayfair, Overstock, Airbnb, and Lyft, this data is notably absent for many others, such as Amazon.
  3. Promotional activity: It can be easy to significantly increase purchase activity through enticing targeted promotions, creating the illusion of rapid growth that may not be sustainable over the long run, due to their substantial cost. Since these promotions are often reported as revenue reductions, rather than expenses, the cost of these campaigns are often opaque, to investors. For example, DoorDash did not disclose their total promotional expense during the most recent 6 months in their IPO prospectus, creating substantial uncertainty for investors as to how this may have influenced gross food sales). 
Fintech Companies
In the last decade, we have seen banks, insurance companies and investment firms face disruption from firms in the "fin-tech" space, covering a diverse array of companies in the space. With all of these companies, though, there is (or should be) a lingering concern that part of their value proposition comes from "regulatory arbitrage", i.e., that these disruptions can operate as financial service companies, without the regulatory overlay that constrains these companies, at least in their nascent years. Since this regulatory arbitrage is a mirage, that will be exposed and closed as these fin-tech companies scale up, investors in these companies need more information on:
  • Quality/Risk metrics on operating activity: In the aftermath of the 2008 crisis, banks, insurance companies and investment banks have all seen their disclosure requirements increase, but ironically, the young, technology-based companies that have entered this space seem to have escaped this scrutiny. In fact, the absence of a regulatory overlay at these companies makes this oversight even more dangerous, since an online lender that uses a growing loan base as its basis for a higher valuation, but does not report on the default risk in that loan base, is a problem waiting to blow up. It is highly informative for investors to observe the evolution of these measures in the years and quarters leading up to the IPO. Indeed, lenders can be tempted to strategically lower their credit standards to issue more loans (and hence significantly increase revenue through loan-related fees, which are often assessed upfront) to create the illusion of growth at the expense of long-term profitability and trust (since many of these risky loans are likely to default in the future).
  • Capital Buffer: It is worth remembering that banks existed prior to the Basel accords, and that the more prudent and long-standing ones learned early on that they needed to set aside a capital buffer to cover unexpected loan losses or other financial shortfalls. In the last century, regulators have replaced these voluntary capital set asides, at banks and insurance companies, with regulatory capital needs, tied (sometimes imperfectly) to the risk in their business portfolios. Many fintech companies have been able to avoid that regulatory burden, largely because they are too small for regulatory concern, but since they are not immune from shocks, they too should be building capital buffers and reporting on the magnitude of these buffers to investors. 
Conclusion
As data becomes easier to collect and access, the demands for data disclosure from different interest groups will only increase over time, as investors, regulators, environmentalists and others continue to add to the list of items that they want disclosed. That will make already bulky disclosures even bulkier, and in our view, less informative. There are three ways to have your cake and eat it too. The first is to allow for increasing customization of disclosure requirements to the firms in question, since requiring all firms to report everything not only results in disclosures becoming data dumps, but also in the obscuring of the disclosures that truly matter. The second is to shift the materiality definition from impact on earnings to impact on value, thus moving the focus from the past to the future. Finally, tying disclosures to a company's characteristics and value stories will limit those stories and create more accountability.

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Papers