YVES SAINT LAURENT, Lady Gaga, David Bowie. Some people do not operate by the same rules as everyone else. Might the same be true of companies? Most bosses complain of being slaves to short-term profit targets. Yet a few flout the orthodoxy in flamboyant fashion. Consider Tesla, a maker of electric cars. This year, so far, it has missed its production targets and lost $1.8bn of free cashflow (the money firms generate after capital investment has been subtracted). No matter. If its founder Elon Musk muses aloud about driverless cars and space travel, its shares rise like a rocket—by 66% since the start of January. Tesla is one of a tiny cohort of firms with a licence to lose billions pursuing a dream. The odds of them achieving it are similar to those of aspiring pop stars and couture designers.
Investing today for profits tomorrow is what capitalism is all about. Amazon lost $4bn in 2012-14 while building an empire that now makes money. Nonetheless, it is rare for big companies to sustain heavy losses just to expand fast. If you examine the members of the Russell 1000 index of large American firms, only 25 of them, or 3.3%, lost over $1bn of free cashflow in 2016 (all figures exclude financial firms and are based on Bloomberg data). In 2007 the share was 1.4% and in 1997, under 1%. Most billion-dollar losers today are energy firms temporarily in the doldrums as they adjust to a recent plunge in oil prices. Their losses are an accident.
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But a few firms love life in the fast lane. Netflix, Uber and Tesla are tech companies that say their (largely unproven) business models will transform industries. Two others stand out for the sheer persistence of their losses. Chesapeake Energy, a fracking firm at the heart of America’s shale revolution, has lost at least $1bn of free cashflow a year for an incredible 14 years in a row. Nextera Energy, a utility that runs wind and solar plants, and which investors value highly, has managed 12 years on the trot.
Collectively these five firms have burned $100bn in the past decade, yet they boast a total market value of about $300bn. Combining punchy valuations with massive losses means taking the entrepreneurial art form to a dizzying extreme. Steve Jobs, Apple’s co-founder, was said to have a “reality distortion field” that allowed him to bend the perception of others (although Apple itself was fairly timorous, losing just $874 in its worst year, in 1993). The experience of the five suggests that bending reality today has three elements: a vision, fast growth, and financing.
Take the vision thing first. A charismatic leader with a world-changing plan is de rigueur. For its first 23 years Chesapeake was led by Aubrey McClendon, a cocky Oklahoman who pioneered the process of blasting rocks to extract gas and oil (he died last year in a high-speed car crash). Reed Hastings at Netflix plans to destroy the conventional TV industry by selling films and shows over the internet. Like Mr Musk, Travis Kalanick, Uber’s tarnished former boss, dreams of changing how humans travel. Nextera is led by technocrats but their aim is grandiose—to usher in a new generation of energy technology.
The vision needs to be validated by runaway growth. Often firms emphasise a flattering operating measure, such as oil and gas pumped from the ground, the number of rides hailed and so on. Investors need to believe in a high “terminal value”, a point in the future when high, stable profits will arrive. So it helps to show that, hypothetically, profits would gush if breakneck growth were to stop. Uber says it is profitable in cities where it has operated longest, such as San Francisco. Nextera says that if it stopped investing in new capacity, it would make $6bn of free cashflow a year. Netflix amortises the cost of content over periods of up to five years, so reports an accounting profit even as it bleeds cash.
The third element is financing to pay for huge cumulative losses. Each of the five firms has been a financial innovator, taking advantage of cheap money and growth-hungry investors. Uber has tapped private capital markets, Nextera has structured part of its business as a partnership, Tesla has taken deposits from customers and also trades environmental tax credits. Chesapeake Energy sparked Wall Street’s lust for shale junk bonds, and Netflix has signed commitments to make $14bn of future payments to studios and artists to buy creative content.
So sustaining a reality distortion field is possible, but the longer it goes on for, the harder it gets. More capital has to be raised and, in order to justify it, the bigger the firm’s projected ultimate size—its terminal value—has to be. Fast growth puts huge strain on managers. At some point the edifice can come tumbling down. The five companies described here have $60bn of borrowings, and one, Chesapeake, is struggling with its debt load.
A few firms other than Amazon have defied the odds. Over the past 20 years Las Vegas Sands, a casino firm, Royal Caribbean, a cruise-line company, and Micron Technology, a chip-maker, each lost $1bn or more for two consecutive years and went on to prosper. But the chances of success are slim. Of the current members of the Russell 1000 index, since 1997 only 37 have lost $1bn or more for at least two years in a row. Of these, 21 still lose money.
To justify their valuations, the five firms examined by Schumpeter must grow their sales by an estimated 8-33% each year for a decade. Based on the record of all American companies since 1950, and the five firms’ present revenue levels, the probability of this happening ranges between 0.1% and 25%, using statistical tables from Credit Suisse, a bank.
Firms that burn piles of cash are often lionised in an era when growth is sluggish and few companies reinvest all their profits. But losing a billion dollars or more a year is a wildly risky affair and the odds are that such businesses will fall flat. This should not be a surprise—hardly anyone can pull off building a fashion empire around androgyny, wearing a raw meat dress to an awards ceremony, or singing about life on Mars.
Companies that burn up bn a year are sexy, dangerous, and statistically doomed