Frank Thoughts: The Illusionists
Dave Canal
November 07, 2019

In theory, a magician and an illusionist are the same.  But an illusionist performs on a much larger scale.  He’s the one who uses sleight of hand to distort the senses.  Especially the brain.  In effect, he makes perception overtake reality.   Such a technique is used today in bringing a “new” company public.  It starts with a “creative” entrepreneur who holds the corporate “vision.” He’s then aided by his venture capitalist, CPA and investment banker.  Together they practice an illusion called non-GAAP accounting.   It’s magic that can take an unprofitable business model and make it appear profitable.

GAAP is an acronym for Generally Accepted Accounting Principles.   It’s a universal accounting standard for comparing companies on the basis of profitability.  After all, a business exists to make money for its owners.  That concept disappeared during the internet boom of the 1990’s.  To attract technology workers, companies gave them stock options.   Under non-GAAP there’s no cost to the company.  As our knowledge economy continues to expand, so does the proliferation of non-GAAP filings.  According to Audit Analytics, in 1996 it was 59% of IPO filings; in 2017 it was 97%!

An example of the accounting distortion this potentially can create recently appeared in Barron’s.  The newspaper wrote about a payment processor called, Square.   It was described as a “highflying technology wonder.” The article then points out, the company was one of the first big unicorns ($1 billion plus valuation) to go public in 2015.  This year the company is expected to generate … “$2.27 billion in sales and adjusted earnings of 77 cents a share.  A profit figure that excludes stock-based compensation.  Using generally accepted accounting principles, Wall Street expects the company to lose five cents a share in 2019.” The difference in using non-GAAP can only be called an illusion.

WeWork is the poster child for non-GAAP accounting.  The company’s “creative visionary,” Adam Neumann, was recently fired.  An example of his vision was that he expressed wanting to “elevate the world’s consciousness.” In the company’s initial IPO prospectus his name was mentioned 169 times!  Just prior to going public, the company had been valued by his venture capital, accounting and investment banking firms at $47 billion dollars.  The venture capital firm is now in the process of rescuing the company’s failed IPO experience with a two billion cash infusion.  The current value is eight billion down 39 billion in the past two months.  Such is non-GAAP accounting.  It’s not reality.

We know this from famous bankruptcies such as Enron and Worldcom.  In the investment world, success is counted in numbers.  One would think, it would be easy for anyone who’s quantitatively gifted.  But it is not.  Mathematics functions in linear progression.  Life seldom does.   Which brings us to the issue of trust.  I learned this investment lesson from H. Alden Johnson.  “Augie” was the portfolio manager of the largest mutual fund in the country at the time, Mass Investors Trust.  We were playing golf the day after Equity Funding had been outed as a fraud.  The stock was the Amazon of its time in 1973.   Everyone owned it.  “Augie, how many shares do you own? “I asked.  “None!  I met “Stanley.” He said “Stanley” with complete disdain. “I didn’t trust him.” Stanley Goldblum was the company’s C.E.O. 

The word evanescence means the appearance of success that is rapidly fading.  Disappearing. Vanishing.  A word that accurately describes non-GAAP accounting.  It also describes creative visionaries who want to “elevate the world’s consciousness.” It is all part of the illusion.

-Francis Patrick Boland

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