Valuation metrics favoured by digital economy firms going public need a long, hard look

DIGITAL services platform Grab released a set of earnings last week with particular focus on gross merchandise value (GMV), one of the ways it assures investors its business has been growing well despite the Covid-19 pandemic. GMV measures the total dollar value of transactions from Grab's services, such as ride hailing and food delivery.

Grab's GMV in the third quarter increased 32 per cent year on year to reach a quarterly record of US$4.0 billion - but even this growing GMV number carries some caveats with its interpretation.

Grab's revenue for the latest quarter was 3.9 per cent of GMV, down from 5.6 per cent a year ago and 4.6 per cent in the second quarter of 2021. This means that for every dollar transacted on its platform, the company got to keep less for itself.

The GMV number compares more favourably against Grab's earnings before interest, taxation, depreciation and amortisation (Ebitda). For instance, despite the impact of lockdowns on the mobility business, the mobility segment's adjusted Ebitda as a percentage of GMV was 12 per cent, versus 11.4 per cent a year ago.

For the deliveries segment, it improved to -0.9 per cent from -1.6 per cent a year earlier. Figures for financial services have also improved.

These profitability metrics are just as important as growth, if not more. And as more tech companies head for the public markets with their "new economy" metrics, investors should pay attention to the indicators that tell a clearer story.

Startup metrics

In the startup world, where companies are not expected to make money, all kinds of metrics are used to indicate growth.

GMV, for instance, is used by venture capitalists to tell how established a platform is, or to derive market share. It is also seen as an indicator of future growth.

Online classifieds startup Carousell is valued at over US$1 billion despite revenue of only US$15.7 million in 2019 (post-pandemic financials are unavailable).

Justifying these valuations, some industry players have noted the large volume of transactions flowing through the platform and the "sticky" user base - pointing to potential for future monetisation.

But GMV can also provide a misleading picture. It fails to take into account how much money the company actually gets to keep, or how easy it is to retain users.

In some cases, startups find ways to boost the transactions on their platform to make their numbers more impressive ahead of a fundraising exercise or initial public offering. They step up promotions or user incentives, even if doing so means losing money on every transaction.

Others take liberties with the way they recognise GMV. Sam Lee, head of mergers and acquisitions at advisory firm Paloe, has come across a marketplace startup that double-booked transactions in its GMV tabulation. The company argued that as an intermediary, it could recognise the transaction between the seller and the platform, and the platform and the buyer.

"This is not uncommon for a trading platform, though it can be misleading especially when GMV is not defined properly," said Lee. "The risk is that when misrepresented, it will be flagged out during the due diligence process and it becomes a deal breaker."

Venture capital-fuelled companies such as Uber and Pinduoduo have popularised new metrics for valuing businesses. The most memorable case is perhaps WeWork, which tried to get away with "community-adjusted Ebitda". In his first interview in 2 years, former chief executive Adam Neumann admitted to DealBook's Andrew Ross Sorkin that "when it comes to finance, it's better to be boring".

New standards

To be clear, this column is not suggesting Grab has engaged in any of such inflation of its numbers.

Investors should, however, pay more attention to the various metrics startups use.

The US Securities and Exchange Commission (SEC) is already taking a firmer stance on companies presenting their financials in a way that investors can easily understand.

After deliberations with the SEC, Grab had to net off consumer incentives, in addition to merchant and driver incentives, when deriving revenue. This makes its reporting more conservative, and complicates comparisons with peers.

Only DoorDash takes the same approach. Uber, Sea and Didi either do not account for, or partially account for, customer incentives when deriving revenue.

Adjusted net sales were also missing from Grab's Q3 report, another sign that the SEC wants companies to reduce reliance on non-generally accepted accounting principles (GAAP) metrics.

This could create a new standard for how "new economy" companies present themselves.

As more startups in South-east Asia go public soon, investors will be wise to evaluate new metrics holistically and in context.