A Practical Guide to IPOs Chapter 12B – Telling a Good Story with Above the Line Numbers

KEY LESSON: Investors hate volatility more than they love growth

In the last post, I laid out an approach to providing initial guidance to investors, from the time of the IPO through the first year. I only looked at Revenue and Earnings Per Share (EPS) as those are the key metrics through which investors view the company. However, I also want to look at the ‘above the revenue line’ numbers, as this is where a company can really position itself well, if presented appropriately.

Here are the numbers from last time:

Year -1 0 1 2 3 4 5
Users 100 200 350 525 700 850 1000
Growth 100% 75% 50% 33% 21% 18%
Interactions 1.0 1.5 2.0 2.7 3.6 5.0 7.0
Growth 50% 33% 33% 36% 39% 40%
Rev/user 1 1.1 1.2 1.3 1.4 1.5 1.6
Growth 10% 9% 8% 8% 7% 7%
The Line
 Year -1 
Revenue 100 220 420 682.5 980 1275 1600
Growth 120% 91% 63% 44% 30% 25%
EPS -2.00 -0.50 0.00 1.00 2.00 3.00 4.00
100% 50% 33%

In this example, I have three numbers the company can report – users, interactions and revenue per user. I made these categories up, companies can pick whichever numbers they want. Well-run companies today tend to have an array of metrics which they track closely in running the business. Bear in mind that the best numbers to run the business may not be the best numbers to present to the Street. All companies will have very different models, the key is to choose the metrics that :

  • Tell a good story
  • Management can predict

In the example here, the company can choose among any of these three. One of the interesting things here is that the company is growing revenue faster than its users. That is a great story on which to focus investors’ attention. Here, management is going to be tempted to disclose the ‘user’ numbers. Those are growing nicely. For the sake of argument, let’s say that it turns out that the user number can fluctuate hugely quarter to quarter, and is very hard to predict. Maybe in some cases, the user numbers actually decline in one quarter, only to grow the following quarter. The full-year trend is positive, but the quarterly numbers can look crazy. Management does not want to disclose those figures. So now they have a problem, if they disclose revenue per user, investors can easily do the math and ‘back into’ the user numbers. Investors will see revenue growing but will not be able to get comfortable with those volatile user numbers.

This leaves the company with disclosing “Interactions”. These numbers look good. They are growing. They are somewhat correlated to actual business, enough that management does not have to tell any lies to investors when discussing their relevance. Management can then construct a narrative around how the company is growing Interactions to some level. Investors will then be able to check back in a quarter, a year, three years and see that Interactions have continued to trend just like management said they would. This builds great long-term credibility.

One of the oddities of the investment community is how much investors hate volatility. In many cases, companies with good growth but ‘bumpy’ numbers get assigned a discount to companies that are growing slower but in a smoother manner. It is not entirely rational, and there are plenty of other investors who exploit that irrationality, but for the most part investors get uncomfortable with numbers that gyrate a lot, even if long-term trends are positive.

A final consideration. After the IPO, investors and sell-side analysts are going to find some way to guess the company’s results ahead of time. They will conduct ‘channel checks’, asking everyone they can for any clue. There is the famous story of analysts using satellite data of Wal-Mart parking lots to gauge sales volumes. To be clear, I am talking about legal ways of doing this, and it turns out there are plenty of ways to make educated guesses. No matter what management does, everyone who cares about their stock is going to make guesses about trends and results. When possible, it is good for management to have a way to corral those interests. Management will never be able to control what analysts do, but just having some channel to focus all that energy is useful to have.

In building this part of the story, I have focused on the company’s basic business. They have a clear story, with a multi-year ‘arc’ around improving Interactions. Beyond this the company should also layer in that Pixie Dust I have mentioned. Since every company’s version of this is going to be radically different, I will not devote a whole chapter to the topic. Those stories are abstract and often use terms like ‘platform’ and ‘synergy’. Management teams should build these based on their own dreams of where they are taking their businesses. For this, big dreams are ok, but hard promises are not.

In the end, the company’s goal is to establish credibility by setting some clear goals and achieving them. Then management has a foundation on which to continue to demonstrate to the Street that growth is going well, that the business is doing what they said it would during the IPO roadshow. As they build up their “credibility equity”, they have a cushion for those quarters when the business hiccups, which will happen someday. Investors will look through those for a quarter or two and still come back, because management is now a known entity and investors will want to come back for that longer-term opportunity.

2 responses to “A Practical Guide to IPOs Chapter 12B – Telling a Good Story with Above the Line Numbers

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