There's a flip side to Anthropic's $80.7 billion net loss for the first half of this year. On the other side of the ledger, Amazon.com and Alphabet booked large paper gains on some of the same financing deals.
This tees up a vexing question as Anthropic prepares for an initial public offering as soon as November: Should gains and losses like those count in the alternative earnings metrics widely touted by Wall Street stock analysts?
At Amazon and Alphabet, the gains count. But at Anthropic, the corresponding losses don't, or at least not in the company's adjusted profit figures.
Anthropic's red ink arose mainly from marking up the value of liabilities on its balance sheet, a process that produces losses on the income statement much like marking down an asset's value does. The liabilities included convertible promissory notes dating to the artificial-intelligence developer's early financing rounds. The convertible notes essentially are loans that turn into company stock instead of being repaid in cash.
As Anthropic's market value soared, so did the notes' value. The surge resulted in large noncash losses for Anthropic and big mark-to-market gains for Anthropic investors, including Amazon and Alphabet, Google's parent.
Those unrealized gains and losses are part of net income under generally accepted accounting principles. The analysts who follow Amazon and Alphabet included the gains in their consensus "Street earnings" metrics, even though the valuation marks are volatile and unrelated to the companies' core operating performance.
Street earnings are whatever earnings metric a majority of analysts covering a company adopt, whether non-GAAP or GAAP. There is no standard governing them. These figures in turn make their way into the most widely collected earnings data for the S&P 500 and other indexes. Depending on which items the analysts exclude or don't, the stock market might look reasonably valued or wildly expensive.
Wall Street's earnings game is a long tradition that has led to widespread confusion for investors. Analysts who track companies' earnings beats and misses routinely strip out recurring costs like stock-based pay, if management guides them to do so. But when a company reaps a balance-sheet windfall, the analysts often are happy to let the boost remain in the bottom line.
The practice of excluding or keeping gains and losses such as these has been inconsistent across the biggest tech companies. Nvidia, for instance, points analysts to adjusted numbers that exclude unrealized investment gains, and the analysts who cover the chip maker have gone along with that approach.
Anthropic, which publicly filed its IPO prospectus Monday, is directing investors to a nonstandard metric called adjusted net income. By this measure, Anthropic had a $2.7 billion profit in the first half, instead of the $80.7 billion net loss.
About $72 billion of the excluded losses arose from marking various liabilities, including convertible notes, to market values. Excluding those losses arguably makes sense, on the grounds that they aren't indicative of ongoing operations. But if that is true, then the analysts who cover Amazon and Alphabet should be excluding the corresponding gains from the companies' Street earnings.
Those weren't Anthropic's only exclusions. To get its $2.7 billion of adjusted net income, it also excluded roughly $9 billion in mark-to-market losses on other financial instruments, along with $2 billion in stock-based compensation expenses.
For context, Amazon during the first half booked about $63 billion of gains on equity investments in private companies, primarily from Anthropic. That was most of Amazon's pretax profit.
Amazon's stake began as convertible notes, some of which converted into preferred stock. It also bought preferred stock directly. Should Anthropic complete its IPO, the instruments would convert into common equity, ending the mark-to-market liability adjustments on Anthropic's books, even as Amazon and Alphabet continue to mark the shares to market values.
Alphabet for its part recorded about $136 billion in net gains on equity investments during the first half. That was most of its pretax profit, but it didn't specify how much was tied to Anthropic.
During the second quarter alone, such gains at these two companies represented about 15% of S&P 500 earnings, according to a Wall Street Journal analysis.
Once Anthropic does go public, analysts will predictably ignore the fair-value losses to focus on the company's forward trajectory. Most investors won't look back either.
Nonetheless, the differing treatments spotlight the double standard in Wall Street's nonstandard earnings metrics. If Anthropic's colossal paper losses shouldn't count in adjusted earnings, neither should the large paper gains on the other side of its deals.
Anthropic's public debut, should it go through, will be a milestone for the AI boom. It should also prompt some long-overdue reflection on what really deserves to be counted in operating performance.
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