Anthropic excludes about $72 billion in liability valuation losses from adjusted profit

Analysts included corresponding Amazon and Alphabet gains in Street earnings

Anthropic is directing investors to adjusted net income of $2.7 billion for the first half of the year, compared with an $80.7 billion net loss under generally accepted accounting principles. About $72 billion of the excluded losses came from marking liabilities to market value. The AI developer publicly filed its IPO prospectus Monday and is preparing for an initial public offering as soon as November.

Anthropic’s net loss arose mainly from marking up the value of liabilities on its balance sheet, a process that produces income-statement losses much like marking down an asset’s value. The liabilities included convertible promissory notes from Anthropic’s early financing rounds. These instruments are essentially loans that turn into company stock instead of being repaid in cash. As Anthropic’s market value rose, the notes’ value rose with it, generating large noncash losses for Anthropic and mark-to-market gains for Anthropic’s investors, including Amazon and Alphabet.

Those unrealized valuation changes are part of net income under generally accepted accounting principles. Analysts covering Amazon and Alphabet, the parent of Google, included corresponding gains from some of the same financing arrangements in their consensus Street earnings metrics, even though the valuation marks are volatile and unrelated to the companies’ core operating performance. Anthropic excludes the corresponding liability valuation losses from adjusted net income.

Street earnings refers to whatever earnings metric a majority of analysts covering a company use, whether GAAP or non-GAAP, and no standard governs the measure. Those figures feed the most widely collected earnings data for the S&P 500 and other indexes. Which items analysts include or exclude can change the valuation measures investors see.

The Journal described Wall Street’s practice of adjusting earnings as a long tradition that has produced widespread confusion among investors. The treatment of gains and losses has been inconsistent across major technology companies. Analysts often strip recurring costs such as stock-based compensation when management directs them to, while balance-sheet windfalls often remain in bottom-line figures. Nvidia, for example, points analysts to adjusted numbers that exclude unrealized investment gains, and analysts who cover the chip maker have followed that approach.

Anthropic’s prospectus points investors to a nonstandard adjusted net income measure. It shows a $2.7 billion profit for the first half rather than the $80.7 billion loss. In addition to the approximately $72 billion in excluded liability valuation losses, Anthropic excluded roughly $9 billion in mark-to-market losses on other financial instruments and $2 billion in stock-based compensation expenses.

Amazon booked about $63 billion in gains on equity investments in private companies during the first half, primarily from Anthropic. Those gains represented most of Amazon’s pretax profit. Amazon’s Anthropic stake began with convertible notes, some of which converted into preferred stock, and the company also bought preferred stock directly.

Alphabet recorded about $136 billion in net gains on equity investments during the first half, also representing most of its pretax profit. Alphabet did not specify how much was tied to Anthropic. If Anthropic completes its IPO, the instruments would convert into common equity and end the mark-to-market liability adjustments on Anthropic’s books, while Amazon and Alphabet would continue marking their shares to market value.

The effects of the valuation gains extend beyond the two companies’ income statements. During the second quarter alone, gains at Amazon and Alphabet represented about 15% of S&P 500 earnings, according to a Wall Street Journal analysis.

Jonathan Weil, the Wall Street Journal reporter who wrote the analysis, said analysts will predictably ignore Anthropic’s liability valuation losses once the company goes public as they focus on its forward trajectory. He also said most investors will not look back. Weil characterized Anthropic’s public debut, if it proceeds, as a milestone for the AI boom and said it should prompt long-overdue reflection on what deserves to be counted in operating performance.

The accounting comparison turns on whether noncash valuation movements tied to financing and equity holdings should affect measures used to assess operating performance. Jonathan Weil said excluding Anthropic’s about $72 billion in liability valuation losses arguably makes sense because they are not indicative of ongoing operations. But if that is true, analysts covering Amazon and Alphabet should exclude the corresponding gains from their Street earnings measures. Weil characterized the differing treatments as a double standard in Wall Street’s nonstandard earnings metrics.