Twitter's Stock Based Compensation Expenses Raise Another Red Flag

Jun. 4.14 | About: Twitter, Inc. (TWTR)

Summary

Stock-based compensation schemes are still very popular.

Twitter recorded over 50% of its revenue as a stock-based compensation expense.

It is doubtful that stock-based compensation schemes create value for shareholders.

Given the amount of stock-based compensation expenses, Twitter is not an attractive investment.

Since Twitter (NYSE:TWTR) went public last year, I am amazed by the very large amount of stock-based compensation expenses that this company grants to its employees. For example, Twitter recorded $521 million of stock-based compensation expenses during last year's fourth quarter, more than double the amount of revenue in that quarter. To put this number in perspective, Twitter already granted $406 million to its employees in months prior to its IPO. Still, Twitter granted and recorded a $115 million stock-based compensation expense in relation to the fourth quarter of 2013.

The trend continued during the first quarter of 2014. Twitter recorded a $126 million stock-based compensation expense, or 50.29% of the company's revenue. This was the second quarter in a row that Twitter recorded more than 50% of its total revenue as a stock-based compensation expense. Bottom line, Twitter recorded a net loss of $132 million under GAAP compared to a non-GAAP profit of $0.2 million. The difference between GAAP and non-GAAP earnings is almost entirely explained by the stock-based compensation expense.

Industry peers

Let me be clear that Twitter is not alone in granting large amounts of stock-based compensations. For example, industry peers like Facebook (NASDAQ:FB) and LinkedIn (NYSE:LNKD) recorded large amounts of stock-based compensation expenses as well. However, Facebook and LinkedIn did not record as much as Twitter, as a percentage of revenue, in the first quarter of 2014. The table below shows that Twitter grants an exorbitant amount of stock-based compensation compared to its industry peers Facebook and LinkedIn.

SBC expense % of revenue
Twitter $126 million 50.29%
Facebook $274 million 10.79%
LinkedIn $68 million 14.33%
Click to enlarge

Employees commitment

This got me thinking. Why would Twitter, or any other company, grant such an enormous amount to its employees? The most logical answer to this question would be that Twitter wants to secure the long-term commitment of their employees. The commitment of quality employees is one of the most important factors within the sector Twitter operates. However, is stock-based compensation the best tool to achieve long-term commitment among employees?

Not so long ago, the global markets went through a financial crisis. This financial crisis was caused by greedy bankers, whom took too many risks only to create short-term winnings in order to earn their generous annual bonus. An option package was most likely of this annual bonus scheme. We all remember how this ended and how little (long-term) value was created for the shareholders. Apparently, companies have not learned from the events in the past.

In my opinion, stock and/or option incentives may create commitment among the employees, but its does not maximize value for the other shareholders. Its just in our human nature to maximize our own benefits in the short-term, rather than making decision that are best for the company and the shareholders over a longer period of time. Therefore, I believe that Twitter's recent earnings reports signal a potential red flag for investors.

Conclusion

I am not arguing that you should not invest in Twitter, based on the amount of share-based compensation expenses alone. However, this argument adds up to the arguments I mentioned in a previous article about Twitter. The article "Twitter's Declining Traffic Numbers First Sign Of Slowing Revenue Growth" was published on December 16, 2013. In this article I argue that Twitter will not be able to grow earnings in developed markets like the Netherlands.

In my opinion, Twitter sends out just the wrong signal to investors. Granting over 50% of revenue in stock-based compensation to employees looks just greedy to me and in the end it is doubtful that Twitter's employees will make better long-term decisions for the other shareholders. Further, the share-based compensation scheme will dilute the position of current shareholders. Based on these arguments, combined with the arguments in my previous article, I do not consider Twitter as an attractive investment.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.