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Source: Dow Jones MarketWatch, February 6, 2015 article

 

Deep Dive

Twitter shows how companies enrich executives at your expense

Published: Feb 6, 2015 9:50 a.m. ET

What’s worse, investors are told to focus on earnings excluding stock options

Getty Images

Twitter CEO Dick Costolo has good reason to appear relaxed because of the humongous stock options being paid to him and his colleagues.

 

By

Philip

van Doorn


 Investing columnist

 

 

In October, we pointed out that the $170 million in stock-based compensation dished out to Twitter employees during the third quarter represented 47% of the company’s third-quarter revenue.

That was an outsized amount — much higher than the most recently reported payouts for any company included in the S&P 1500 Composite Index. Twitter Inc. suffered a third-quarter net loss of $175 million, owing almost entirely from the stock awards. (Twitter is not yet included in the S&P 1500, presumably because it has been publicly traded for only a little over a year.)

Following a memo to employees in which Twitter CEO Dick Costolo said the company was doing a poor job preventing abuse over its messaging platform, the company said on Thursday that for the fourth quarter, its stock-based compensation totaled $177 million, or 37% of revenue. The company reported a net loss of $125.4 million, or 20 cents a share, but would have shown a profit of $79.3 million, or 12 cents a share, if the non-cash stock awards were excluded.

The good news for Twitter was that its fourth-quarter revenue totaled $479.1 million, rising from $361.3 million the previous quarter and $242.7 million a year earlier. The company beat consensus estimates for earnings and revenue, though it reported a slowdown in subscriber growth. Twitter said it expects growth to pick up, and investors believed it, sending the shares up 13% on Friday.

Twitter is no longer shoveling more stock-based compensation, relative to revenue, than any other large publicly traded U.S. company. That distinction is now held by United Therapeutics Corp.

Here are the 10 S&P 1500 companies with the highest stock-based awards for the most recently reported quarter, as a percentage of revenue:

Company

Ticker

Industry

Fiscal quarter end date

Stock-based comp. ($mil)

Revenue ($mil)

Stock-based comp./ revenue

United Therapeutics Corp.

TWTR, +0.08% UTHR, -0.02%

Pharmaceuticals

9/30/2014

$220.3

$330.0

67%

Momenta Pharmaceuticals Inc.

MNTA, +0.05%

Biotechnology

9/30/2014

$3.4

$9.4

36%

Vertex Pharmaceuticals Inc.

VRTX, -0.04%

Biotechnology

12/31/14

$46.1

$144.6

32%

Ligand Pharmaceuticals Inc.

LGND, +0.35%

Biotechnology

9/30/2014

$3.7

$15.0

25%

Facebook Inc. Class A

FB, +0.05%

Internet Software/ Services

12/31/14

$845.0

$3,851.0

22%

Kopin Corp.

KOPN, -0.57%

Electronic Components

9/27/2014

$1.2

$9.5

13%

ComScore Inc.

SCOR, +0.05%

Internet Software/ Services

9/30/2014

$10.2

$82.1

12%

Ultratech Inc.

UTEK, -2.01%

Electronic Production Equipment

9/27/2014

$4.1

$33.8

12%

Monolithic Power Systems Inc.

MPWR, +0.39%

Semiconductors

12/31/14

$8.9

$75.7

12%

Entropic Communications Inc.

US:ENTR

Semiconductors

12/31/14

$4.6

$42.6

11%

Source: FactSet

When a company issues additional shares, for any reason, shareholders’ ownership positions are diluted. Companies can make up for some or all of the dilution by buying back shares. A stock-repurchase plan can be a wonderful tool and boost earnings per share, but only if the number of shares bought back is significantly more than the number of shares being issued.

That is why the mere announcement of a new buyback plan doesn’t mean much to investors. The important thing is reducing the share count. Apple Inc. is the poster child for effective buybacks, having reduced its average share count by 6.8% from a year earlier.

Here’s another table showing Twitter along with the same group of S&P 1500 stocks, showing the change in the share count over the past 12 reported months, as well as total returns:

Company

Ticker

Change in share count - past 12 months

Total return - YTD

Total return - 2014

Total return - 3 years

Twitter Inc.

TWTR, +0.08%

74%

14%

-44%

N/A

United Therapeutics Corp.

TWTR, +0.08% UTHR, -0.02%

-11.9%

9%

15%

180%

Momenta Pharmaceuticals Inc.

MNTA, +0.05%

1.0%

-14%

-32%

-38%

Vertex Pharmaceuticals Inc.

VRTX, -0.04%

1.1%

-8%

60%

197%

Ligand Pharmaceuticals Inc.

LGND, +0.35%

2.4%

1%

1%

290%

Facebook Inc. Class A

FB, +0.05%

10.1%

-3%

43%

N/A

Kopin Corp.

KOPN, -0.57%

-1.4%

3%

-14%

-7%

ComScore Inc.

SCOR, +0.05%

-2.9%

-7%

62%

84%

Ultratech Inc.

UTEK, -2.01%

1.6%

-13%

-36%

-45%

Monolithic Power Systems Inc.

MPWR, +0.39%

2.0%

-4%

45%

196%

Entropic Communications Inc.

US:ENTR

-0.8%

21%

-46%

-53%

Total returns assume dividends are reinvested. Source: FactSet

Twitter’s 74% dilution over the past 12 months reflects the huge payouts following the company’s IPO in November 2013. However, the company’s share count grew by 2.4% just in the fourth quarter.

As you can see, four companies completed sufficient buybacks to avoid dilution of common shareholders’ ownership positions. United Therapeutics managed to lower its common-share count by nearly 12%.

What does stock-based compensation really cost?

Even though boards of directors dishing out the juicy stock options push the idea that there is no real cost to shareholders by focusing on adjusted results in earnings announcements, the decline in earnings per share from dilution, or the lack of a significant boost to EPS from buybacks that serve mainly to cover for the stock awards, speak for themselves.

Buying back shares issued for the purpose of awarding employees has a real cash cost to a company somewhere down the line. If a company is successful in growing its revenue, earnings and stock price, the cost of “mopping up” the dilution can be very high.

What’s the solution?

Albert Meyer, a co-founder of Bastiat Capital, suggested that a slight change in reporting requirements would better represent what stock-option awards to employees cost shareholders.

That cost is the difference between the strike price, which is the discounted price the recipient pays to exercise an option and buy a block of shares, and the market price on the day the option is exercised.

“It would be helpful if an additional footnote could show how much the company claimed as a stock-based compensation expense on the tax return,” Meyer said in an email exchange on Wednesday.

The current rules require companies to disclose the tax benefit they realize, but not the actual tax dollars they deducted from their income.

Meyer called this “theoretically the amount that the company would have spent had it repurchased the stock immediately on the exercise of the option., i.e., the discount to market price at which the stock was issued to employee. That would make stock-based compensation totally transparent and easy to analyze.”

Meanwhile, Twitter’s stock awards are so large that little of the company’s operating profit is left over for shareholders.

Standards board to the rescue

Also on Thursday, the Financial Accounting Standards Board (FASB) published an article describing its work on a set of enhancements to simplify reporting for cash-flow presentation, the valuation of stock-based awards and tax consequences. The research is at a “pre-agenda” stage, but changes will be made, which may improve investors’ understanding of the pain that can be caused by large stock-based payouts to executives.

 

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