Opinion: Twitter spends 35% of revenue on stock-based compensation

Published: July 28, 2015 5:13 p.m. ET

The company’s shareholders are suffering major dilution

Chalk up another winning quarter for Twitter, which continues to “innovate” by diluting shareholders’ stakes — that is, all shareholders other than the executives who run the company.

During the second quarter, Twitter Inc. spent 35% of its revenue on stock-based compensation. Here’s how that compares with similar payments made over the past year:

The good news is that stock-based compensation as a percentage of revenue declined when compared with the previous four quarters.

Twitter certainly impressed investors, with second-quarter revenue of $502.4 million having swelled 61% from a year earlier, and soundly beating the consensus estimate of $482 million, among investors polled by FactSet.

Headlines following the company’s earnings announcement will no doubt focus on the revenue “beat,” and the company’s adjusted earnings figures, which leave out “non-cash” expenses, most of which resulted from stock-based compensation.

On a GAAP basis, the company posted a net loss of $137 million, or 21 cents a share, which was less than the 23-cent loss expected by analysts. On a non-GAAP adjusted basis, leaving out $185 million in non-cash expenses that included $175 million for stock-based compensation, profit totaled $48.5 million, or 7 cents a share, which exceeded the consensus estimate of 4 cents.

So much for the good news. The company’s shares were up 3% in aftermarket trading, following a 5% increase Tuesday.

But Twitter’s weighted average diluted share count used to calculate EPS increased 2.4% during the second quarter. The count was up 10.1% from a year earlier. Sell-side analysts tend to focus on the adjusted earnings numbers, which help obscure a major problem for shareholders of Twitter: The dilution from quarter to quarter is significant, as the company just keeps handing out new shares at a shockingly fast pace.

Now, a company that is losing money but needs to attract and retain executive talent can certainly justify high levels of stock-based compensation, but in the case of Twitter, the amounts seem exorbitant. CFO Anthony Noto joined the company in July of last year, but his total compensation for 2014 totaled $72.8 million. That’s a tidy sum for less than six months’ work.

Read: The real reason to worry about obscenely high executive pay

Analysts’ focus on the adjusted profit number might make you think there’s “no real harm” in non-cash expenses, but Twitter’s dilution of shareholders means investors’ ownership percentages continue to decline, and the higher share count means less earnings per share. EPS is really “the investor’s portion of earnings.” If Twitter becomes profitable on a GAAP basis, those earnings per share will be a lot lower than they would have been if the company took a slightly more sane approach to executive compensation.

Sorry to use Noto as an example again, but it’s just too easy. Noto’s compensation totaled $72.8 million last year, as Twitter’s revenue came in at $1.40 billion and its net losses totaled $579 million. As a comparison, Wells Fargo & Co. CFO John R. Shrewsberry’s total compensation for 2014 came to $8.1 million, while the company’s revenue totaled $84.3 billion and its earnings totaled $23.1 billion.

Twitter is in turmoil, with CEO Dick Costolo announcing in June he would resign effective July 1, with no permanent successor in place. And interim CEO Jack Dorsey, a co-founder, is really only serving part time, since he is CEO of Square, a mobile-payments services provider that has confidentially filed for an initial public offering, according to Bloomberg.

Another surprising management change at Twitter this year was the expansion of CFO Noto’s duties to include the company’s marketing efforts as well.