New Talent Retention Strategy Could Hurt Twitter Stock

  • Twitter is doling out restricted stock and cash bonuses to retain talent.
  • This is likely to hurt profitability and Earnings Per Share (EPS) growth.
  • Twitter stock is best avoided for now.

Twitter shares have had a good run since the company reported its Q4 2015 results, partly due to the company's continued curtailing of losses. Further, Twitter's move to cut its workforce by 8% might have raised hopes of a further improvement in the company's profitability. However, that might not be the case. Latest news reports suggest that Twitter is sweetening its compensation packages for employees with additional restricted stock and cash bonuses to retain talent. While the move might be great for employees, it is likely to hurt profits in the near term and Earnings Per Share (EPS) growth in the medium to long term as equity dilution becomes a bigger risk for investors.

Twitter's New Talent Retention Strategy (Reportedly)

The Wall Street Journal reported that Twitter is sweetening compensation packages for employees across the board with additional restricted stock and cash bonuses. However, it's not as simple as it sounds. Twitter's strategy is quite unique and has been hailed as being "shocking and highly effective". Quoting from the report on WSJ:

"These latest compensation packages to rank-and-file employees haven’t been uniform, however. According to current employees and others close to the company, the guiding principle in calculating roughly how much additional stock is offered was predicated on how much the estimated value of an employee’s restricted stock has fallen since they joined."

In other words, Twitter is reportedly looking to make up for the value employees have lost since they joined the company. Twitter slashed its workforce by 8%, cutting up to 336 jobs as per its announcement in early October 2015. More recently, Twitter saw 4 top executives exiting the company. Some believe that the reported compensation strategy is aimed at soothing concerns among its personnel amidst job cuts, exits by top executives and a battered stock price. While this might be great for employees, it's not likely to be as exciting for an investor who holds Twitter shares.

What This Means For Investors In Twitter's Stock

Well, for starters, the magnitude of such a move might not be negligible, given how far down the stock has fallen and the number of employees Twitter has added since going public, following which the share price soared.

According to its last S-1 filing update, days prior to its IPO, Twitter had 2300 employees as on September end 2013. That number is less of a worry in this context because stock options or restricted stock issued back then are likely to have been issued at lower prices. However, look ahead from there, and Twitter has added 1,600 employees to that tally, most of whom were added at times when the stock was trading much higher than it does today, at about $17/share. So, nearly every employee who was compensated using the company's stock is likely to have lost a good chunk of the value.

TWTR stock chart

Twitter stock price chart by amigobulls.com

While the use of this particular strategy might be a first for Twitter, what concerns us here is that Twitter's generosity with stock-based compensation is not new. For those who have watched the company over its life as a public limited company, there's a consistent trend of elevated stock-based compensation.

For instance, Twitter's stock-based compensation expenses have consistently eaten up a sizeable chunk of the company's revenue. It's also interesting to note that the company has spent about $1.83 billion in stock based compensation since going public, well over its total net loss of $1.6 billion during the period. As is evident, if curtailed, this line item could have single-handedly swung Twitter to profitability.

Stock-Based Compensation Dec-13 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 Dec-15
% of Revenue 215% 50% 51% 47% 37% 42% 35% 29% 22% 22%

Some might argue that elevated stock-based compensation is common for young high-growth tech companies. As the table above indicates, Twitter's stock-based compensation expenses have only just fallen below the 30% mark (of revenue) in the last two quarters, taking the tally for FY 2015 to 30.8%. Even at these levels, Twitter's expense on this line item is significantly higher than other tech companies like LinkedIn (17.1%) and Facebook (16.6%) for the year.

While some might argue that stock-based compensation is a non-cash expense, it undisputedly impacts investors in the form of equity dilution. Even for those who go solely by non-GAAP numbers (excluding stock-based compensation), the creation of fresh shares does adversely impact earnings per share growth.

For instance, Twitter now has about 681 million outstanding shares, up from 362 million in the quarter ending Dec 2013, immediately following its IPO. That's an addition of nearly 319 million shares. Now look at the company's non-GAAP net income of $114.6 million in the latest quarter. Without the addition of as many shares, Twitter's non-GAAP earnings per share would have stood at $0.32 a share, as against $0.17, where it stands today, which is clearly not the ideal situation for an investor.

Conclusion

To sum up, Twitter's recent improvement in profitability might not be sustainable, given that the company's spends on stock-based compensation are likely to remain at elevated levels. Further, the potential risk of equity dilution is something investors must take into account while evaluating Twitter as an investment option. Unless Twitter manages to deliver revenue growth that's way beyond its current projections, the company is not likely to be profitable anytime soon. Twitter is a stock best avoided for now.

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Neither Amigobulls, nor any members of its staff hold positions in any of the stocks discussed in this post. The author may not be a certified/registered investment advisor, and the opinions expressed should not be treated as investment advice. Buying and selling of securities carries the risk of monetary losses. Readers/Viewers are advised to carry out their own due diligence and consult their investment advisors before making any investment decisions. Neither Amigobulls, nor the author have any business relationship with any of the companies covered in this post.

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