Marketwatch Article- is this a cause for concern?
UPDATE: Twitter isn't paying employees; shareholders are
1 hours 6 minutes ago - DJNF
By Philip van Doorn, MarketWatch
There was plenty of euphoria among investors and analysts late Tuesday after Twitter reported huge increases in revenue and active users, but the company is still losing plenty of money, as investors ignore very high expenses from stock-based compensation to employees.
Twitter Inc. (TWTR) reported second-quarter revenue of $312 million, up 124% from a year earlier and blowing past the consensus estimate of $283 million among analysts polled by FactSet. Active users were up 24% from a year earlier, to 271 million, and advertising revenue per 1,000 timeline views doubled to $1.60.
The company reported adjusted earnings of $15 million, or 2 cents a share. That non-GAAP earnings figure excluded "noncash" expenses of $158 million for stock-based compensation to employees.
Andrew Bary pointed out in Barron's on Wednesday that the stock-based-compensation expenses equaled "nearly 50% of the company's revenues of $312 million." In comparison, Facebook Inc.'s (FB) $314 million in expenses tied to stock-based compensation during the second quarter came to a "comparatively modest" 10% of revenue, he wrote.
Twitter's average share count rose 4% to 595.6 million in the second quarter from $570.2 million in the first quarter. That's quite a bit of dilution for a stock in just one quarter, but it is not so unusual for a tech company to do this during the first year following an initial public offering. Twitter raised $1.8 billion through its IPO in November and booked $512.2 million in stock-based compensation expenses during the fourth quarter.
The full set of figures for the second quarter isn't yet available, but the company reported that 39.8 million stock options were outstanding as of March 31, with an intrinsic value of $1.780 billion.
The stock-option expenses are noncash items, but they can still cost shareholders quite a bit over the long haul. "The noncash cost becomes a very real cash cost to shareholders when the company begins mopping up all this dilution through stock buybacks," according to Albert Meyer, a co-founder of Bastiat Capital.
Investors now must hope Twitter will continue on its solid growth path and begin reporting "real" earnings, leading it eventually to begin buying back shares. This at some point could assuage the dilution caused by issuance of additional shares to employees. But shareholders will pay a price.
Combined with 83.2 million in restricted stock units outstanding as of March 31, the potential "overhang" to the 589.3 million shares outstanding as of March 31 was 20.9%. That's the potential dilution to shareholders' ownership stake, assuming no additional stock options or grants of restricted stock units.
Twitter reported that the intrinsic value of options that were exercisable as of March 31 was $1.482 billion, with gains to employees of roughly $1.4 billion, which is what it would have cost the company to buy back those shares on March 31. The hypothetical cost to buy back shares equivalent to the restricted stock units would be $3.8 billion, based on a price of $46, according to Meyer.
Twitter's shares rose 20% on Wednesday to close at $46.30, trading for a very high 253 times the consensus 2015 earnings-per-share estimate of 34 cents. In early trades on Thursday, shares were down 91 cents at $45.39.
"People aren't investing in Twitter because of what's happening today," Meyer said in a phone conversation Tuesday. "They are investing because they expect a 20% return over the next six or seven years. To do that, you have to make some pretty generous assumptions, but not overly generous."
These assumptions, according to Meyer, include a continual rise in annual revenue to $9 billion by 2020, with a net margin of 30%, for earnings of about $4.50. This would lead to a price-to-earnings ratio of about 30, "which would make the current valuation make sense," he said. This set of assumptions also includes spending by Twitter of a considerable amount of free cash flow on buybacks.
Can Twitter do it? Can the company achieve a profit margin of 30%? The second-quarter adjusted margin was 17%, while Facebook's GAAP margin was a very impressive 48%.
Time will tell. Meanwhile, unless you firmly believe Twitter will show a continual and very significant improvement in revenue over the next several years, leading to strong profits, the stock is just a trade, and you might want to take some money off the table.
