Twitter's Incentive Stock Plan Wipes Out Shareholders' Profits

Many investors are perplexed that Twitter could have a successful analyst meeting that sent the social networking stock up 7.5% on Wednesday, after announcing a slew of enhancements to its core services–then lose most of the gain the next day. But Twitter will continue to be a problem for investors because they have such a ludicrously generous stock-based compensation scheme that wipes out shareholder profits by rewarding insiders with new shares as compensation for revenue gains.

At Twitter’s “Analyst Day” meeting held at the Four Seasons Hotel in San Francisco, CEO Dick Costolo previewed new Twitter initiatives, including:

1. “an instant timeline for new users (so there’s) no need to follow accounts when you sign up”
2. significant functionality to private messaging
3. “a ‘while you were away’ feature that uses algorithms to surface popular/interesting tweets published since the last time a user logged in
4. “location-based content curation”
5. “push notifications for breaking news”
6. “in-app video capture/uploading”
7. “curated timelines for following live events”

Twitter’s stock vaulted to close at $42.54 Wednesday because the company’s new capabilities have a tremendous opportunity to steal ad dollars from Google and Facebook, especially in the mobile space.

For media advertising dollars in 2014, Google will rake in 10.6%, Facebook will capture 2.7%, and Twitter will collect only .4%. But in the fast-growing sector of mobile media advertising, Google collects 46.8%, Facebook 21.7%, and Twitter 2.6%, according to Seeking Alpha.

Twitter’s CFO Nota stated at the analyst meeting, “Looking by platform, our mix of revenue from mobile also continues to grow with 85% of total ad revenue now generated from mobile devices up from approximately 70% from the prior year period.”

Noto added that Twitter’s exciting new capabilities are focused on converting the 500 million people who web surf the service each year but never log in or become active users. CFO Noto gave a slide presentation demonstrating how Twitter believes they can reach 2 billion users and $14 billion in revenues within a decade.

All this buzz encouraged analysts to substantially up their revenue and earnings projections for Twitter. The stock went ballistic for a day, until reality started to creep in.

Twitter’s stock-based compensation structure will wipe out the company’s profits through dilution. The company booked $158.4 million as stock-based compensation expenses for the second quarter of 2014. Instead of making a profit of $13.9 million for the second quarter, Twitter booked a loss of $144.5 million, up from a loss of only $42.2 million the year before. That works out to 50.75% of revenue!

Pim Kuelen at the Seeking Alpha blog observed that Twitter’s 50.75% stock expense as a percentage of revenue seems very greedy compared to Facebook at 10.8% and Linkedin at 14.3%.

It is usually considered an excellent strategy for high growth companies to tie employee compensation to the success of the company. But that success has to be associated with spurring profits for shareholders to benefit. Twitter is becoming a great company; it just might not be a great company for the shareholders.

Chriss Street suggests that if you are interested in California technology, please click on Government-Enforced Net Neutrality is Problematic.