Watch out for Accounting Gimmicks

It was announced yesterday that Microsoft is buying LinkedIn for $26.2 billion.  A lot of people are questioning the deal but I think Andrew Ross Sorkin hit the nail on the head regarding LinkedIn’s decision to sell – to get out of the accounting hole they were digging with massive amounts of stock based compensation and the fear of losing their best talent with the stock down so much over the last year.

But it’s not just LinkedIn.  Most of the big name tech companies pay employees and executives with very nice stock and option packages.  The Financial Times had a good article on it last month.  Twitter has dished out over $600 million in stock based compensation in each of the last 3 years!  $600 million!  They only have 3,900 employees…  They claim to operate at an adjusted non-GAAP operating profit when their GAAP Net Income last year was a loss of over $500 million.  Companies like this are engaging in accounting gimmicks by reporting non-GAAP adjusted numbers to make things look better than they really are.  Some non-GAAP numbers can be a helpful indication of business trends if the company is backing out truly one-time expenses.  Annually recurring expenses like stock based compensation certainly does not fit the bill.  I’m all about taking care of your employees but not when it means fleecing your non-employee shareholders.

More and more companies these days are reporting “adjusted” numbers to cover up declines in the underlying business but an easy takeaway for investors is to pay close attention to things like compensation packages, especially for stocks that went public in the last 5 years.  If a company is continually issuing tons of new stock every year as a benefit for employees and executives, they’re diluting your ownership and doing so at a discount to the market price which destroys value.  You’re basically swimming upstream every year which makes it pretty difficult to make money over the long haul… unless you get bailed out through an acquisition like LinkedIn.

-Nick