On Stock Based Compensation
We recently had a discussion of SBC as a side issue on another thread, but I thought it’s such an important issue, and otherwise bright guys get so tied up and moralistic about it, that I thought it deserves its own thread.
First, in discussing his worries about Sentinel, one of our valued posters wrote:
First, dilution: S’s weighted average share count was up 7% in the last 4 quarters. That’s quite a lot. More than most companies we follow I believe.
I suggested a different way of thinking about that. Sentinel had 7% more shares than a year ago but revenue was up 106%. That means revenue per share was up 92.5%. Did he consider having 92% more REVENUE PER SHARE of stock a damaging dilution? Did he have any other companies who had revenue per share up 92% last quarter ???
Then he went on to discuss his worries about GAAP operating margin (so he included expensed SBC according to the way GAAP requires).
I responded: Well, actually, SBC causes dilution but doesn’t cost the companies a penny. Expensing SBC has nothing to do with reality.
GAAP counting it as an expense AND a dilution is just the way the bunch of obsessive CPAs who created GAAP decided to punish the tech companies who used SBC for being bad boys.
Look, if a company creates and gives away a share of stock , it dilutes the stockholders by a share, but it doesn’t cost the company anything. And if they give away a thousand shares it doesn’t cost the company any more than one share, which again, is zero dollars.
If the adjusted earnings are $5 million but the company gives away 100,000 shares worth $20 million , guess what? The company doesn’t actually lose $15 million. In actual dollars that you can hold in your hand, it makes the same $5 million they had before GAAP started messing with them. That’s the profit they have before capex, etc. Those 100,000 shares didn’t cost the company anything. They just diluted us.
And that’s the reason that every one of our CFO’s says “when I give results everything after revenue will be in adjusted figures,” and why they say they use adjusted internally to evaluate how the company is doing, and why both company and analyst estimates are in adjusted numbers, etc.”
Then another bright guy, talking about Bill, wrote:
“This is a whopping 31% increase in share count over just the last two years! This kind of dilution is very excessive and going to make future returns difficult if they continue at this pace. I expect much of this was driven by the Divvy and Invoice2Go acquisitions.”
I couldn’t believe it and pointed out that two years ago Bill had $46 million revenue in the quarter. This last quarter they had $230 million. That’s FIVE TIMES as much revenue as they had two years ago !!! 500% as much revenue !!! And he was complaining about 31% dilution in that time???
It seemed so ridiculous to me that I accused him of kidding. Bill had two crucial acquisitions that changed the entire nature of the company, and if they paid 31% dilution to have 500% as much revenue it was well worth it. They had almost four times as much REVENUE PER SHARE as two years ago! Wow! what a catastrophe!
Do you have any other companies with four times as much revenue per share as two years ago?
The only possibility would be Sentinel which has grown revenue from $25 million to $115 million in that quarter in the last two years. That’s 460% as much revenue as two years ago !!! And assuming 7% dilution each year, the REVENUE PER SHARE of our stock is now 402% of what it was two years ago, so four times as much revenue per share! Wow! What a lot of dilution !!!
To summarize. Yes, the SBC dilutes our shares but a few per cent dilution in a company growing by leaps and bounds turns out to be insignificant (Sentinel and Bill were good examples of that), and the SBC is good for our investment as it binds the company employees interest in the stock price growing to our interest in the stock price growing (instead of having them just take their salaries and go home). SBC dilutes us, but SBC doesn’t cost the company anything, nothing, not a penny, even if the company gives away $10 million dollars of stock.
I hope that this helps, and sorry if I get vehement about this, but the idea of saying the SBC is an expense to the company is so obviously and clearly unrelated to reality that I get emotional confronting it.