I came across this article about square yesterday. The author’s claim is that square is inflating its EBITDA by including stock based compensation in the figure. I just thought it was interesting to consider the existence of accounting shenanigans considering the departure of Sarah Friar.
https://www.thestreet.com/technology/square-avoid-this-stock…
I think the author is misleading his readers. In his table comparing several similar companies (Paypal, Shopify, Intuit and Square), he think Square is over priced. If it’s true, Shopify is several times more overpriced.
His conclusion:
As the table above highlights, not only does Square carry a very heavy price tag, with a P/Cash Flow from Operations of more than 200x, but the whole sector is exuberantly priced as investors crave participating in this fast-growing space. If history teaches us anything, however, it’s that it is very difficult to ultimately forecast which company will be the biggest winner from a nascent sector.
New, rookie CFO. Powerful, media savvy CEO dealing with another massive company. Fertile ground for chicanery. I’ll let the numbers guys debate validity of this claim, which on the surface feels excessive. That companies put numbers in most favorable light is nothing new. But it doesn’t radiate candor. I’m watching this one closely as the space, the TAM, the name recognition, growth - tons to like. But my gut, as a story guy (I know, I know) continues to be rankled as if full of boiled cabbage and dated milk.
BD
Fan of …
Narrative and Numbers - Aswatch Damodaran
https://tinyurl.com/yahf7q9d
inflating its EBITDA by including stock based compensation
just to clarify, he’s not saying they are adding back SBC to EBITDA (which wouldn’t be allowed, because EBITDA is a standardized metric with a required standard definition). His issue is that they are adding the SBC back to “adjusted” EBITDA metric, which is allowed and many, many companies, particularly most tech companies do this exactly the same way. They also add back several other things to “adjusted” EBITDA (acquisition costs, capex, etc), which is pretty normal.
It’s fine to take issue with the level of stock based comp they give employees and to consider that into your investment decisions, but simply the fact that the company shows an adjusted EBITDA which they’ve fully disclosed as adding back SBC and other things (again, as many companies have always done) is a strange thing for the author to focus on.
-mekong
I left out important point. You’re a 32B financial company going after a massive market. And you hire a rookie CFO? When you can hire virtually anyone? You can get a veteran with long, proven track record and knowledge of the fast-changing space. Yet you pick a total rookie? For the Chief FINANCIAL Officer role? If you want the very best person, this is silly. If you want someone to do what they’re told, and look nice doing it, it makes perfect sense. Again, NOT saying I know of evil intentions. I’m only saying the conditions for it are ripe. That’s all. Main reason Patriots beat the Chiefs? Pats had 26 guys with championship game experience. Chiefs had none. Color me goofy, but I like veterans with long proven track records. Especially here. Forgive shameless hedge - I think there’s a good chance I’m overreacting. But too many great stocks with smaller market caps and greater potential for me to muck around with gut-ranklers.
BD
Mekong I agree with you totally. I am always confounded by analysts that seem to be finding something that is in plain sight for all the world to see. SBC is often included in adjusted EBITDA. As long as the reporting is consistent what difference does it make. If you don’t like using it then take it out and do your calculation without it. If a company I am researching doesn’t put SBC into their adjusted EBITDA numbers then I always add it in. To me it is a non cash item so I add it. I don’t think SQ is trying to fool anybody, as you said, many companies include SBC in their EBITDA calculations. As long as they are consistent and you can see the number right in front of you, why would you think they are trying to fool anybody. Just don’t see it.
And have I missed something or didn’t the new CFO come over from ATVI a 36 billion dollar market cap company, where she was the CFO. I would hardly call that a rookie.
Mike
She was CFO at ATVI for less than a year. Fair to say you need at least one year experience to exit rookie status.
That’s fair, but Sarah Friar was not CFO prior to joining Square.
She was Senior VP of Finance @ Sales Force from April 2011 to July 2012 (just over a year), and then went to become the CFO @ Square.
Before Square, she was at Goldman Sachs, covering software stocks, and was a Managing Director.
So Square’s new CFO is actually a bit more experienced than Sarah Friar was when she joined Square.
I still don’t understand why Ms. Friar joined the neighbourhood social-media company as CEO. Yes, step up the ladder, but the company isn’t very high profile. But that’s a discussion for another board.
David
Amrita Ahuja was the CFO of Blizzard Entertainment, a subsidiary of Activision Blizzard. Spencer Neumann was the CFO of Activision Blizzard who left for Netflix, all about the same time.
SBR
As also posted on the SQ board
Current GAAP rules [foolishly] require deducting share-based compensation from profit. I say foolishly because the issuing of shares costs the company nothing … it costs the shareholders by diluting their ownership. So, everyone backs out share-based compensation from non-GAAP earnings.
As for CAPEX, CAPEX is booked to Assets and depreciated, by everybody. It makes no sense to suddenly add it into current spending any more than it would make sense to exclude the annual depreciation from expenses.
I had to look up when SQ went public as the author said in the last four to five years of SQ being public…
In October 2015, Square Inc. filed an IPO to be listed on the New York Stock Exchange. Shares were priced at $9 on November 18, 2015, and on November 19, 2015, Square officially began trading.
Not saying that it is impossible that some bits are true, but simple math puts author’s opinion in question
To me that is just an article by a short.
First, Sarah Friar had NEVER been a CFO when she came to Square. The new CFO sounds like an impressive, experienced person.
Second, the treatment for stock based compensation that he is condemning as some kind of fake accounting is ABSOLUTELY STANDARD for ADJUSTED Ebitda.
Just saying…
Saul
To me that is just an article by a short.
The Street is a financial website not a hedgie site. I think folks are missing the point. I can’t go into details because I don’t follow SQ, so I can’t spell out the details. I’ll simply note that SQ acquired Weebly in a cash/stock deal. The stock compensation is issued to the founders and employees in installments. I believe the significant growth in adjusted EBITDA reflects these stock grants.
I think folks are missing the point. I can’t go into details because I don’t follow SQ, so I can’t spell out the details. I’ll simply note that SQ acquired Weebly in a cash/stock deal. The stock compensation is issued to the founders and employees in installments. I believe the significant growth in adjusted EBITDA reflects these stock grants.
I’m sorry, Putnid, because you are a smart guy, but you have that really wrong:
EBITDA means Earnings Before Interest, Taxes, Depreciation and Amortization. GAAP accounting makes companies account for SBC as a cash expense, even though there is NO cash expense to the company. It’s sort of moralistically punishing them for being bad boys and girls and paying SBC, which does dilute the stockholders. This is why most tech companies give everything in Adjusted form, eliminating that make-believe expense, and why at the beginning of the conference call they say, “After this point, we’ll give all results in adjusted form unless otherwise stated”, why headline numbers are usually the adjusted ones, and why analysts give their estimates in adjusted form, etc.
Adjusted EBITDA means without counting SBC as a cash expense (without the GAAP junk). Giving stock grants to principals of an acquired company doesn’t make any more EBITDA than was there before. Adjusted EBITDA simply doesn’t subtract the imaginary dollar cost to the company that GAAP invented. And if Square had simply paid more in cash for the acquisition, instead of giving stock grants, that wouldn’t have counted in adjusted EBITDA either, as it would have been capex, not operating expense. There is no way that “the significant growth in adjusted EBITDA reflects these stock grants,” if that is supposed to imply that the money isn’t there. The money is in the bank. Giving stock grants doesn’t touch a penny of it. It’s still in the bank after you give the stock grants.
Best,
Saul
I’m sorry, Putnid, because you are a smart guy, but you have that really wrong
Oh, please. I’m well aware of what EBITDA means and what GAAP versus non-GAAP (i.e., “adjusted”) mean. I’m also very well aware of the pros and cons associated with each of those terms.
Let’s go back to the original Street article:
For Q3 2018, Square wants investors to focus on the fact that not only was its adjusted revenue up by 56% YoY, but its adjusted EBITDA performed even better and was up 107% YoY to $71 million. However, once we dig a little into Square’s adjusted EBITDA figure, we can see that the majority of the gains have come from its share-based compensation being backed into the EBITDA figure.
Let’s delve into this a bit deeper.
Square reported ADJUSTED earnings of $0.13. GAAP earnings were $0.04. That’s quite a difference. Granted, Square posted its first GAAP profit during the third quarter, but the company disclosed that this was largely due to its investment in Eventbrite Inc. which went public during the quarter. However, the company now has to show mark-to-market numbers for that investment every quarter, and it would have posted a net loss during the latest quarter if not for the Eventbrite impact.
On a GAAP basis, Square reported a net income of $19.6M. However, the ADJUSTED EBITDA was reported as $70.9M. That’s a BIG difference. I wasn’t entirely sure about the author’s assertion that SBC was the big driver of the adjusted earnings number, so I looked up the latest 10-Q. As it turns out, Square reported that on May 31, 2018, the Company acquired 100% of the outstanding shares of Weebly, a technology company that offers customers website hosting and domain name registration solutions. The purchase consideration was comprised of $132.4 million in cash and 2,418,271 shares of the Company’s Class A common stock with an aggregate fair value of $140.1 million based on the closing price of the Company’s Class A common stock on the acquisition date. That explains the significant jump in EBITDA. Square added $58.9M in stock-based compensation to that net income figure. Note, there were also other additions and subtractions to net income leading to the ADJUSTED EBITDA figure, but you get the gist.
I don’t want to get into another debate about GAAP versus non-GAAP. Let’s just say there are plenty of investors (and CEOs/CFOs) who wince at large adjustments to the income figure by adding in SBC. As Warren Buffett asked: If SBC isn’t an expense, what is it? At any rate, buying a company with a big dollop of SBC to the founders/employees skews the income figure significantly.
I wonder why the author didn’t mention FCF? Sq has been FCF positive for the last 3 quarters and in the last quarter alone they produced 33.5 million dollars in FCF. So ebitda is just a single number to look at but when you see a company that is growing at 56%, fcf positive, more cash then debt, and recently profitable, I want to be invested in. I have read the authors write up on other companies and am really not impressed. He seems to be someone looking for a reason to scare everyone into not investing.
Andy
I’m well aware of what EBITDA means and what GAAP versus non-GAAP (i.e., “adjusted”) mean.
I know this is a bit of a moot point, but both EBITDA and Adjusted EBITDA are non-GAAP. There is no such thing as a GAAP EBITDA metric
If SBC isn’t an expense, what is it?
Not an expense … except under GAAP rules. No money flowed out of the company for the SBC, so how can it be a real expense? The only ones impacted by the issuance of those shares are 1) the people who received them and 2) existing shareholders whose stake in the company has been diluted.
This is perhaps the stupidest rule under GAAP ever.
Hi again putnid, I don’t want a thread on GAAP vs Adjusted either. (I actually didn’t know there were still people who paid attention to GAAP. I notice that even Bert is using adjusted now most of the time). I won’t post again on this and if you want to have the last word go ahead.
This guy is being purposely misleading, acting as if he’s caught something that the company was hiding:
However, once we dig a little into Square’s adjusted EBITDA figure, we can see that the majority of the gains have come from its share-based compensation being backed into the EBITDA figure.
THAT’S what Adjusted EBITDA means for God’s sake! You don’t count SBC as an expense! It’s what every company means by adjusted EBITDA! And it’s not something being backed into EBITDA !!! It’s just not taken out as an expense to the company, because it’s NOT an expense to the company. It’s already accounted for as a dilution.
Geez! If the company dilutes stockholders by selling more shares, IS THAT an operating expense? Would you remove that from Earnings because there are more shares?
If Adjusted EBITDA (Earnings Before Interest, Taxes Depreciation and Amortization) was $71 million, THAT IS THE CASH DOLLAR amount it was. GAAP just wants to take most of it away as an imaginary expense because they issued more shares.
I’m through.
Saul
I wonder why the author didn’t mention FCF? Sq has been FCF positive for the last 3 quarters and in the last quarter alone they produced 33.5 million dollars in FCF.
Not looking to argue here, but there’s quite a bit more to a company’s cash flow than just the cash flow from operating activities. Using Square as an example (last Q numbers from Yahoo):
Total Cash Flow From Operating Activities 47,628
Total Cash Flows From Investing Activities -609,208
Total Cash Flows From Financing Activities -101,073
Change In Cash and Cash Equivalents -663,302
I encourage all investors to consider corporate financial statements in their entirety.