Will Twitters Brain Drain Problem Cost Investors in More Ways Than One?

By Markets Fool.com

Image source: Twitter.

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It appears Twitter is suffering from a "brain drain" problem. While the economic term generally refers to countries that see their most talented citizens leaving, the term is equally apropos to struggling businesses that experience a loss of productive employees to competitors. That appears to be happening at Twitter, with four high-level managers departing the company in one weekend this January.

In a Silicon Valley wrinkle, the impetus for Twitter's brain drain probably wasn't harsh working conditions, but might have been related to the fact that the stock options many employees were earlier granted are essentially worthless since the per-share price of the company has cratered. Meanwhile, a host of Silicon Valley's up-and-coming private companies and successful tech giants like Facebook, Alphabet, and Apple are looking for the unique skills these employees possess.

Twitter's plan for stemming the emigration of highly talented employees could put it at odds with investors. According to The Wall Street Journal, Twitter has been doubling down on stock grants and cash bonuses to keep employees around for six months to a year.

Twitter doubles down on its biggest operational problem
Listening to Wall Street, you're likely to hear that Twitter's biggest problem is increasing monthly active user growth. That's most likely true, but the company also hasn't been profitable on generally accepted accounting principles basis, even in the face of continued strong year-over-year revenue growth.

The biggest reason top-line growth hasn't made it to the bottom line is Twitter's tremendous stock-based compensation costs. For technology companies, it's common to highlight non-GAAP earnings instead of GAAP, as the difference between the two is generally these stock-based compensation costs.

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The argument for non-GAAP is that stock-based compensation costs aren't really "costs" in the traditional sense of the word because they involve no cash outflows. However, they do cost investors and should be monitored closely. While prudent stock-based compensation programs are value-accretive for investors by retaining talent without using company cash, large stock-based compensation is a drag on EPS in the period in which the transaction is expensed -- and earnings per share figures in future periods.

In the technology world, which is notorious for high stock-based compensation expenses, Twitter is among the worst offenders. The Journal reports that Twitter spent $682 million in stock-based compensation during calendar year 2015 -- nearly 31% of its revenue. As a comparison, large social-media networks LinkedIn and Facebook reported this figure at 17.1% and 16.6%, respectively, according to the Journal. Doubling down on stock-based compensation and adding cash bonuses will continue to draw the ire of investors.

What's up with the cash bonuses rather than stock?
More surprising is Twitter's use of cash bonuses instead of traditional stock grants. All else being the same, employees are more likely to prefer stock if they feel prospects for the company's are sound and the company is undervalued by the stock market. While I'm sure many employees are upset about prior stock grants possibly expiring worthless, that's a sunk cost, and the decision to take stock grants or cash should be evaluated on a current cost/benefit analysis.

That the company is reportedly paying cash bonuses in addition to stock -- and requiring recipients to stick around -- points to the fact that employees are not confident in the company's path forward. While this may be a great move long term, look for Twitter to continue to be unprofitable on a GAAP basis in the short term while it works on retaining talent.

The article Will Twitters Brain Drain Problem Cost Investors in More Ways Than One? originally appeared on Fool.com.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fools board of directors. Jamal Carnette owns shares of AAPL. The Motley Fool owns shares of and recommends GOOG, GOOGL, AAPL, FB, LNKD, and TWTR. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.