Twitter’s shady accounting: Why is Twitter using the same accounting tricks that have been criticized so many times before?

Twitter’s shady accounting

By Stephen Gandel, senior editor October 8, 2013: 5:00 AM ET

Why is Twitter using the same accounting tricks that have been criticized so many times before?

FORTUNE — When it comes to its bottom line, Twitter would like potential investors to put on some heavily tinted rose-colored glasses. In the registration statement for its upcoming IPO, which was filed on Thursday, Twitter said through the “eyes of management” the company had a profit of just over $21 million in the first six months of the year. That’s probably how Twitter’s execs would like potential investors to see it. Through an accountant’s eyes, though, Twitter actually lost just over $69 million.The difference has to with an unorthodox accounting term called “adjusted EBITDA.” Companies have long tried to steer investors toward metrics that make their results as good as possible. EBITDA is the most popular one, which stands for earnings before interest, taxes, depreciation, and amortization. Some have questioned the logic of looking at earnings without all these costs. Tax, for instance, is a real cash expense that all companies have to pay.

But Twitter says it excludes even more expenses when its management looks at earnings. That’s where adjusted EBITDA comes in. On top of the other stuff, Twitter’s metric excludes stock-based compensation as well. Without that adjustment, Twitter’s management wouldn’t be able to say the company looks profitable, at least to them.

Using typical EBITDA, Twitter still had a loss of around $14 million for the first six months of the year. Exclude the $35 million of restricted stock units that Twitter handed out to employees, an expense that official accounting rules require companies to include when computing their bottom lines, and that’s how you get to the gain of $21 million.

Other social media companies have professed their love for adjusted EBITDA as well. LinkedIn (LNKD), for instance, used adjusted EBITDA in its 2011 IPO filing, boosting its bottom line to $64 million, from an official $5 million, in the first nine months of 2011. But not all use it. Facebook (FB) eschewed the use of any alternative measures of its bottom line when it went public.

Some have argued that it makes sense to exclude stock-based compensation because it’s a non-cash expense. And Twitter says the expense is rapidly shrinking. It estimates its stock-based compensation will drop to less than $11 million in 2017, from $185 million this year.

Along the way, though, the company projects stock grants will cost the company $325 million. And even after that, the company will have to pay its employees. It just won’t pay them with stock. Warren Buffett and others have argued that companies that exclude stock-based compensation from their expenses are using phony accounting.

“It’s like the employees are working for free,” says Jack Ciesielski, the publisher of The Analyst’s Accounting Observer. “It’s silly.”

And while excluding depreciation may make sense for companies that have large one-time expenses, most of Twitter’s depreciation expenses have to do with computer servers. Twitter spent $60 million on servers or server space in the first six months of the year alone. Use adjusted EBITDA, and that expense completely disappears from Twitter’s financial statements.

The real silly thing is that the Securities and Exchange Commission allows this. The SEC’s rules state that companies can include the adjusted figures in their IPO filings, alongside the official numbers, as long as the company’s management includes a statement as to why they are useful. Twitter says it prefers adjusted EBITDA because it shows underlying trends that “could otherwise be masked by the effect of the expenses” that Twitter likes to exclude.

In the end, the effect of those expenses is that they add up to fact that Twitter is very unprofitable, and that’s not an underlying trend that Twitter likes, or at least wants you to notice on the eve of its $1 billion IPO. Who would?

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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