What They Didn’t Tell You About The Microsoft-LinkedIn Deal

LinkedIn’s Manhattan newsroom. Some investors, including Warren Buffett, are critical of excluding stock-based compensation from earnings calculations. Credit Hiroko Masuike/The New York Times
LinkedIn’s Manhattan newsroom. Some investors, including Warren Buffett, are critical of excluding stock-based compensation from earnings calculations. Credit Hiroko Masuike/The New York Times

“Let me explain why.”

While Jeff Weiner, LinkedIn’s chief executive, may have written a lengthy memorandum to his employees on Monday morning, he may have left a few things out.

Weiner explained the surprise decision to sell the company to Microsoft for $26.2 billion, because of the heft that Microsoft gives LinkedIn “to control our own destiny.”

But there may have been another reason that he left unspoken.

That would be the company’s struggling stock price and its reliance — some might say overreliance — on stock-based compensation.

On one grim day in early February, LinkedIn’s stock price plummeted more than 40 percent after it forecast weaker-than-expected growth for the year. The share price had hovered at $225 at the beginning of 2016; a month later it briefly got close to $100.

The rapid devaluation has posed more than just a problem for investors. LinkedIn’s employees are paid largely in stock, and therein lies the rub: Around the company’s new 26-story skyscraper that opened in downtown San Francisco in March, as well as the corporate headquarters in Mountain View, Calif., there have been persistent whispers about whether LinkedIn could retain its top talent as the marketplace clobbered their incomes.

Among Silicon Valley companies, “LinkedIn is among the most aggressive in using share-based compensation — there is no question about that,” Mark Mahaney, a veteran technology analyst at RBC Capital Markets, said in an interview on Monday. “If the stock had stayed down, it would have seen employee churn.

Mr. Weiner — who took over as LinkedIn’s chief in 2009, succeeding Reid Hoffman, the founder — has done a tremendous job in the past years building the company’s business, which is primarily about helping people connect to one another for employment and conduct business-oriented social networking. But despite all the headlines about growth and profits, LinkedIn has been a money-losing operation for the last two years.

You wouldn’t know that if you only glanced at LinkedIn’s news releases. That’s because LinkedIn steers investors to focus on what’s known as its adjusted Ebitda, or non-GAAP earnings. The company purposely strips out the cost of stock-based compensation, which has the effect of turning losses into gains. LinkedIn paid out $510 million in stock-based compensation last year; over the last two years, that stock-based compensation represented a whopping 96 percent of operating income, or 16 percent of revenue, according to Mr. Mahaney. Companies like Google, Amazon and Facebook paid out about 15 percent of operating income, or well under 10 percent of revenue.

LinkedIn justifies the practice by saying that stock-based compensation “is noncash in nature” and that excluding it from its earnings calculation provides “meaningful supplemental information regarding operational performance and liquidity.”

But investors like Warren E. Buffett have been highly critical of the practice. “It has become common for managers to tell their owners to ignore certain expense items that are all too real,” Mr. Buffett wrote in his annual report published this year. Stock-based compensation, he said, “is the most egregious example. The very name says it all: ‘compensation.’ If compensation isn’t an expense, what is it? And, if real and recurring expenses don’t belong in the calculation of earnings, where in the world do they belong?”

Mr. Buffett also criticized analysts who “play their part in this charade, too, parroting the phony, compensation-ignoring ‘earnings’ figures fed them by managements.”

In April, Facebook, which also used to steer investors to use adjusted-Ebitda earnings numbers that also excluded the cost of stock-based compensation, announced that it was changing its policy. “Stock-based compensation plays an important role in how we compensate our employees, and therefore we view it as a real expense for the business,” David Wehner, Facebook’s chief financial officer, said in an earnings call.

(Article first appeared in The New York Times)

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