This earnings season has not been kind to all companies. While there have been some notable wins, including well-received results from Uber and Amazon, other major tech companies fared poorly in the wake of their second-quarter financial reports.
However, two companies that posted results that were disfavored by investors, Airbnb and Snap, are interesting for reasons apart from their negative share-price movements in the wake of their earnings reports despite divergent results. What makes the two companies stand out this earnings season is they both announced plans to spend heavily to buy back their own stock, a form of shareholder return that we don’t tend to see from tech companies until they are older and have a longer history as public entities.
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The use of cash in high-growth companies has a virtue-signaling component. Companies that use cash for shareholder return over, say, growing faster are telling investors that they cannot deploy all their cash flow into efficient growth opportunities. This can mark a turning point wherein a company generates shareholder return not merely in the form of share-price appreciation built off of rapid top-line expansion, but with a mix of growth and direct investments in shareholder value. Buying back stock limits a company’s total float, or equity base, making each individual share of stock worth more, something that investors appreciate.
For firms that have been valued on growth terms over profit, firing cash into shareholder return — buybacks, dividends, that sort of thing — is nearly admission of business-model or market maturity.
So it caught our eye when Snap’s announcement of a $500 million buyback came as it reported slower growth. And we blinked again when Airbnb announced four times that amount. For the two firms, $2.5 billion is real money. We’re not talking about Apple, here, but companies that have gone through recent layoffs or hiring slowdowns.
What’s going on? Let’s peek at their numbers and get a vibe for their choice to kick a material fraction of cash into shareholder return. Or as we like to think of it, paying back some of the money the companies spent paying employees through equity compensation that was then discounted from their cost tallies as they grew.
Share-based compensation
Why do we hear so much about adjusted EBITDA today when we track high-growth tech companies? Because it’s an incredibly forgiving metric. EBITDA, or earnings before interest, taxes, depreciation and amortization, is a method of calculating profit that proponents claim gives a clearer view of a company’s operating results, discounting certain charges that may be less related to its day-to-day work.
Maybe. Adjusted EBITDA, however, takes the discounting one step further, usually stripping the cost of share-based compensation from profit calculations, making the figures look even rosier. All that spending in the form of stock has a dilutive effect; the more compensation that tech companies pay out in the form of stock over cash, the better their adjusted EBTIDA results appear. It’s a brilliant move, pushing a huge category of compensation to the side, effectively asking shareholders to pay staffers in the form of their stake in the business shrinking over time so that the corporate entity can conserve cash and boast better adjusted profit results.
For reference, Airbnb spent $442.0 million in the first half of 2022 in the form of equity compensation for its employees. That’s a lot of shares. (Airbnb’s basic share count rose from 611.7 million at the end of Q2 2021 to 638.4 million at the end of Q2 2022.) Snap spent $318.8 million on share-based compensation in just the second quarter of this year, a key component in its ability to convert a $422.1 million Q2 2022 net loss into $7.2 million worth of adjusted EBITDA in the period. (Its share count rose from 1.55 billion shares at the end of Q2 2021 to 1.63 billion shares at the end of Q2 2022.)
But then time moves along, businesses grow, and, at some point, they often wind up sitting on too much cash — or some cash and too much share price value erosion. In either case, cash can be used to buy back stock that is then retired, reducing float and making investors — in theory — happier with the company in question.
Here’s how Airbnb announced its buyback program (emphasis added):
We’re announcing today that our Board of Directors has approved a share repurchase program with authorization to purchase up to $2 billion of our Class A common stock at management’s discretion. The repurchase program will be executed as part of our broader capital allocation strategy which prioritizes investments in organic growth, strategic acquisitions where relevant, and return of capital to shareholders, in that order. Our strong balance sheet and meaningful cash flow generation provides us the capital to do all three. The share repurchase program will enable us to offset dilution from our employee stock programs.
And here’s Snap:
Total fully diluted shares grew 3.3% year-over-year in Q2, down from 4.0% in the prior year when dilution was elevated by the impact of early conversions of our convertible notes that contributed 2.3% to the dilution rate. The portion of our year-over-year share count growth driven by stock-based compensation was 2.5% in Q2, up from 1.7% in the prior year. Q2 is the quarter during which we have historically issued ongoing grants to existing team members and the year-over-year decline in our stock price — combined with the growth of our team — were the primary drivers of the increase in dilution related to stock-based compensation in the current period. To protect shareholder value from the impact of dilution, we are announcing a stock repurchase program of up to $500 million.
Airbnb ($9.9 billion in “cash, cash equivalents, marketable securities and restricted cash”) and Snap (“$4.9 billion in cash and marketable securities on hand and total outstanding convertible debt of $3.7 billion with no debt maturing prior to 2025”) are discussing spending a real chunk of their cash to repay shareholders, which means that a lot of the cash they saved by paying employees with stock is now coming due.
This gives us another data point for determining the maturity of a given tech company. Recall that we noted that when it comes to generating massive ad incomes, the biggest tech companies are aces at the work. Thanks to their massive platform scale, diverse product array, and deep customer and corporate penetration, the ads game is great for Big Tech. But that’s less true for startups, given a comparative lack of audience scale and pricing power.
Tech companies age in a timeline that goes something like this:
- The startup is born, often raises external capital and focuses on growth over profitability.
- As the startup matures toward IPO scale, it tends to clean up its spending somewhat, but still leans on equity compensation to juice adjusted profitability and conserve cash for growth.
- Post-IPO, tech companies that reach the next stage of maturity begin to buy back their shares with sporadic campaigns, paying back investors for the money that the company effectively borrowed from them (investors paid dilution, employees were paid stock, and the company got to pretend all along that it wasn’t effectively going into debt to shareholders that it would later need to repay in the form of share buybacks).
- And, finally, once the company reaches platform scale, it combats dilution with ongoing buyback programs, rewards shareholders with regular dividends, and likely has a kick-ass ads business that helps keep all the numbers tidy.
Airbnb and Snap have now reached the third marker, albeit in very different states of health. Airbnb is growing rapidly at scale and is profitable on a non-adjusted basis. It also generates mountains of cash through its operations. Snap, in contrast, is dealing with a growth crunch, net losses and falling adjusted profitability.
That two so very different companies wound up making buyback announcements at the same time is not a coincidence — Snap has lost nearly 88% of its value when we compare its present-day share price against its 52-week high, while Airbnb lost a more modest 45%. The two companies wound up in buyback land not merely due to reaching a new business maturity level, but also thanks to the stock market being rather rude to their value in recent months.
That tells us that tech companies that are getting older, bigger and richer over time may find themselves in a position where buybacks make sense — either to fend off annoyed shareholders sitting on paper losses, or as a way to repay prior equity compensation at depressed prices, and therefore an attractive discount — sooner than they anticipated.
What we can take away from this is that there is no free lunch for startups. All that stock that is paid out in worker comp to preserve cash is really just an IOU to investors that the shares will get bought back eventually. Shareholders effectively loan dilution to startups so that they can grow more quickly with conserved cash. When growth slows, or growth becomes worth less than before, the math changes. Startups would do well to keep in mind that the moment of payback for employee share-based payouts may come sooner rather than later.