LinkedIn, Twitter stock stories show profits matter

SAN FRANCISCO — U.S. investors have had two years to compare the financial performance of Twitter and LinkedIn, two social media companies whose annual revenue and market values both trail well behind that of No. 1 Facebook.

Investors’ preference for LinkedIn over that time, as measured by market value, is evidence of the prudence of using net income – rather than growth in revenue or cash flow — to measure the performance of public companies.

The stock market’s verdict on Twitter TWTR and LinkedIn LNKD has shown that growing profitably ultimately trumps growing at all costs, even for social media companies and their investors.

Twitter, which in the top after its November 2013 IPO was worth 80% more than LinkedIn, is now worth 45% less.

Its shares are back near where they started then, at $26 a share.

LinkedIn shares, meanwhile, are up about 20% during those same two years and have surged 175% in the four-and-a-half years since their May 2011 public debut. As of the close of markets Wednesday, LinkedIn was valued at $33 billion and Twitter $18 billion.

This is the case even though Twitter is growing faster and has three times as many monthly users than its rival.

One key difference behind the stock performance gap: LinkedIn, during its first three years as a public company (as in its last three years as a private startup) was mostly profitable.

Twitter, on the other hand, has yet to earn annual net income. Instead, it’s lost more than $1 billion over the last seven quarters and shows an accumulated deficit of $2 billion on its latest balance sheet.

Net income takes into account the dilution to ordinary shareholders from the sizable stock options and grants given to insiders, executives and employees.

Fast-growing tech companies dole out a lot of those, which hurts their bottom line.

So the Twitter IPO (among others) was sold to investors with the aid of a relatively new financial metric called adjusted cash flow. Also called adjusted EBIDTA, it doesn’t conform to generally accepted accounting principles, or GAAP, but is widely used by Wall Street analysts.

Its use is the result of a compromise struck 13 years ago on stock-option expensing between Arthur Levitt, former chair of the U.S. Securities and Exchange Commission, and the tech industry.

The resulting accounting rules required all firms to account for stock-compensation charges on their income statements, yet it also allowed them to take a writedown of equal amount on their cash flow statements.

Sounds like esoteric and innocuous financial jargon, right? It isn't.

The difference in financial impact between net income and adjusted cash flow can be seen in the results of Twitter and LinkedIn.

In 2014, Twitter’s adjusted cash flow quadrupled to $300.1 million, while LinkedIn’s rose “only” 57%, to $592.2 million.

Yet, when it came to the bottom line, Twitter reported yet another massive loss of $577.8 million, or 96 cents.

LinkedIn also reported an annual loss, but it was its first in five years and relatively small at 13 cents a share.

(That’s the twist in this story: Investors have fallen in love with LinkedIn at the same time the company is investing for growth, as CFOs like to say, and reporting large losses. LinkedIn lost $150 million, or $1.18 a share, for the first nine months of this year, for example.)

If growth were all that mattered, Twitter should be worth more on a relative basis. Sales in its most recent quarter surged 57% year-over-year, for example, much faster than LinkedIn’s 37% growth.

Yet LinkedIn is worth far more.

It earned annual net income for five consecutive years from 2009 through 2013 and so has given investors confidence that its business is profitable.

Twitter, as noted above, has never demonstrated that it can operate at a profit. In its most recent quarter, it lost over $100 million or 20 cents a share.

What Twitter does have is a lot of shares outstanding, relative to LinkedIn – more than five times as many as of Sept. 30. That means a retail investor who owns one share of LinkedIn owns more than five times the relative equity stake of a Twitter shareholder.

And Twitter’s share count is still growing fast, 50% faster than LinkedIn’s.

All that dilution – which net income accounts for but adjusted cash flow does not – matters over the long run.

Regular readers know I have recommended avoiding Twitter shares since they went public.

However, this column is not an endorsement to buy LinkedIn, whose shares are richly valued by any traditional stock-price measure.

Instead, the column is an opinion that the growth-at-all-costs investment strategy of the social media boom has now fallen out of favor among public investors.

John Shinal has covered tech and financial markets for more than 15 years at Bloomberg, BusinessWeek,The San Francisco Chronicle, Dow Jones MarketWatch, Wall Street Journal Digital Network and others. Follow him on Twitter:  @johnshinal .