Snapchat operator Snap (NYSE:SNAP) just reported a massive $2.2 billion net loss for the first quarter. Of that, $2 billion was directly related to stock-based compensation (SBC) expenses that were recognized during the quarter in connection with the company's IPO. That total was greater than the $1.7 billion in IPO-related SBC expenses Snap had originally predicted in its prospectus. The IPO met performance conditions on previously awarded RSU grants, triggering recognition of SBC expenses, which is not uncommon.
However, it's worth pointing out that a disproportionate amount of those costs are directly tied to one person: CEO Evan Spiegel.
Cashed out some shares? Here's some more!
You may recall that immediately after its IPO, Snap awarded Spiegel with a massive bonus for taking the company public, a process that inevitably entailed him cashing out nearly $300 million in stock. The young CEO was given roughly 37.4 million shares, or about 3% of shares outstanding, more than replacing the 16 million shares he sold in the IPO. The bonus was valued at $800 million based on Snap share prices at the time.
Giving a CEO or founder a bonus for taking a company public is also not uncommon at face value, but Spiegel's award was strange for other reasons. For starters, the award vested immediately and as such comes with no requirement that Spiegel stay with the company. The shares vested immediately, but Snap will deliver these shares to Spiegel in quarterly installments over the next three years, although it has recognized the related SBC cost now.
This was all disclosed in the prospectus:
The CEO award will vest immediately on the closing of the initial public offering and such shares will be delivered to the CEO in equal quarterly installments over three years beginning in the third full calendar quarter following the initial public offering. There is no continuing service requirement of the CEO following the closing of the initial public offering. Accordingly, such shares will be delivered in equal quarterly installments regardless of the CEO's employment status with Snap Inc. following an initial public offering. This award will be recognized as compensation expense based on 3% of shares outstanding post initial public offering and the initial public offering share price. The CEO award compensation expense will be recognized immediately on the closing of the initial public offering.
Snap initially estimated that the SBC expense associated with this CEO award would be $624.8 million, but that was based on an award of 36.8 million shares. Since Spiegel received more shares than expected, investors can now deduce that the SBC expense directly related to Spiegel's award was more like $636.6 million.
In other words, Spiegel's award comprised nearly a third of total SBC costs for the quarter, which in turn represented nearly all of the red ink.
It didn't have to be this way
Consider an alternative scenario where the award vested over the three-year period that it intends on delivering those shares. Not only would that have retentive effects of ensuring that Spiegel stays with the company, but it would spread out the SBC costs from his award as well, since companies only recognize SBC costs once the underlying RSUs vest.
Instead of eating $636.6 million upfront, Snap could have recognized the related SBC costs over three years, although it's hard to quantify how much, since those costs would be a function of Snap's share performance in the years ahead. What we can say is that if Snap had only recognized one quarter's worth of the award based on the $17 IPO price, the SBC cost would have only been $53 million.
In terms of the costs borne by shareholders, it's extremely unlikely that recognizing these SBC costs upfront will prove favorable. The only way that it ends up working in shareholders' best interests is if Snap shares march higher in the years ahead, in which case Snap would instead recognize SBC costs based on those higher share prices. Given Snap's absurd valuation, the possibility of shares trending upward is extremely remote.
What's far more likely is that the market overcomes the hype and shares trade lower, in which case Snap could have recognized those SBC costs at lower share prices -- and over time, to boot.