During its fiscal year 2018, chip giant Broadcom (NASDAQ:AVGO) spent $1.23 billion on stock-based compensation -- up 33.4% from the prior year. That was a significant increase, but that jump seems downright modest compared to the $2.1 billion -- a more than 70% increase -- in share-based compensation that the company expects to dole out in fiscal year 2019 (the current fiscal year).
Let's take a look at what's driving that massive increase and what it means for investors.
Equity for everyone
According to Broadcom CFO Tom Krause, the company is "implementing a special broad-based, multi-year equity award program for our employees, including our new CA employees."
In explaining the rationale behind this, Krause explained that the company thinks that "providing four years of equity grants upfront creates clarity regarding future compensation that creates a powerful retention incentive in an otherwise tight labor market and a sharpened focus on long-term stockholder value creation."
For some perspective, much of Broadcom's core engineering happens in Silicon Valley, where many successful high-tech companies operate. This leads to substantial demand for skilled hardware and software engineers -- demand that's so high that, as you might have noticed, Krause characterized it as a "tight labor market."
In fact, as Silicon Valley Business Journal recently pointed out, the median Broadcom employee makes north of $200,000 per year.
So what Broadcom is ultimately trying to do is to make sure that its workforce sticks around.
The right long-term move, but at what cost?
What Broadcom is doing here is unquestionably the right long-term move -- the company needs to ensure that its workers are well compensated, lest they be lured away in large numbers by Broadcom's peers in Silicon Valley.
This will, however, cost shareholders. Firstly, the issuance of these shares will increase the total number of shares that the company has outstanding, serving to dilute the company's earnings per share (EPS) -- although the company's share-repurchase program could serve to mitigate that increase.
Moreover, the large increase in share-based compensation is going to negatively impact the company's earnings on a GAAP basis, since such compensation does count toward the company's operating expenses on that basis. Broadcom's non-GAAP results exclude, among other things, share-based compensation, so those results should continue to look good.
In fact, when Broadcom issued its financial guidance for fiscal 2019, it gave both GAAP and non-GAAP guidance. On a GAAP basis, the company's operating margin is expected to be just 20%, but on a non-GAAP basis, the company's operating margin is expected to be an incredible 51%.
Now, to be fair, that disparity isn't entirely -- or even mostly -- driven by share-based compensation. In addition to the $2.1 billion in share-based compensation, Broadcom says that there's $4.7 billion of "amortization of acquisition-related intangible assets," $570 million in "restructuring charges," and $210 million in "acquisition-related costs" separating its GAAP and non-GAAP operating expenses.
So if we add back in the share-based compensation but exclude everything else, Broadcom's operating margin for its fiscal 2019 would have been north of 42% -- still excellent by any measure, but not as good as the 51% that the company is guiding to.
Back to normal by 2022
According to Krause, the company's stock-based compensation expense will "start to come down in 2020 and decline from there back to our normal level by 2022."
For investors who primarily pay attention to a company's GAAP results (which, frankly, for an acquisitive company like Broadcom, probably doesn't make a ton of sense), the EPS headwind that the company will face in fiscal 2019 will abate over the next few years.
If you mainly judge the health of the business based on its non-GAAP results, then this spike in share-based compensation expense probably isn't likely to impact your view of Broadcom stock as an investment.