Vicious picture behind EBITDA by weaponizing Stock based compensation.
I have been thinking about dilution a lot lately.
It started with a simple discomfort, why do some companies, even while showing strong growth in revenue, profits, and “improving unit economics” still manage to leave shareholders feeling underwhelmed (Trying to Impress)?
That question led me down a deeper path, equity dilution, capital allocation, and eventually stock based compensation (SBC).
Believe me then i faced a very uncomfortable truth ,"Paying employees with shares instead of cash doesn’t eliminate the cost. It just changes who pays."
This Reading is about that idea and how it plays out in companies like Zomato (now Eternal), where “Adjusted EBITDA” often tells a cleaner story than reality.
I would like to breakdown into misunderstanding , Distortion and what is the real cost of such adjustment.
Misunderstanding -
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Investors are taught that Depreciation & amortization is non cash , hence should be added back, stock based compensation (SBC) is also non cash and hence should be added back.
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Investors should know that Depreciation is an Accounting adjustment and therefore is an Non cash item, However SBC is a PAYMENT but NOT in CASH.
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for eg: if a company pays salary, cash goes down, but if a company pays stock , dilution happens.
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so in first case , company is paying and in second case clearly SHAREHOLDERS are paying.
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I just want to give a data point from IPO year 2021 to 2025, the amount of SBC booked is ₹ 2841 Cr( approx.)
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I don’t know it may sound weird that a listed company with a mammoth market cap of more than ₹ 2 lakh Cr can’t able to generate an POSITIVE operating cashflow from 2021 to 2025 (combined).
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Criticisms are welcomed but one must remember ETERNAL is a NEW AGE co. , but not a NEW company.
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How long a benefit of doubt is given in the name of growth and crazy valuation seems unjustifiable.
Distortion -
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Actually there is no point of accounting but it directly affects VALUATION.
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If i as investor consider DCF approach , usually EBITDA improvement leads to higher operating margins, Higher margins leads to higher cashflow, Higher cashflow leads to higher valuation.
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If SBC is excluded then , Cashflows are overstated, Margins seems inflated, Valuation becomes opportunity.
In hindsight, you are valuing a company like as if SBC doesn’t exist.
Real cost of Adjustment -
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The real cost is dilution of existing shareholders Equity.
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The most dangerous dilution is not loud. It doesn’t come with announcements. It comes quietly, quarter after quarter, through ESOPs, while the company tells you margins are improving.
Conclusion-
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Stock-based compensation is not a Noncash expense. It is a Nonobvious expense.
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Sometimes company doesn’t hides it but they show clearly , effectively visible but gets distorted when it comes to understanding to shareholders.
Disclaimer - I am not a financial advisor, and do not construe this in any manner as financial advise, this is purely for Educational purpose.
Happy Reading.