With all of the bad weather here in the East, this aging number cruncher has had his hands full with scraping and shoveling. But I just had to take a break and comment on Twitter’s recent Form 8-K (February 5, 2014), particularly given the Company CEO’s comments last Fall on the importance of transparency to being a good leader.

According to Kurt Wagner of Mashable, CEO Dick Costolo said the following about transparency at a TechCrunch Disrupt event last September:

The way you build trust with your people is by being forthright and clear with them from day one. You may think people are fooled when you tell them what they want to hear. They are not fooled. As a leader, people are always looking at you. Don't lose their trust by failing to provide transparency in your decisions and critiques.

Well, when you go “on the record” about one of my favorite themes, I just had to give Twitter’s 8-K a look. And what did I find? Apparently, Twitter’s CFO does not share the same transparency philosophy as his boss.

But before I begin, I thought it useful to report on the accuracy of some predictions that I made about Twitter’s financial performance before the Company’s IPO. In “What Will Twitter’s Financials Really Tell Us?”, I took a shot at forecasting the Company’s post-IPO balance sheet using a comp group consisting of Facebook, Sina Corp, Yelp Inc., and Meetme Inc. And while the average revenue to assets percentage for this comp group (46.84%) yielded total assets of only $1.3 billion instead of $3.4 billion, the forecasted balance sheet category percentages were quite close as illustrated in the following table:

 

 

My comp analysis forecasted the high levels of cash and short-term investments and stockholders’ equity reported by Twitter, and was almost spot on in predicting other current assets, net PPE, and other intangibles. However, my predictions for goodwill were a bit off the mark.

As for the income statement, I expected operating losses (no surprise there), but nothing close to the $645 million reported by Twitter for the 12 months ended December 31, 2013. And of course, I predicted the Company’s use of non-GAAP metrics to transform poor performance into “a great year” as noted by CEO Costolo (Exhibit 99.1, page 1). Sure enough, Twitter converted its over half a billion dollar net loss into an Adjusted EBITDA of $75.4 million by deducting over $600 million in stock-based compensation from EBITDA.

When it came to operating cash flows (OCF), I expected either negative or transitory numbers, and the Company delivered exactly that: an anemic $1.4 million in OCF driven largely by the non-payment of accounts payable and increases in accrued and other liabilities. So, basic market multiple analysis did a decent job painting us a picture of Twitter’s post-IPO primary financial statements.

Then, there was my rant about the Company’s cost structure in “Twitter’s S-1: More Social Media Company IPO Drama.  As you may recall, I used the High-Low Method of Cost Estimation to calculate a breakeven sales point of $639.5 million for Twitter.  Well, guess what?  Had the Company not expensed $600 million for stock-based compensation (an increase of $575 million over the prior year), this prediction would have come close to being reality.  Actual revenues which approximated $665 million yielded an adjusted net loss of $45.3 million (actual net loss of $645.3 million less stock-based compensation of $600 million).  So again, fundamental cost estimation tools can provide insights even for social media companies.

But back to the transparency of Twitter’s recent 8-K. What really stirs me up this time is the Company’s blatantly positive spin to the exclusion (or minimization) of anything negative.  For example, quarterly and annual revenue increases are reported, but little or nothing on costs.  And when losses are reported, they are accompanied naturally by non-GAAP numbers that paint a much rosier performance picture.  What about some real operating data?  After all, Twitter devoted a whole page to non-GAAP metrics (Exhibit 99.1, page 8)! Could it be that real operating data highlights some "chinks in the armor?" The following table raises some questions about the Company, its business model, and its management:

Operating Data Chart.jpg

Of particular concern is the slowdown in growth in the Company’s revenues over the prior year (almost 200% growth in 2012 and only 110% for 2013). Also of interest are the declines in several key percentages: operating assets to total assets and revenues to operating assets.  And if we buy into the validity of adjusted EBITDA, note that the ratio of adjusted EBITDA to operating assets increased only about 1.5% during the past year, despite a 178.4% increase in operating assets during the same period.  What are those operating assets contributing?  Well, it’s definitely not OCF, as OCF to revenues totaled only .21% for 2013.  I am not sure that I buy into the “great year” description of CEO Costolo.

And why doesn’t the Company tell us about its cost problems? I’d gladly swap the non-GAAP metrics page for some insights into why costs increased over 230% from the prior year. Yes, earnings were adversely affected by over $600 million in stock-based compensation, but that raises another question? Given this type of performance, were these “rewards” really earned and warranted? And this wasn’t just a one-time pop…the 8-K indicates that next year’s stock-based compensation will be just as large (Exhibit 99.1, page 3).

If we adjust the Company’s operating expenses for stock-based compensation and amortization of intangibles, some interesting insights about Twitter’s business model (or lack thereof) surface.

Operating Expense Adjusted Data.jpg

Without stock-based compensation and intangible amortization, total costs and expenses still increased at a whopping 95.6% rate.  Although this represents a slight decline from the prior year (12.2%), the decline is much less than the revenue decrease for the same period (88.3%).  And as the above table shows, this year’s increase was driven primarily by continued triple digit R&D spending, and sales and marketing, suggesting that the Company’s business model is still ill defined and in flux.

And as I pointed out in “Twitter’s S-1: More Social Media Company IPO Drama,” goodwill and intangible asset valuations are more questionable than ever given the Company’s operating losses and anemic OCF.  Then, there’s the issue of potentially unrecorded liabilities for contingent consideration associated with the Company’s recent acquisitions.

So will Twitter address these financial reporting and operating concerns in its next quarterly or annual report? Probably not…why should management tackle these tough questions, when the answers just might jeopardize the Company’s share price? On the other hand, didn’t CEO Costolo preach transparency just a couple of months ago? Or is this just another case of “do as I say, not as I do?”

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If your goal in getting a college business degree was simply to get a “job” with the least effort expended, stop reading now!  But if you were serious about learning the fundamental skills needed to support a long-term professional career in business, including a life-long learning perspective, your passion and zeal just may not have been enough according to a number of recent articles in the popular business.

Some suggest that college in general should be questioned.  Glenn Harlan Reynolds, a University of Tennessee law professor, encourages parents and students to “be skeptical” about the value of college.  With average student debt exceeding $29,000 and 40 percent of college graduates taking jobs that don’t require a college degree, he suggests that:

America's higher education problem calls for both wiser choices by families and better value from schools.

It’s hard to disagree with this statement particularly when so many parents and students conduct more due diligence in a car purchase than selecting the “right” college or university. 

Reynolds also notes that the value proposition for a college degree is frequently obscured by the “bait and switch” tactics increasingly used by administrators, as well their lack of budget transparency.  Many schools now routinely “outsource” class instruction to low-paid adjuncts to cut costs (and let’s not even get into on-line “classroom” initiatives), and it is next to impossible to see where one’s tuition dollars actually are being spent (e.g., administration, athletics, research, or teaching).

And guess what? Surprise…surprise…many employers now are questioning the skills of today’s graduates. Richard Vedder and Christopher Denhart from Ohio University confirm that:

Declining academic standards and grade inflation add to employers' perceptions that college degrees say little about job readiness.

They argue that the numbers just don’t work when college degree benefits are questionable and college costs are increasing. And the narrowing gap between what college and high school graduates earn particularly concerns them.  As an old jarhead, I found one of their statements particularly telling:

We now have more college graduates working in retail than soldiers in the U.S. Army, and more janitors with bachelor's degrees than chemists.

But what about business degrees specifically?  Dan Kadlec, a journalist for TIME, believes that:

Colleges are minting money-focused graduates in a work world that increasingly values critical thinking and softer skills like the ability to communicate.

Melissa Korn of the Wall Street Journal reports that “undergraduate business majors are a dime a dozen” and “may be worth even less,” since more than 20 percent of undergraduates in the United States are business majors. And graduate business education doesn’t get a free pass either. John A. Byrne, a contributor to CNN Money, documents the case of Josh Kaufman who believes that MBA programs “teach many worthless, outdated, even outright damaging concepts and practices.” 

Still not convinced that there just might be a flame or two behind all this “smoke,” then just take a look at look at Lynn O’Shaughnessy’s number one reason why NOT to get a business degree: business majors don't learn much in business school!  Her conclusion was based on Academically Adrift, a bestselling book that finds that business majors are among the students who learn the least in college. 

All of this negativism makes this Grumpy Old Accountant seem absolutely cheery doesn’t it?  Well, I must confess that my recent interactions with experienced business graduates (both at the bachelor and master levels) employed as accountants, analysts, managers, and reporters have raised more than a few doubts in my own mind. So, I decided to create a short, five question test (no accounting included, I promise) that administrators, current students, faculty, and recent graduates may find useful for assessing the effectiveness of their B-school experience.  And it’s no coincidence that the five questions mirror the major themes routinely discussed today by business academics and professionals alike. Being naturally grumpy, this exam is a closed book, closed note, essay test that should be completed with no outside assistance…what did you expect?

Question One: What is a business?

Believe it or not, many B-school graduates cannot answer this query in a clear, concise manner.  Often, the response is a long-winded, rambling summary of discrete topics that parallel course requirements that fails to accurately capture the essence of today’s enterprises. To receive full credit, the answer should be close to the following:

 A business is an economic entity that creates wealth (e.g., value, cash flow, etc.) by using financial, human, and physical capital to deliver products or services that the market demands.

And if you really want to wow this old prof, throw in a bit of the “nexus of contract theory” to motivate the need for information to monitor the various contracts which companies execute with shareholders, employees, suppliers, customers, debtors, and the like.

Question Two: What is business strategy?

So, once you decide on a business, what’s the strategy? The answers commonly received to this question are particular disturbing in that they refer to assorted permutations of action plans and related documents.  Sorry, just not specific or good enough. To receive full credit, the answer should address two key issues:

Business strategy is how an organization creates value for its customers and differentiates itself from competitors in the marketplace.

Value creation and differentiation must be addressed in every good strategy whether it be for a company as a whole, or each individual operating unit.  This short definition specifically focuses managers on their markets and customer needs.  If customers don’t value a company’s product or are indifferent to it vis-a-vis that of the competition, the company is unlikely to succeed in the long-run, regardless of its stated “strategy.”  If you add some verbage about Michael Porter’s Five Forces model in your differentiation discussion in the context of today’s technology dominated world, you will bring a smile to this Grumpy Old Accountant’s face.

Question Three: What is a business model?

This dot-com era buzzword can generate some very interesting definitions which provide great insight into what has been learned (or not) in the B-school.  Frequent responses include a business idea, an overly-complicated financial model, or a business plan.  These answers don’t even warrant partial credit!  So what is it?

 A business model describes how the pieces of a business fit together as a system to execute the firm’s stated strategy.

Every business model whether it be for the whole entity or each individual operating unit must address ALL of the following fundamental “value chain” activities: market analysis, product development and design, sales and marketing; procurement, production, and distribution, and after sale customer service.  How do each of these activities contribute to strategy execution?  Answer that and now you have a business model!  And some references to “How to Design a Winning Business Model” by Ramon Casadesus-Masanell and Joan E. Ricart will likely get you some bonus points.

Question Four: How should a business evaluate its performance?

As an accounting professor, I find the answers I often receive to this question to be downright depressing: stock price appreciation, revenue growth, earnings per share, and a host of other financial statement driven metrics.  These might earn some partial credit, but if you even hint at “adjusted EBITDA,” you get a zero.

Answering this question requires getting Question Three correct!  To evaluate performance you must have something concrete to measure.  In the case of a business, it’s how each of the five value chain activities that comprise a firm’s business model are performing.

A business should measure its performance by monitoring the implementation, execution, and effectiveness of its entire business model.

This means that managers need both financial and non-financial metrics to judge their market analysis, research and development, selling and marketing, production and distribution, and customer service activities.  Unfortunately, all too often, companies rely almost exclusively on financial statement numbers to do so.  The best answers to this question will be organized around Kaplan and Norton’s Balanced Scorecard framework.

Question Five: What role does innovation play in business today?

Historically, business innovation has been equated primarily with the development of new products and new technologies.  But as Birkinshaw, Bouquet, and Barsoux suggest, “products and services represent just the tip of the innovation iceberg.” So, a few points might be awarded for this weak “common sense” response.  But to receive full credit, respondents must have scored well on Questions 3 and 4. The following represents a more complete response:

Business innovation refers to any ideas and/or actions that can positively transform any part of the business model or its individual value chain activities, as well as the development of new products or service offerings.

The implications of this question are clear…to innovate, one must clearly understand the business model (Question 3) and how it is performing (Question 4).  The best responses will refer to the work of Clayton Christensen who distinguishes between disruptive and sustaining technologies.

There you have it.  Five grumpy questions that provide huge insights into the quality of one’s B-school education experience.  And these questions apply to all majors at both the graduate and undergraduate levels!  Students of accounting, economics, finance, information systems, and other business concentrations all must be able to address these fundamentals in order to apply their “specialized” knowledge effectively.  If none of the above material sounds familiar, get a refund on your business degree, as it has indeed failed you!  All of these themes should have been integrated and reinforced in every one of your classes.

But there is one other possible explanation before you file that refund claim.  Maybe the blame shouldn’t be assigned exclusively to the educational institution.  I tend to agree with Michael Sloan, a Wake Forest assistant professor, who concludes that our current educational predicament “is problematic for a citizenry whose attention span is as thin as the phones in our pockets.” His comments on our society’s apparent work ethic today are particularly compelling:

We forsake the mountaintop because getting there is too hard, and after time we believe all the world is a valley.


This essay reflects the opinion of the author and not necessarily that of The American College, or Villanova University.


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It’s the last week of the calendar year, and much of the accounting world is abuzz. Corporate accountants are putting the final touches on the those revenue accrual entries that will ensure that their company’s earnings will meet analyst expectations.  Global accounting firm auditors are completing audit “hand waving” exercises to justify their client’s optimistic balance sheet valuations and earnings increases.  And accounting standard-setters continue to avoid meaningful solutions to significant reporting problems including revenue recognition, lease accounting, and goodwill valuation, just to name a few.  What do grumpy old accountants do you ask?  This one tilts at windmills… 

It’s only been three months since I expressed displeasure with recent hype about what characterizes great CFOs today (see “Ten Commandments” for Today’s CFO), and nine months since I ranted about innovative performance metrics that were anything but (see “Innovative Performance Metric or Marketing Spin?”  Well, the business press is at it again with an article in the Wall Street Journal (WSJ) CFO Journal titled “ModCloth CFO: Four Metrics That Mean More Than Money,” penned by Jeff Shotts, ModCloth’s CFO.  The “innovative” measures this time are engagement, relevant user generated content (UCG), underserved market signals, and the ratio of rules broken to rules followed.  These four non-financial measures purportedly “power a high return on investment,” but instead are quite superficial, ill-defined, and clearly qualify as MBA speak.  What’s my beef this time?  ModCloth’s CFO fails my transparency standard (Commandment No. 6) , and is close to violating my “real” performance measurement criteria (Commandment No. 7).  Also, as someone who has clearly crossed the threshold of geezerdom, I have no patience for those selling something as “new and innovative,” when it is not.  Not a good start at all at being a great CFO!  So, let’s dig in…

My biggest disappointment in this article is the CFOs suggestion that some performance metrics “can be” more important than others.  This completely ignores the basic principles outlined in the widely-used, and time tested Balanced Scorecard planning and management system.  Performance metrics are supposed to provide evaluation data on different aspects of an organization’s operations (financial, customer, process, and learning and growth).  So, if you decide to measure something, presumably this dimension is important in its own right.  

It also is interesting that the four key metrics touted are all non-financial in nature.  I am not surprised at all that financial measures are ignored by the ModCloth CFO. Since ModCloth is still a young, private company, presumably focused on growth, the financial metrics are likely not very flattering (i.e., operating losses, negative cash flows, etc.).  In fact, I bet the Company’s senior leaders and investors regularly shrug off the financial metrics as not being representative of the great things happening in the organization.  Could “adjusted EBITDA” be far behind?  

But what about measures that provide insight into how ModCloth’s business model is performing ?  Only one of the four non-financial metrics (i.e., UGC) appears to directly relate to even one of the Company’s five value chain activities.  And then there’s learning and growth?  How are ModCloth’s investments in its people and technology performing?  How are these being evaluated?  But enough on what was NOT discussed in this article. Let’s take a closer look at the customer-based measures about which ModCloth’s CFO is so passionate.

Engagement

ModCloth’s CFO defines engagement as user actions that have been proven to increase the average lifetime value of a customer and drive powerful solutions to otherwise intractable business problems. He concludes that:

The more engaged your customers are, the more value your business can create and the more flexibility your business will have to solve problems in a unique and differentiated way.

What an insight!  Customer relationships matter and longer, more engaged customers are particularly valuable…I am simply stunned that this is something that should be measured…NOT!  Don’t most retail businesses routinely recognize this through their use of loyalty programs, discounts for multiple service subscriptions, and the like?  

What troubles me most about this so called metric is how this CFO measures engagement. His threshold for achieving engagement is quite low, as simply signifying that you “like,” “love,” “share,” “review,” or “endorse” constitutes engagement.  Sorry, without an actual sales transaction, I would argue that he is really capturing technology usage, or interest…not consumer engagement. Yes, hopefully this consumer interest will ultimately lead to a purchase transaction, but ultimately it’s a sale that confirms engagement.  At best, this “interest metric” is a leading indicator.  However, this grumpy old accountant understands why this CFO measures customer engagement this way particularly in an online environment…absent actual sales, his engagement (and growth) numbers are going to look much better than the sales numbers. And this is likely going to be a big deal as ModCloth plans its inevitable IPO. Imagine if “brick and mortar” retail companies measured and reported customer traffic through their outlets as engagement…I am quite sure those numbers would dwarf retail sales.

User Generated Content (UGC)

The MBA-speak term UGC refers to nothing more than after-sale customer feedback that the Company captures and uses to improve the sale and marketing of its products. Again, after-sale customer feedback has been a key business model component for decades, so there is nothing new here.  Should I be troubled that ModCloth’s CFO thinks this is something to write home about?  Could there be other business model components that this on-line Company is missing or not addressing adequately?

 Signals from Underserved Markets

This purported metric is NOT a measure, but rather data collected from a number of “tried and true,” traditional, customer-focused performance evaluation tools.  And once again, ModCloth’s CFO serves up yet another marketing gem:

If you have direct connections with your customers and listen well, they will tell you when you have the potential for a break-through offering in the market.

Imagine…listening to your customers and observing their behavior pays off!  Who would have thought?  And what media does this CFO use to collect this consumer data…nothing that we haven’t been using for decades: surveys and interviews.  And of course, being an online retailer, there’s also the data gleaned from the aforementioned customer product reviews (i.e., engagement), and Facebook posts.  Particularly surprising is that this CFO admits to learning the value of customer feedback from his eBay experiences, rather than his MBA program…hmmmnn.

Ratio of Rules Broken to Rules Followed

ModCloth’s CFO concludes his article, not with an actual performance metric (as promised), but with encouragement to “break the rules.”  There is no discussion of which rules should be broken or which rules should be followed, which can be quite dangerous if he is “selling” his ideas to the uneducated and/or inexperienced entrepreneur.  Not surprisingly, he provides no benchmark level for this metric either.  His “ratio” is nothing more than encouragement to innovate by questioning the status quo and generating ideas on process improvement.  As with his other three non-financial metrics, this “new” advice on innovation has been in the marketplace for quite a while.  Maybe he should check out “Every Manager Can Be an Innovator” for some ideas on how to extend innovation throughout his Company’s business model.

Hopefully, you now share my grumpiness about this “fluffy” article, and are now asking how and why this CFO ever was allowed to publish this piece in what many consider to be a well respected, and reputable media outlet.  Well, you don’t have to search far for the answer…simply google “MedCloth and Deloitte,” and the answer will be clear.  You will find that MedCloth’s reporting manager came from Deloitte, as did one of the Company’s senior accountants.  Additionally, a Deloitte partner Tim de Kay acknowledges providing client services to ModCloth on his LinkedIn page.  So what,  you ask?  Well, Deloitte pays the WSJ to publish such articles. 

So, given the superficial nature of this ModCloth CFO article, this grumpy old accountant must conclude that it was nothing more than a shameful exercise in hyping a future Deloitte technology IPO client.  Doesn’t this call into question pretty much everything published in the WSJ’s CFO Journal?  Now I have to view all WSJ articles with greater skepticism (if that’s possible) to decide if they are really news, or just marketing promotions (as apparently this one was).  And, if it wasn’t bad enough that Deloitte has recently damaged the credibility of audits, now the firm is contributing to pseudo-journalism thus further hurting society.  There has to be a New Year’s resolution in here somewhere, right?


This essay reflects the opinion of the author and not necessarily that of The American College, or Villanova University.


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AuthorAnthony Catanach

For those of you that may have thought that my grumpiness may have been tempered a bit by the advent of the holiday season…Bah Humbug!  There is just so much accounting and financial reporting nonsense out there this quarter, that I have been simply overwhelmed by stuffing stockings with lumps of coal for my favorite global accounting firm (GAF) partners, and the humbug large bank clients they serve.

Let’s begin with Jonathan Weil’s recent discussion of Morgan Stanley’s “immaterial” $9.2 billion correction of an operating cash flow (OCF) classification error.  The problem?  Morgan Stanley (MS) accountants didn’t formally restate the Company’s financial reports for the error as required, instead opting for the sleazier “stealth restatement” route on the basis of immateriality.  Where were the auditors?  Well, the auditors actually appear to have discovered this error…my heart be still.  But MS has been “audited” by Deloitte (of recent PCAOB fame) since 1997 according to Audit Analytics.  Why should I be surprised that a GAF auditor actually found something, then looked the other way?  

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AuthorAnthony Catanach

Several years ago, the Grumpies were pretty hard on the agencies tasked with enforcing audit quality and ethical accounting behavior in the United States (see Paper Tigers: The U.S. Accounting Oversight Regime).  But my how times have changed…the “Paper Tiger” has become “Tony the Tiger,” and that is just grrrrreat!  What am I talking about?  Well, it has been a really bad month for the global accounting firms (GAFS).  

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AuthorAnthony Catanach

When we think about the worst U.S. accounting scandals ever, those new to the profession usually cite the Lehman collapse or Madoff scam of 2008,  or maybe even the Enron tragedy in 2001 which has become symbolic for bad accounting and auditing.  And those of us with gray (or no hair) might recall the ZZZZ Best, Crazy Eddie, or Equity Funding debacles.  However, many of us may have missed what may be the largest and longest running accounting swindle ever, one that finds accountants scamming accountants.

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AuthorAnthony Catanach

With yields on fixed income securities at or near historical lows, today’s retirees and those planning for retirement are facing major challenges.  Not surprisingly, many individual investors as well as pension funds increasingly are turning to high-yield bonds and bond funds to meet their income requirements. So what’s the problem?  An increasing number of bond funds, pension managers, and other institutional investors are loading up their portfolios with an untested and unproven product about whose long-term performance we know very little:  the event-linked security or catastrophe bond (CAT bond).

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I love Twitter!  Why you ask?  It allows me to easily discover and distribute content…that’s why!  But as Twitter continues its march to a November 15th offering date, there’s a storm brewing that just might end this love affair.  The Company’s recent filing raises a whole new series of questions about its strategy, business model, AND accounting that probably won’t get answered before its initial public offering (IPO).  There just isn’t enough time left for capital market regulators to force answers (thanks to the JOBS Act), nor is management likely motivated toward transparency given the nature of the issues. 

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Recently, we learned that Twitter had begun its initial public offering (IPO) process using the streamlined regulatory framework introduced by the 2012 Jumpstart Our Business Startups (JOBS) Act.  And as analysts and investors search for clues on Twitter’s valuation, many again are raising questions about how the JOBS Act impacts financial reporting transparency.  In questioning the Company’s recent JOBS Act filing, Holman Jenkins of the Wall Street Journal asked:

Why does a super-prominent company like Twitter need to avail itself of these arrangements?

 Great question!  As many of you know already, this grumpy old accountant has never been a fan of the JOBS Act (see “Garbage In, Garbage Out - Are Accountants Really to Blame?” and “Is Model N A Transparency Violation?”).  Any legislation that reduces the ability of market participants to make informed investing decisions, gets a “no” vote from me.  But in this case, what WILL Twitter’s financials really tell us?  Nothing that we don’t already know!   Let me explain…

We should not be surprised by Twitter’s JOBS Act filing.  There are already hints that the 2010 and 2011 numbers were not good, so why not postpone public disclosure as long as possible.  As for current numbers, not much is publicly available, but market-research firm eMarketer reported advertising revenues for the Company of $288.3 million in 2012, and expects $582.8 million in 2013 and $950 million in 2014.  All of this makes valuation a bit problematic, forcing reliance on recent private transactions which some believe may justify a $9 to $10 billion value.  From this one might incorrectly conclude that the Twitter IPO could be a “poster child” for what it is wrong with JOBS Act disclosure.  But we don’t really need current financial statements from Twitter!  We already have everything we need to form a pretty good idea what the post-IPO balance sheet, income statement, and statement of cash flows will look like.

All we have to do is apply the basics of market multiples analysis to create a set of financial statements for Twitter.  If we agree that similar companies have similar assets and capital structures, then we should be able to “back in” to Twitter’s post-IPO balance sheet.  But first we must find a set of “comparable” (comp) companies.  This comp group should share commonalities in industry, technology, customers, size, capital structure, and growth prospects, to the greatest extent possible. 

I used the Global X Social Media Index ETF as a starting point in finding my Twitter comps.  This yielded 27 companies which I narrowed down to 19, as 8 were listed on foreign exchanges which precluded easy data access.  Next, I eliminated companies that did not appear to have a business strategy or model similar to that of Twitter.  For example, I retained all companies with Standard Industrial Classification (SIC) codes 7320 (i.e., computer programming, data processing, etc.) but deleted those with SIC codes 7371 and 7372 (i.e., computer programming services and prepackaged software). Companies like Changyou.com, Zynga, and Jive Software fell out as comps.  Finally, I deleted companies whose primary revenue source was NOT advertising.  This eliminated Nutrisystem, Pandora, Groupon, United Online, Youku, Google, Netease Inc., Yandex, Angie’s List, LinkedIn, Demand Media, and Renren.  This yielded a final comp group consisting of Facebook, Sina Corp, Yelp Inc., and Meetme Inc. 

After selecting comps, I used fiscal year-end 2012 balance sheet data from Wharton Research Data Services to create common-sized balance sheets for each company.  Then, I averaged each balance sheet line item for each asset category.  With this data I then forecasted a post-IPO balance sheet for Twitter.  This yielded a balance sheet comprised of the following major asset categories (and percentage amounts): cash and short term investments (41.84 percent), other current assets (11.83 percent), Net PPE (8.36 percent), and goodwill and other intangibles (28.36 percent). Given the relative recency of these comp company IPOs, Twitter’s hypothetical capital structure is dominated by a stockholders’ equity of 81.16 percent, with current and long-term liabilities totaling only 10.93 percent and 7.92 percent, respectively.

Next, I estimated Twitter’s total assets relying on recent annual revenue amounts reported in the popular press ($600 million), and the average revenue to assets percentage (46.84%) of my four company comp group. This generated a total Twitter post-IPO asset base of almost $1.3 billion. Finally, to get amounts for each balance sheet line item, I simply multiplied the $1.3 billion in total assets by the above balance sheet category percentages for my comp group.  And voila, a post-IPO balance sheet for Twitter!

 Now, does the balance sheet make sense?  Sure and here’s why.  The significant cash balances reflect the recapitalization proceeds from the IPO.  The large amounts of goodwill and other intangibles are the result of numerous company acquisitions made during the past two years according to Victor Luckerson: Vine (October 2012), We Are Hunted (Fall 2012), Bluefin Labs (February 2013), Ubalo (May 2013), Marakana and Trendrr (August 2013), and MoPub (September 2013).  There is no surprise here and some of you may recall the grumpies ranting about intangibles and cost capitalization issues last year in “The Beauty of Internet Company Accounting.”  In that same post, we also explored valuation concerns about deferred tax assets.  As noted above, Twitter’s balance sheet undoubtedly will include these intangibles as well, probably a function of the sizeable tax net operating losses that the Company is now compiling.  

And what about the income statement you ask?  Well, since advertising seems to be the major revenue source in this version of the Company’s business model, it is unlikely that we will see any of the unusual sales treatments found in the recent IPO’s for Groupon (i.e., gross vs. net), Linked In (i.e., multiple deliverables), or Zynga (i.e., virtual goods).  

There is generally nothing very complicated or interesting about advertising revenue recognition.  However, three of the four comps (Facebook being the exception) reported operating losses after depreciation and amortization for fiscal year 2012 which is understandable given the start-up nature of these ventures. Twitter no doubt will report operating losses as well, and can be expected to make liberal use of non-GAAP metrics to “explain away” poor performance as not reflective of “reality.”  It will be interesting to see what expenses the Company deems “special” or “non-operating” in nature: depreciation, amortization, stock-based compensation, acquisition costs?  All of the above?

Then, there are the operating cash flows (OCF).  The same three comps (Sina, Yelp, and Meetme) reported either negative or transitory OCFs for 2012, clearly reflective of their stage in their company life cycle.  We should expect more of the same from Twitter.  For those of you that think I am being overly harsh toward social media IPOs, remember that Facebook earned an “A” in financial reporting from the grumpies.

So, see…we really don’t need those financial statements after all, do we?  But in “Please Twitter, Just Stay Weird,” Fahad Manjoo raises a number of strategic concerns which this grumpy Twitter user wants answered, and soon! For example, once a public company, Twitter will be forced to run more ads.  We already see this coming as the Company “Strikes Deal with the NFL” and “Pitches Itself to TV Networks.”  How will monetization ultimately affect the user experience?  And then there is the continuing social media company dilemma…who is the customer?  The media user who pays little or nothing, or the advertiser who is so key in revenue creation?

Taking care of the advertiser might actually chase off users.  As the Wall Street Journal’s Yoree Koh and Keach Hagey indicate:

Getting companies to pay for Twitter publicity is a crucial distinction for the seven-year-old company as it tries to convert its online influence into a business model—especially when rival Facebook Inc. also wants to become a hub for real-time conversations.

 

If Twitter simply “devolves” into another Facebook News Feed, one could argue that the Company may be sacrificing the very identity that made it special in the first place.  

And the concerns/questions don’t stop there.  Why all the sudden pre-IPO buzz on NFL contracts, new ad products, and new acquisitions?  How do all these tie into the Company’s strategy, or do they? Why the sudden pre-IPO need for working capital?  Is there some sense of urgency to look like a real company?  Or could this just be another Grouponesque scenario designed to enrich a select few by bringing to market a neat idea and platform with no real proven way to make money with it.  Few would disagree that Groupon’s initial premise was exciting…using technology to bring merchants and customers together. However, initially the company had no real strategy, model, or sense of market competition, all of which has contributed to its recent operating struggles.  And it doesn’t help that Twitter turned to a former Zynga player to lead it to market, or that it just now is looking for a financial reporting manager. Just some of the concerns running through this Twitter loving grumpy old accountant’s head.

I vehemently disagree with Wharton Professor Lawrence G. Hrebiniak who indicated that:

[Twitter] must release its data at least 21 days before marketing the IPO, which, in today’s highspeed cyber world, is more than sufficient for investors and others to examine and evaluate the company.

Twenty-one days may be enough to push some numbers around in a spreadsheet, but it is clearly inadequate to promote a meaningful dialogue with management to address the unanswered questions about strategy and business model and leadership.  Yet, people are still going to buy into the Twitter IPO, just like they did for Groupon and Zynga.  Hopefully, the outcome will be more positive.  If not, Twitter’s 140 character limit should be sufficient for the eulogy…


This essay reflects the opinion of the author and not necessarily that of The American College, or Villanova University.


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AuthorAnthony Catanach
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I’m really getting tired of hearing about the changing role of today’s Chief Financial Officer (CFO), particularly all of the consulting hype about the “need to be strategic.” Good CFO's have always been strategic!  This recent barrage about the advent of the strategic CFO is simply 21st century spin that masks a major human resource dilemma at today’s global companies: the wrong individual is in the CFO seat.  And then there’s the compulsive need to anoint the “Best CFO.”  Yes, we live in a rankings crazed society, but those who feel compelled to create such a list simply don’t know anything about business, much less what CFO’s do, or are supposed to do.  All of this has prompted this former CFO to share my “Ten Commandments” so that readers can judge for themselves who the top CFO’s just might be.  But first, some context is in order.

The “Pragmatic Strategist”

A recent blatant sales pitch in the CFO Journal titled “The CFO as Pragmatic Strategist: Lessons from the Lab,” really made this Grumpy Old Accountant’s blood boil.  This superficial piece resurrects an old theme, and repackages it as something new, this time as coming from the “lab.”  But as my colleague Noah Barsky and I pointed out in “What Makes a CFO ‘the Best’?”, there already exists a rich reading list going back a decade, which offers meaningful insights into the skills needed by a CFO.  And not surprisingly, one of these is a strategic mindset.  It also really bothers me that this article attempts to cloak a consulting exercise in the robes of scientific inquiry by suggesting that its rather obvious finding came from a “lab.”  So, exactly what did the “lab” yield? The big takeaway was a seven question CFO guide to value creation that targeted two main areas: does the CFO know the company’s strategy and the related risks to executing it?  Duh…

In an attempt to reign in my cynicism about this article, I did find one potentially worthwhile nugget.  Maybe the “lab” stumbled on to a serious problem in the C-suite.  Presumably the lab assistants evaluated a large sample of CFO’s.  If so, their finding that CFO’s need to “cultivate” a strategic mindset suggests that currently many CFO positions are being filled by unqualified individuals!  That just might explain the rash of disappointing IPO’s, accounting restatements, internal control weaknesses, and frauds that continue to plague global companies. Maybe we should be addressing this issue in the growing laundry list of risks disclosed in today’s security registration statements and annual reports…it might read something like this:

Our chief financial officer lacks a strategic focus (and potentially other critical skills) which may negatively affect the execution of firm strategy, as well as the management of key processes and related risks. As a result, our operating results are likely to vary significantly from period to period and be unpredictable, which may cause our stock price to decline.

Too far-fetched you say?  Just check out Model N’s prospectus risk list…I think it would fit in nicely, particularly given the company’s recent struggles in the C-suite.

The “Best CFO”

Determining who might be the “best” CFO may be an impossible task because there are just too many determinants. As with so many of today’s rankings (e.g., best company, top college, etc.), there is simply no one answer because the metrics used in these CFO “studies” are generally biased, incomplete, or otherwise flawed.  The CFO role is a function of a variety of factors including organization age, growth, scale, industry, market, etc.  Small firms often get along just fine with using their controller to fill the role of financial leader. And other companies often bridge the gap between controller and CFO using temporary help providers like CFO Edge.  But as companies continue to grow, they realize the need for a CFO to specifically oversee the link between strategy and financial success.

When discussing what makes a CFO “the best,” I feel compelled to demystify the notion of the strategic CFO.  First, we have to understand just exactly what a CFO does, vis-a-vis the controller.  A controller’s duties generally center around such traditional financial and managerial reporting tasks as preparing financial statements, budgets, cash flow projections, performance measurement reports; and creating and monitoring accounting policies, procedures, and internal controls.  And recently, in larger (or more diverse) entities that are suffering the burden of GAAP overload, some of the controller’s financial reporting duties have been spun off into the Chief Accounting Officer position.

In contrast, the CFO’s role is to specifically link strategy to financial performance.  Every company engages in three primary activities: financing, investing, and operating.  The CFO plays a major role in orchestrating all three as a company strives to execute its strategy. Of course a CFO needs to be strategic!  Without a detailed understanding of how a company intends to create value for its customers and differentiate itself in the marketplace, there is little chance that a CFO will be effective.  After all, CFO financing activities will be driven by investment decisions that are made to execute corporate strategy.  So, it is not surprising that today’s CFO’s find themselves increasingly on executive management teams, involved in planning and implementing growth strategies, IPO’s, and acquisitions.  All of these activities clearly fall under “investing responsibilities.”  And to make good investments, the CFO has to be an expert analyst skilled in both financial and tax strategy, as well as risk management. 

But the CFO’s responsibilities don’t stop there…they need a strategic focus not only for their investing and financing roles, but also so that they can monitor the efficiency and effectiveness of the company’s business model.  For example, are all of the business model processes adequately financed and sourced?  And what about process evaluation and risk management?  In short, three terms define the role of today’s CFO: strategy, process, measurement. These provide the criteria by which CFO greatness should be evaluated.

Amy Errett, an experienced venture capitalist, seems to agree in a February 2010 Inc. article:

A great CFO must be a great strategic thinker, strong manager, have a strong business sense and have excellent finance skills.

Several McKinsey consultants also seem to support my contention that “one size does not fit all” when it comes to evaluating CFOs. They suggest that because management roles can vary by organization, industry characteristics, and investor demand, there may actually be different types of CFO's.  Their review of CFO's at the top 100 global companies by market capitalization revealed four profiles for today’s CFO: the finance expert, the generalist, the performance leader, and the growth champion. The finance expert is what we normally would have expected to fill the CFO position historically, a former accountant and controller with audit experience and an advanced accounting degree. The generalist CFO is typically an MBA with significant experience in strategy and business operations and strategy, but significantly lighter in accounting expertise.  The performance leader is simply a generalist CFO who specializes in restructuring situations.  Consequently, the performance CFO’s focus are costs, and performance metrics to assess progress on re-engineering efforts central to strategy execution.  Finally, there is the growth champion CFO whose role is to effect growth strategies through dramatic changes in resource allocation (i.e., acquisitions, divestitures, etc.).  Not surprisingly, the growth champion skill set includes those of the finance expert, generalist, and performance leader, as they must be able to address strategy, process, and measurement challenges across the firm. The McKinsey consultants, Agrawal, Goldie, and Huyett, sum it up as follows:

It would be simplistic to suggest definitive rules prescribing a specific CFO profile for general categories of company.

 And Kristina Salen, the new CFO at Etsy seems to also validate my perspective.  She definitely gets it.  At the top of her advice list on making better investments is “Invest in a Strategy,” followed by “Investing in the Entire Management Team.”  Particularly telling, is her admission that quarterly numbers have little to do with strategy, and likely are poor measures of strategic success.

So, it is simply ludicrous to suggest that CFOs can be somehow classified, compared, and ranked with any degree of validity.  How then will you recognize a top CFO?  You will know them when you see them…they follow this Grumpy Old Accountant’s “Ten Commandments.”

“Ten Commandments” for CFOs

  1. Be honest.  Robin Freestone, CFO at Pearson Group and chairman of the Hundred Group of FTSE CFO’s,  sums it up nicely: "Your greatest asset is your personal credibility. That will travel with you, no matter who you’re working for. Lose it, and you render yourself valueless. The only real way to maintain that credibility is to tell it like it is."
  2.  Honor thy creditors and investors.  Hold the interests and needs of these stakeholders above all others, including your own and those of your management team.  Remember that without the financing provided by these parties, your vision and strategy cannot be achieved.
  3. Put a premium on strategy and process.  As Lewis Carroll stated, “if you don’t know where you’re going, any road will get you there.”  A strategic focus implicitly fosters innovation and promotes world class performance.
  4. Run your own company.  Don’t turn the keys over to consultants…they will never understand your strategy and processes as well as you do, no matter their purported business acumen.
  5. Embrace risk and risk management.  Risk is fundamental to business model processes.  Avoid temptations created by financial reengineering...there is never a good “quick fix.”
  6. Be transparent.  Place a premium on clear, concise, relevant information, and communication.  Avoid MBA speak and accounting jargon.
  7. Make “real” performance measurement a priority.  Recognize GAAP reporting for what it is, a flawed, politically-based, judgment-ridden, and historically focused financial assessment.  Link strategy to performance by adopting a balanced scorecard perspective.
  8. Shun the “earnings game” and avoid all who play it.  Abandon all earnings management activities including aggressive accounting and non-GAAP disclosures.  Instead of asking your independent auditors to “bless” outrageous accruals, require them to do real audits which just might benefit the company.
  9. Think long-term when evaluating performance.  Reject all short-term performance metrics and related incentives, including stock based compensation.  Recognize that it takes time to get things done. Take your pay only in salary and bonus, after you have earned it. Man up!
  10. Respect experience.  Recognize the value that work history and a proven record of accomplishment actually bring to a company. Don’t mistake academic pedigrees, certifications, and high energy for real competence.   

This essay reflects the opinion of the author and not necessarily that of The American College, or Villanova University.


Posted
AuthorAnthony Catanach