Wayfair
Wayfair’s Compensation Shenanigans And Massive Insider Selling by Whitney TIlson
Summary
Wayfair has persuaded investors and analysts to focus on “adjusted EBITDA” and free cash flow rather than GAAP earnings.
The company pays its top executives far below market salaries, thereby minimizing cash compensation costs.
To offset low cash comp, Wayfair gives its top executives large stock/option grants.
The company has instituted a Rule 10b5-1 automatic selling plan to convert the stock/option grants back into cash comp, resulting in massive insider selling by the top eight executives of nearly $7 million per month over the last seven months.
The effect of this scheme is to inflate reported “adjusted EBITDA” and free cash flow.
This scheme is fairly common among tech and venture/private equity-back companies – but Wayfair’s is among the blatant and has among the biggest impacts on reported financials.
Some public companies, especially money-losing ones in the tech sector, adopt some form of a compensation scheme for top executives that has the effect of maximizing both total compensation and also, counterintuitively, preferred financial metrics like “adjusted” EBITDA/earnings and free cash flow.
Here’s how it works:
- Persuade investors and analysts to focus on “adjusted” EBITDA/earnings and free cash flow rather than GAAP earnings;
- Pay top management very low cash salaries;
- Replace this lost income with large stock/option grants; and
- Institute a Rule 10b5-1 automatic selling plan to convert the stock/option grants back into cash comp
As a result of this compensation scheme, adjusted EBITDA/earnings is enhanced because it excludes “the impact of equity-based compensation and related taxes”, and free cash flow is enhanced because lower cash comp means “cash provided by operating activities” is higher.
Cash Comp and Insider Selling for Wayfair’s Top Eight Executives
While many companies have adopted some form of this scheme, Wayfair appears to be an extreme example, as cash comp for the top eight officers is laughably low (a mere $1.8 million annually combined) and they’re dumping their stock like mad: $48 million of stock sales since April 1st – an average of nearly $7 million per month – a jaw-dropping run for the exits, as this table shows:
But wait – it gets worse! Even among these ultra-low salaries, the $80,000 for each of Wayfair’s co-founders, Shah and Conine, are noteworthy – but they weren’t always so low, as each “elected to reduce their base salaries to $80,000 for 2014 from $480,000 in 2013…because our goal was to weigh compensation towards providing equity awards to ensure that a significant portion of an NEOs’ [named executive officers’] compensation opportunity is related to factors that directly and indirectly influence stockholder value.”
The impact of them cutting their salaries by $400,000 each was to increase Wayfair’s “adjusted EBITDA” and free cash flow by more than $800,000 in 2014 (there’s also a tax benefit to the company).
But don’t shed any tears for Shah and Conine: in addition to each owning Wayfair stock worth approximately $600 million, in October 2013, at roughly the same time that they agreed to cut their salaries by $400,000, the board awarded each of them large stock awards (restricted stock units) valued at $3.1 million. Now that’s a “sacrifice” I’d make all day long!
The Impact of Wayfair’s Compensation Scheme on Its Financials
So let’s take a look at how all this stock-based compensation improves Wayfair’s non-GAAP, self-reported financials. First, here’s Wayfair’s GAAP net income for each quarter since Q1 ’13:
Now, here’s net income as well as Wayfair’s non-GAAP, self-reported “adjusted EBITDA”:
Over these nine quarters, net income was -$217.2 million vs. adjusted EBITDA of -$81.1 million, a massive $135.1 million higher – and, nearly two-thirds (64%) of this improvement was due to excluding “equity-based compensation and related taxes.”
Equity-Based Compensation as a Percentage of Free Cash Flow
One way to measure how much equity-based comp is being doled out by a company is to compare it to the free cash flow a company generates. Here’s a chart showing each of these amounts by quarter for Wayfair:
As one can see, in the nine quarters since Q3 ’13, Wayfair has generated $17.2 million of free cash flow – and doled out stock and options worth $86.5 million. Over the past four quarters, the figures are $62.3 million of free cash flow and $81.0 million of stock-based compensation.
This chart shows how Wayfair compares to three other companies over the past year (Wayfair’s percentage would be much higher if the comparison were the entire nine quarters or Q1-Q3 ’15):
Stock-Based Compensation as a Percentage of Free Cash Flow
As one can see, Wayfair is much worse than even salesforce.com, which is notorious for doling out excessive stock-based compensation.
The Best Time to Short Wayfair
Wayfair is a very crowded short right now, with 42% of the float short, which means there’s a risk of a short squeeze, so size it appropriately. In addition, even if you can get the borrow (I’ve heard it’s tough), it’s expensive: I’m currently paying a negative rebate of -17.2% annually. This isn’t surprising given that the stock only went public a year ago and only 37% of the 84 million shares outstanding are part of the float currently.
However, the risk of a short squeeze will diminish and the borrow may become less expensive and more readily available over time if insiders and private equity firms continue to sell. In particular, keep an eye out for Wayfair to announce a secondary offering, which I would expect in the next few months if the stock remains elevated.
This would significantly increase the float and put a lot of stock into weak hands – as one friend described to me: “some chumps whose investment banking salesperson told them, ‘You gotta take this down.'” This point, right after the secondary, might be the very best time to short the stock.
Conclusion
Wayfair is by no means the only company to utilize stock-based compensation, report non-GAAP earnings, and have massive insider selling, but it certainly appears to be an extreme example.
Prudent investors might want to ask themselves: if insiders are in such a rush to sell this stock, why would I want to buy it?
Disclosure: I am/we are short WAYFAIR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
