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Why is Twitter spending so much on R&D?

October 25, 2013: 5:00 AM ET

The king of limited media has an unlimited budget for research.

131018151458-twitter-stock-ipo-620xaFORTUNE -- One of the long-time knocks on Twitter is that it doesn't do a very good job of innovating. Users came up with hashtags. TweetDeck was created by another company that Twitter had to buy. Twitter is reportedly considering shutting down a music site that it launched earlier this year. Go to Twitter.com and you will basically see the same thing you did five years ago. FastCompany booted Twitter from its list of most innovative companies this year.

This is apparently not for lack of trying. Twitter, which priced its IPO Thursday at $17-$20 per share, giving it a valuation of $10 billion, spends a lot on research and development. According to its IPO document, in the third quarter of the year, Twitter shelled out nearly $90 million on R&D. That was equal to more than half, 52%, of the company's revenue in the same period. It is Twitter's largest cost, nearly 50% more than it spent on marketing. And it's far more than most of its rivals spend. Facebook, for instance, spent just 14% of its revenue on R&D in the the quarter right before it went public. It has since ramped up that spending to 26%. But Facebook (FB) makes money, unlike Twitter.

MORE: Twitter is not ready for Wall Street

Google (GOOG) spends just 15% of revenue on R&D. And Google is working on a self-driving car, high-tech glasses and, maybe, space elevators.

There is no sign that Twitter is working on anything that cool. Twitter actually gives very little detail about what it spends its R&D budget on in the offering documents for its IPO. It says that R&D expenses are to "improve our products and services." And it doesn't appear that Twitter is building some kind of high-tech lab or supercomputer. In fact, the bulk of Twitter's R&D expenses go toward personnel-related expenses. And a good portion of that expense, about a quarter, was the cost of handing out stock options.

Twitter doesn't say how many employees work in its R&D groups. The company has a total of 2,300 employees. That would be $104,000 per employee if all of its employees were in R&D, which they are not.

In all, Twitter says on its income statement it has spent close to a quarter of a billion dollars on R&D in the past year. Since the beginning of 2010, Twitter has logged a $428 million expense for R&D. But that isn't actually all the money the company has spent on R&D. In reality, it has spent more than that.

Twitter, like other technology companies, capitalizes some of its software and other development costs. That means that while Twitter pays for those R&D expenses upfront, that cost doesn't actually show up on its income statement. Instead, Twitter expenses the cost in chunks over the next few years. The rules allow that as long as you think the R&D expense will add to your sales over the next few years. In addition to its regular R&D expenses, Twitter spent another $87 million on capitalized software and other development costs since the beginning of 2011.

MORE: Twitter's shady accounting

Some analysts who have looked at Twitter's IPO filing have said its finances may be better than they appear. Take away the R&D expense and Twitter would be profitable. But considering the R&D expense likely makes up such a large part of what the company spends on employees, it's unlikely to go away any time soon, unless Twitter expects to start downsizing. In fact, in the IPO documents, Twitter says that it expects R&D expenses "will increase in dollar amounts for the foreseeable future."

"I can only assume a lot of it is on making the site seamless, delivering to mobile, and building out servers that can accommodate video. That's a lot of buildout," says Michael Pachter, an analyst who follows social media companies at brokerage firm Wedbush Securities. "I don't know what they're doing to innovate, but I think it is early to criticize them for lack of creativity."

Overspending, perhaps?

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About This Author
Stephen Gandel
Stephen Gandel

Stephen Gandel has covered Wall Street and investing for over 15 years. He joins Fortune from sister publication TIME, where he was a senior business writer and lead blogger for The Curious Capitalist. He has also held positions at Money and Crain's New York Business. Stephen is a four-time winner of the Henry R. Luce Award. His work has also been recognized by the National Association of Real Estate Editors, the New York State Society of CPA and the Association of Area Business Publications. He is a graduate of Washington University, and lives in Brooklyn with his wife and two children.

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