Why I posted the options on this board.
related article we should probably be addressing w/ each tech company we own.
Speaking of Value
Timothy Vick -- analyst/editor,
Today's Value Investor
Options Impact Hits Technology Companies
The combination of a strong stock market and a historically tight labor pool is starting to have a quiet effect on the
earnings prospects of companies. Through the granting of options to senior managers, companies are putting
increased pressure on themselves to meet earnings targets.
The situation appears to be getting worse for investors, not better. Watson Wyatt Worldwide estimates that 19 percent
of employees at public companies are eligible to receive stock options today.
That's up significantly from 12 percent of employees in 1998.
Another study showed that if S&P 500 companies had treated their options
grants as real costs, their 1998 earnings would have been, on average, 4
percent lower than reported. In 1997, earnings would have been 3 percent
lower than reported.
The problems become acute when companies try to offset the potential
dilution by repurchasing shares, as Microsoft and other technology companies regularly do. As of the end of fiscal
year 1999, Microsoft reported having 766 million options outstanding. These options can be exercised at an average
price of $17.28, so one can assume that most, if not, all these options will eventually convert to shares. At present
prices, Microsoft would have to spend $52 billion to buy back enough stock over the next few years to maintain its
present share count. Intel would have to spend about $37 billion to neutralize the bottom-line impact of options.
The theory behind issuing options is to tie compensation to performance while circumventing the need to raise
salaries. Research has shown a link between employee ownership of stock and company performance. It is not always
clear, however, whether companies perform well because they issue employees stock, or whether companies issue
stock and options to employees because the enterprise performs well.
Anymore, options are the main carrot for hiring and retaining senior management. Money-losing Internet ventures
rely heavily on options to lure senior managers used to six- and seven-figure salaries. And since corporations lose
some tax deductions for salaries in excess of $1 million, they are opting to increase noncash compensation.
Investors need to be concerned about the hidden cost to shareholders of options. Dilution will be a potential problem
for several recommended companies, particularly those in the technology sector, where options packages have been
most generous and prevalent.
For most investors, options packages will not have a large impact on the bottom line going forward. Outstanding
options constitute less than 5 percent of shares outstanding for most companies. Still, the problem is growing as
companies continue to dole out options by the millions and stocks keep rising in value. Eventually, companies are
on the limb to issue millions of new shares that, in many cases, will offset completely their share buyback plans.
High-flying telecommunications components maker Vari-L
(NASDAQ: VARL) stunned analysts in the December quarter
when it posted earnings lower than expected due to the
conversion of options and warrants. Analysts were expecting
$0.17 per share; Vari-L posted $0.14. In the March quarter, a
42 percent increase in shares outstanding caused flat
earnings and completely offset the effects of a
better-than-expected 48 percent sales increase. The extra
shares, which were converted during the December-quarter
rally, will make it tough for Vari-L to post much earnings
growth the next two quarters.
Companies with few options outstanding promise negligible
dilution for shareholders. That's important because it means
management can spend cash on more worthwhile projects,
such as expansion or debt retirement, rather than on buying
back stock just to offset options conversions. Harley-Davidson
(NYSE: HDI) has not been particularly generous with options
throughout its history. Partly as a result, the company has met
or exceeded analysts' estimates five consecutive quarters.
Outstanding options constituted 3.8 percent of current shares
outstanding, which puts much less pressure on the company
to meet future estimates.
Investors should not make options the overriding factor in buying or selling. But, as shown in the table, the size and
shape of the packages offered management should be a contributing factor. When management is overly generous
with options it, it may be forced to repurchase stock in the future just to keep per-share earnings growing at
acceptable levels. Among the factors to weigh:
1. Growth estimates of analysts - It is customary for analysts to base future estimates on the number of shares currently
outstanding without regard to whether shares will be repurchased or issued. Electronic commerce concern Remedy
(NASDAQ: RMDY) to has 8.1 millon options outstanding, 26 percent of its current float. Assuming all these shares are
converted, the company would need to post net income growth of 36 percent the next five years to meet analysts'
earnings targets. Micros Systems (NASDAQ: MCRS), the maker of point-of-sale systems for hotels, had outstanding
options equal to 21 percent of outstanding stock at years' end. Unless it repurchases shares, it would need to post
earnings growth of 30.3 percent the next five years to meet analysts' current targets.
2. Size of grants - Generally, if the number of outstanding options constitutes just a small percentage of shares
outstanding, the effect on investors will be slight. If options constitute, say, 8 percent of shares outstanding or more,
dilution is a potential concern.
3. Exercise price - The extent to which dilution will occur depends on the exercise price of options. By comparing
the option's exercise price (found in annual reports) to the stock's current price, an investor can roughly gauge how
many shares are "in the money" and could be converted. At the end of fiscal year 1999, Oracle's (NASDAQ: ORCL)
options exercised at an average price of $6.90 (split adjusted), less than one-tenth the current stock price. Barring a
collapse of Oracle's stock, nearly all 240.1 million options will likely be exercised and thrown onto the income
statement. |
