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ecompany.com
Ka-ching Around the Collar
By:Scott McMurray
Issue: March 2001
"Costless collars" can cut execs' stock risk. But are they good for shareholders?
Rick Dyer ought to be as miserable as the rest of us. The vice president for retail sales at SanDisk watched his company's stock price fall more than 85 percent from its all-time high last March, dipping into the mid-20s in early January. But the 54-year-old high-tech sales veteran is surprisingly calm when he contemplates the market mayhem. Before the Nasdaq plunged last March, Dyer converted about 20 percent of his personal SanDisk holdings at the time into a $900,000 loan.
Rick, meet Microsoft co-founder Paul Allen, CNET founder Halsey Minor, Broadcast.com co-founder Mark Cuban, and JDS Uniphase director William Sinclair. They are among the hundreds of corporate execs who have partaken of the latest bit of financial alchemy to sweep Silicon Valley. Known generically as "monetization trades," these increasingly popular -- and controversial -- strategies have seemingly magical properties: Those who engage in them can eliminate most of the downside risk of holding a big position in a single stock by converting part of their holdings into cash without selling a single share. They retain at least a portion of the upside potential if the share price soars. To top it off, taxes on any gains they may realize can be deferred.
The most popular of the new financial fixes are so-called costless collars, in which put and call options on a certain stock are bought and sold in tandem, with one paying for the other. The result is a "collar" that limits potential losses -- and potential gains -- on a stock holding. Loans can then be taken out against the value of the collared stock. A variation on this strategy -- used by Rick Dyer -- is to take out a non-recourse loan of 90 percent of the value of the stock. The borrower typically makes stiff yearly interest payments of 10 to 12 percent, and can't touch the stock during the loan term (which in Dyer's case was three years), but can walk away from the deal -- with the principal -- at the end of the term if the stock price is lower than when the loan was made.
Many financial firms -- from Morgan Stanley Dean Witter, Goldman Sachs, and Merrill Lynch to upstart Derivium Capital -- have descended on Silicon Valley in the past few years to peddle monetization gambits. They tended to be a tough sell during the Nasdaq's glory days, but the decline in tech stocks since last spring has spurred demand. "People who thought that March was a hiccup suddenly realized by the fall that they had better get serious about trying to preserve some of their wealth," says Andrea Kramer, who advises clients on these kinds of strategies as a partner with Chicago law firm McDermott, Will & Emery.
The financial rewards of monetization strategies strike some as too good to be true. And they may be. The transactions have stirred up a lot of criticism and drawn the attention of class-action lawyers. For one thing, monetization trades by corporate insiders aren't reported to the public as consistently or efficiently as insiders' outright sales of stock are. And some companies, including Adobe Systems, Nortel Networks, and Sun Microsystems, already ban or actively discourage collars and related trades, arguing that the hedging trades that brokers make when they execute options collars often depress the price of the company's shares.
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