For Compaq's Capellas, Rewards Have Little Risk: Graef Crystal
By Graef Crystal
Las Vegas, March 23 (Bloomberg) -- Michael Capellas's pay package for being chief executive of Compaq Computer Corp. is a sign of just how far the high-tech industry has traveled toward old-line America.
The terms also show that Capellas has little faith in his ability to get his company's stock price back up to its record close of $49.25 a share, reached on Jan. 26, 1999.
In the days of yesteryear, the norm was for a high-tech CEO to accept an ultra-low base salary. Not Capellas. His salary under a three-year employment contract is $1.6 million a year -- a level so high that $600,000 of it isn't even deductible on Compaq's U.S. income-tax return under federal law.
The previous norm also was for the CEO to take only a small cash bonus, so as to conserve funds for investment. Not Capellas. His cash bonus for merely ``normal'' performance, however Compaq's board defines that term, is set at twice his base salary.
In recognition of the low base salary and cash bonus, the high-tech CEO tended to receive an ultra-large stock option grant. Not Capellas. When he signed the contract last October, there was no new grant anywhere in sight. Instead, there was a staggering grant of 970,000 free shares, valued then at $24.4 million.
Few Strings
In the opening paragraph of a letter to Capellas confirming his new employment arrangements, Compaq expressed gratitude on the part of the board for his ``outstanding contributions'' as CEO.
Hah! Between Capellas's first day on the job and the day Compaq's board awarded the free shares, he engineered a negative 2.6 percent total return. During that period, lasting from July 22, 1999, to Oct. 13, 2000, the return on the Standard & Poor's 500 Index was 1.1 percent.
You can't argue Capellas was a dog of a performer when the difference is that small. But does it mean he made ``outstanding contributions''? Gimme a break.
Now some of the free stock comes with strings attached. To earn 50,000 shares, he has to ratchet up Compaq's stock price to $35 or more by Nov. 1, 2004. To earn another 200,000 shares, he has to produce a price of $50 or more. This provision suggests he has great confidence in his ability to deliver for shareholders.
But hold on a minute. He stands to receive 250,000 shares by delivering just slightly higher-than-average growth in earnings per share when compared with International Business Machines Corp., Dell Computer Corp., and Hewlett-Packard Co.
For the remaining 470,000 shares, the only string attached was that Capellas stay on the job. His ``stick-around'' period for 170,000 of these shares was a mere 30 days.
Little Faith
Capellas presumably could have turned his back on the offer of free shares and instead have chosen to take an option with the same present value, $24.4 million.
According to my calculations, he would have received an option on 2.12 million shares in lieu of the free shares. This total assumes the option's strike price would be $25.20 a share, where Compaq closed last Oct. 13. The stock closed at $19.40 a share yesterday.
If we posit a world without taxes and look ahead 4.05 years, the maximum time limit for any restrictions on resale of his free shares, the option would be more valuable as long as the stock's price rose more than 11.8 percent a year on average.
That calculation assumes he would have to forfeit 200,000 of his 250,000 price-triggered free shares, as the growth rate would produce a price just under $40 per share and not the $50 required to earn all of them.
The 11.8 percent figure would change under another set of assumptions. But no matter how you figure, you can't tease out of the mathematical model a stock-price growth rate that shareholders would be proud of. Conclusion: Capellas has little faith in his own abilities to return Compaq to its glory days.
Forgiven Debt
Capellas' employment agreement contained other provisions that reinforce the conclusion. When he signed, for instance, the board gave him a ``special one-time bonus'' of $850,000. And this notwithstanding the fact that just four months earlier, the same board gave him another ``special one-time bonus'' of $300,000.
These descriptions come from a single sentence in a footnote included in Compaq's proxy statement. Granting two ``special one- time bonuses'' in a single year sort of undercuts the notion that the bonuses are either special or one-time, doesn't it?
As if that wasn't enough, Compaq's board answered a request that could be included in many CEOs' nightly prayers: ``Forgive us our debts.''
The board decided to forgive, over three years, a $5 million loan which Capellas took out to buy Compaq shares. Then, because the forgiveness will trigger an income-tax liability and because the first 170,000 free shares vested 30 days after being granted, the board turned right around and loaned him another $2.5 million to pay the resulting taxes.
Explaining to Do
In the proxy, the board piously noted that this second loan would be of the full-recourse variety and would require Capellas to pay a market interest rate. But with a few more ``forgive us our debts'' prayers, maybe he can pull off some further relief.
The willingness to forgive the loan is one more piece of evidence of how far companies such as Compaq have moved away from the low-cash, large stock options and low charges-to-earnings diet of yesteryear.
That shift is one of the reasons why the high-tech stock market is in such trouble these days. Now earnings are being hit heavily by the likes of $1.6 million salaries, even larger cash bonuses and $24 million free share grants.
For high-tech CEOs, the problem is to explain to their shareholders how they are worth as much as ever even though they take hardly any risks. It will be interesting to see what Capellas has to say on that subject when his shareholders hold their annual meeting in Houston on April 26.
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