Zeev,
I received this from ChangeWave recently. Have you heard of this bill? I think the mood in congress is "off with their heads" right now. If it gains support, might it change the turnips forcast for the year? (sorry if the formatting is difficult)
Carol
Last Wednesday (2/13), one of the most potentially powerful and
destructive ChangeQuakes lofted a warning shot across the bow of
tech stocks. When Senators McCain and Levin, among others,
introduced a bill to force companies to either recognize the cost
of stock options on the income statement or to give up
option-related tax deductions, you could hear tech company CEOs
gulping throughout the land.
That this bill, which was excoriated eight years ago, now has
political capital is perhaps the best indicator (other than Wall
Street firms reversing casual dress) that the pendulum-like wave of
accounting conservatism and sobriety is beginning to build into a
potentially LETHAL ChangeWave.
How can this bill, which has the potential to exact a 20%-30%
haircut in equity valuation on companies with large option exposure,
have legs? Especially during a recession?
It's the backlash of Enron, Global Crossing and the terrible
smugness of many technology companies during the boom, baby. And
payback is a you-know-what. I have news for you, there is NO
political capital in voting against this bill--10% of the citizens
own 90% of stocks in America. Democrats are lining up to support the
bill and for the Republicans to get the Senate back and keep the
House, it will take very nimble moves that the GOP has not shown in
years.
My worry is this changing of the rules could have the same effect on
tech that the 1986 Tax Act had on the commercial real estate
business. To refresh your memory, when the Tax Act of 1986 removed
most of the tax savings from owning commercial real estate, it
caused a 20%-25% reduction in the value of trillions of dollars in
commercial real estate with the stroke of a pen. Stripped of that
economic value, commercial real estate values plummeted--which was
the REAL reason the savings and loan crisis soon followed. (Forget
the Milken Junk Bond story--it was a minor player.)
How big an impact could this have on tech? Take Microsoft, for
example. Counting options as an expense for its fiscal year ended
June 2001 would have trimmed its reported earnings from $7.3
billion, or $1.32 a share, to $5.1 billion, or 91 cents a share,
according to Bill Alpert in Barron's.
Sans options expense, Applied Materials would have only earned $291
million in 2001--which brings it to a 163 P/E on a trailing basis.
Get the picture? Well, it gets worse.
When you combine the specter of options accounting reform with the
swing to the market looking for GAAP accounting vs. pro-forma
accounting (as in "everything but the bad stuff"), the picture gets
worse. According to a new study by John May at
SmartStockInvestor.com, if you go back and revisit the profits of
the five largest Nasdaq 100 companies (Intel, Cisco, Oracle, Dell
and Microsoft) for the first three quarters of 2001, they reported
$13.4 billion of pro-forma earnings to stockholders. To the SEC,
they reported just $4.4 billion of GAAP profits. This means more
than two-thirds of the headline pro forma profits resulted from net
POSITIVE adjustments made to GAAP earnings.
And GAAP accounting ALLOWS for not expensing stock option costs! If
combined, the impact on tech earnings power of a reversion to strict
GAAP for figuring P/E--and added back option expense costs--means
Cisco's P/E GOING FORWARD 12 months is at 340! And The Nasdaq 100
forward P/E is incalculable.
Any wonder why I'm a little verklempt about the new market risks
that are weighing on the valuation of legacy tech stocks?
Granted, the bills are not law. But opposed to the climate in 1994
when this bill was last shot down, the world is a vastly different
place. Already the Institutional Investor Association is behind the
bill--they fought big against it last time. The International
Accounting Standards Board is now considering the bill, where they
fought it before.
Until these two enormous issues are killed off or neutralized, I
can't come up with a good reason why ANYONE would want to own
big-cap tech stocks.
Just when the market needed a break, we get the real potential for a
rule change that would launch a HUGE revision of tech company
valuations. (Not to mention add 10%-20% higher employee compensation
costs to the highest-paid workers in the world.) |
