Clark - we can agree on a few things. Like there is no obvious "right" way to account for stock options.
But you are dead wrong in saying that mine is "without a doubt" the wrong way. Maybe in your opinion. But there are a few facts that put this opinion of yours on very shaky footings. IMHO.
And so far, nobody has offered up a comparable way to value stock options in dollars and cents. Except at Zero. Which is pretty naive if you ask me.
In what way did they incur a cost equal to the difference between fair market value and exercise price?
Assuming you want to know and aren't just baiting me, I will go through your post and address each point.
Did they create a formal debt with all of the problems associated with servicing it? No! You are wrong. In fact they are legally obliged to issue new shares, in consideration for payment that will be less than the fair market value of the shares at the time the options are exercised (unless the option holders are clueless).
You might not recognize this as a debt obligation, perhaps because you think debts have to have interest payments. But you are wrong. It is a debt and it is quite formal. It's just a different kind of debt with different terms and conditions.
The problem is that we just don't know how big it is until we get there. However, at that time the amount will be exactly the difference between what these shares are worth at the time the obligation is satisfied, and the exercise price of the option instrument. Namely the difference between fair market value and exercise price.
Just because we don't know how big something is doesn't mean it doesn't exist or has size zero.
There are many ways we can estimate the size of this non-zero thing. Feel free to pick your own science, but we can at least use the "if it were paid up today then it would be..." method. And we can always use the "when it was paid in the past, this is what it was" method. Or the "if tomorrow looks like today except for the following changes then..." method.
These are the three that I use consistently depending on whether I am remarking on the past, the present or the future (respectively). Fairly cheeky of you to say that any of these are "without doubt" the wrong way.
There is another way, which is the dilution net of antidilutive contribution method. The funny thing is that when stock price is fair, they give the same answer.
Did cash flow get hit? No! Wrong again. Yes, cash flow did get hit. Or does get hit. Or will get hit. After the fact, in all three tenses. Positively. Due to the stock option tax benefit. The IRS calculates the cost to shareholders IN EXACTLY THE SAME WAY I DO and applies this tax credit to avoid double taxation.
Did they dilute the current shareholders claim on equity? Perhaps. "Perhaps" implies doubt. You should be more emphatic: yes. Actually, I did the math for the half 200 M$ worth of shares issued, 50 M$ worth of consideration received = 150 M$ worth of dilution, in a period where 180 M$ was earned. All figures approx. Net actual gain to shareholders of $30 while people are calculating PE ratios as though it was $180. How well advised is that?
If you send me $180, I'll send you $30. Deal? Open to the thread, actually. I don't discriminate in my offers to fleece anyone.
But by how much? Not by (share price)x(number of shares) as you are claiming!!! I never claimed this. I claimed that the dilution is equal to the number of shares times the DIFFERENCE between strike and market price at exercise. See above for the calculation I referenced in my post.
In fact, since the equity per share was approximately equal to exercise price, they did not perform much of any dilution. Not true. Again, see above. When the option is issued there is an ESTIMATED cost. When it is exercised, there is an ACTUAL cost. I merely tabulated actual costs looking backwards.
A stock option is not like a share purchase. In that case, the holder deposits capital with the company that the company can do something with, and the benefits flow back to all shareholders proportionately. With an option, the holder deposits nothing, but gets a "free ride" on whatever the company does with its capital between the time of grant and the time of exercise.
Both holders get the appreciation (difference in price), but one of them gets it on a contingent basis and gets to buy in later, the other one pays the opportunity cost of capital. Another difference is the risk profile. Not only does the equity investor forgo the opportunity cost (what they could have earned from their capital elsewhere), but the equity investor also has their capital at risk. If the value of the company goes down, the equity investor loses. Not so with the option holder. Their uninvested capital remains intact and carries no opportunity cost.
For these reasons, options are considered more valuable than the opportunity cost of capital on the strike price over the life of the option. Despite having an accounting value of zero.
If you doubt me, ask any good investment banker what they would charge to underwrite ten thousand call options on Qualcomm at $32, expiring April 2012.
The only dilution was that retained earnings per share went down by the dilution percentage which by your figures is less than 1% in a half year or 2% per year. Not a particularly big impact given that retained earnings grew at whopping 75% over the same timeframe.
You say "only". 2% of Qualcomm's market cap is very large compared to what they earn in a year. Even a fraction of 2% of their market cap. The outstanding dollar amount that employees currently have claim to is 2.1 B$ if the share price goes nowhere. That's 3 years worth of earnings. Easy.
It won't show up on the books anywhere. But that doesn't mean it doesn't exist.
When cash flows from Pocket A to Pocket C, just because it doesn't stop in Pocket B along the way doesn't mean it doesn't exist. In this case Pocket A is shareholders, Pocket B is the company and Pocket C is the employee. To be sure we are clear.
And it occurs to me that keeping track of money from a shareholder perspective is a lot more important than just watching what's happening inside the company. Give me something that generates 180 M$ a year and I'm happy. But if I have to pay 150 M$ a year... well I'll still be happy, but only 1/6'th as much.
Here is the transaction mechanics once an option is granted to an employee.
(a) Company prints share
(b) Employee pays company exercise price.
(c) Company gives employee share
(d) Company sells share to shareholder
(e) Shareholder gets share
Employee gets difference between market price and strike price
Company gets strike price
Shareholders pay market price, and (because they also own the company), get back Strike Price.
Clearly, shareholders paid the difference between market price and strike price.
The company did not create any other value as part of this transaction, just diluted itself by printing more shares. Thus we know that the dilution is EXACTLY equal to the difference between strike price and market price.
Bottom line - It certainly isn't great if Qualcomm continues to grow retained earnings by the amount that they have over the last 2 quarters and increasing by 10% per year all while diluting the stock base by 2% per year.
Comparing percent of x to percent of y is a very dangerous proposition. It is more meaningful if you use absolute numbers. Go check Qualcomm's accumulated earnings, lifetime to date. A grand total of 428 M$ to date.
2% of Qualcomm's shares represent 500 M$
Qualcomm's annual earnings represents about 366 M$
And there are 82 Million options out there already granted with a strike on average less than $6. Even if they don't issue another one. At $32 per share market price, that makes the value going to employees from shareholders about 2.1 B$
How long do you think it will be before Qualcomm earns for shareholders what shareholders are obliged to pay employees?
But neither is it the utter disaster that you predict. The reality is much more like your first scenario when you didn't account for stock options. But of course even this assumes that the earnings grows at some steady rate, but the bull's assumption is that earnings will jump up from their recession levels and grow from there.
I am not predicting any disaster. Merely pointing out that the company is not nearly as profitable as individuals seem to think it is. Furthermore, that there is a 2.1 B$ hidden liability just waiting to be exercised that will soak up quite a few years worth of profits going forwards. It doesn't show up on the company's books, but that doesn't mean it's zero. Shareholders are the ones who will pay this price.
As far as "earnings will jump up from their recession levels"... there is another possible perspective.
Perhaps we are not really in a recession so much as a "back to normaling" on the other side of a bubble. In which there is no real jumping up to be done 'cause we're already there.
John. |
