Israeli article on Dell's disappearing trick ('earnings')
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"Dell's disappearing trick
Doron Tsur 19.5.2002 | 11:24
It shouldn't happen. Not in a country with such a sophisticated financial system, which has reporting regulations copied by the whole world, which sports a first-rank securities watchdog and which has investment houses and funds that pour millions into analyses. No, there shouldn't be a crisis of faith in its publicly-traded companies and their managers. But there is.
Companies are supposed to be transparent, with their problems clearly described in reports and analyses, with a resulting effect on their share price.
Yet the system keeps failing, from the watchdog supposed to protect shareholders' interests, to the financial press. Failing to recognize a company about to fail, that is, and sounding the alarm.
Consequently, the public learns of problems only when they become so huge that they can't be hidden any more.
Obviously, neither the watchdogs nor the press can detect every single problem as it arises. Moreover, skullduggery will always exist, and will often only be uncovered when it's too late.
Incidentally, expectations of American investment houses and analysts shouldn't be too high. Cold-eyed objective scrutiny isn't their top priority, to put it mildly. So let's leave them out of this equation for now.
Cases such as Enron epitomize the problem. Though actually, in Enron's specific case, the degree of anger is unjustified. It is hard to spot cases of companies deliberately falsifying their results by ignoring certain debts and expenses in their financial statements. Non-insiders couldn't have known.
The problem I present today is the way American companies screw ¿ I have no better word ¿ their shareholders out of billions while adhering strictly to the law and proper disclosure.
It is a remarkable talent. Just like carny magicians, companies manage to whip the dollars out of their shareholders' pockets without their noticing a thing.
Did Dell net 18¢ per share, or lose 2¢?
Take Dell Computer Corporation (Nasdaq:DELL). Last week it announced a net profit of $457 million, or 18¢ per share, beating expectations by one cent. Though, it should be said, investors should know better by now than to evaluate a company solely by its profit per share.
I claim and shall demonstrate that Dell actually lost 2 cents per share.
Moreover, I claim that Dell, which claimed to have netted $1.4 billion over 12 months, actually lost $850 million. In other words: there is a $2.2 billion gap between what Dell claims it netted and what I claim it did net.
How could that be? Simple. Don't look at what the company reported as profit per share. Look at the development of its equity per share.
When a company is profitable, its equity grows. Distributing dividends and repurchasing shares reduces its equity per share, but shareholders are compensated.
In the case of dividends, they are compensated by cash. When a company buys back its stock, the number of floating shares drops, so their portion of future profits increases. Whoever kept his shares winds up with a bigger chunk of the company, and a proportionately bigger share in profits.
But Dell, and many other companies, exploit shareholder ignorance. They found a great trick. On the one hand, equity per share dropped precisely as though a dividend had been distributed, or shares bought back, while on the other hand ¿ shareholders received no compensation in cash or in the form of a bigger chunk of profits.
Take the figures of the last quarter. At its start, Dell's equity stood at $4,694 million divided into 2,599 million shares. Read: equity per share of $1.8.
For the quarter, Dell claims to have netted $457 million. Its share capital dropped to 2,595 million shares, meaning it bought back 4 million shares.
Take the equity at the beginning of the quarter - $4,694 million, and add the reported profit of $457 million. Now deduct the 4 million shares buyback at about $25 per share, costing the company say $100 million.
We deduce that Dell's equity at the end of the quarter should be around $5,051 million, or $1.94 per share. Note: No dividend was handed out.
Dell started with $1.8 equity per share, netted 18 cents per share and spent 4¢ per share in repurchasing stock ($100 million divided by 2,595 million shares is about 4¢ per share).
But: the equity at quarter-end was only $4.521 million, or $1.74 per share.
Here lies the explanation behind the 2-cent per share loss. We began with $1.8 equity per share, bought stock for 4 cents per share, leaving $1.76 equity per share before the reported profit. In practice, we ended with $1.74 equity per share. Meaning, we did not gain 18¢ per share, we lost 2¢.
Physics can't be flouted
In terms of the entire year, the picture is even blacker. A year ago the company had 2,600 million shares and equity of $5,505 million. During the year, the number of shares dropped by only 2%, to 2,595 million. But its equity dropped dramatically, by $984 million, or 17%. And no, it did not distribute dividends.
Here too, the math for the year is clear. We began with equity of $5,505 million. We add profit of $1.421 million and deduct an estimated repurchase of 5 million shares net, for around $135 million.
Dell's equity should therefore be around $6,791 million. It isn't, it's $4,521 million. Wonder of wonders! $2.2 billion seems to have vanished, and nobody saw it go. Magic!
The truth is a tad more complicated. Sums like that don't evaporate so easily.
In net terms, Dell repurchased only 5 million shares. Wait - that is the bottom line of buybacks that involved tens of millions of shares, and sales of tens of millions of shares, at slightly different prices.
Its repurchase price was high: Dell paid over $20 per share, but sold them cheaply, at only $1 to $4 per share ¿ through exercise of stock options by its high-ranking employees, directors, and Michael Dell himself.
So, dear reader, don't fash yourself. The law of conservation of matter still exists. The $2.2 billion didn't vanish into thin air. They are padding the pockets of the Dell people who exercised options at low prices and sold the stock to the company on the market for top dollar.
What is less clear, is how the authorities haven't forced Dell to spell out this little trick in its profit and loss statement, so shareholders who don't understand accounting can understand that the company didn't really make any profit this year. It isn't clear why the financial press, aside from a few underground websites, didn't pounce. And it isn't clear why Dell's investors aren't manning the barricades. " |
