John, Huey, Mindmeld, et al.,
While I have believed Cisco to be wildly overvalued for six years, thus missing both the ecstacy and the agony, I must stress that cash flow valuation MUST assess the value of current assets and future cash flows to a holder of a single share of stock in today's values. Yes, option grants dilute the current shareholder by adding a further claim on assets and cash flow and no, current accounting principles do NOT adequately provision for this effect on value. However, this does not mean that present period free cash flows should be decreased by a non-cash share issuance.
In response to John's example of the amazing disappearing cash flows - there is a little non-purposeful misdirection going on here. When assets are paid for with shares rather than cash, the book value is transferred and the goodwill set by the per share price of the stock at the time of the transaction. To use these values to determine wealth creation years later, by subracting them from actual cash flow ignores the change in the value of the additional shares over time and the possibility that the book value of the assets may no longer be a fair representation fo the market value of the assets. Moreover, unless you're planning to liquidate the company, even the market value may be specious.
Between 1996 and 2002, Cisco's cash and investments increased from $2B to over $20B (almost 2/3s from the paid in capital and tax shield of the option program, no other significant financing in flows). Total shares increased from split adjusted 5.7B at the start of 1996 to 7.5B at the end of 2002. To be fair, there are another few hundred million options that are unvested, so lets up the share count to 8B. So options and acquisitions account for between 2 and 2.5B shares, or 40% dilution. So the cost of the share increases to date is 40% of the $18B increase in cash, or $7.3B (plus 40% of claims to future cash flows, but we're just counting weath creation here). Nonetheless, the wealth creation to the existing shareholders during the period was more than $10B not $627m.
If the wealth creation on a cash basis had only been $627m, with prospects for more of the same, Cisco wouldn't deserve to trade for a dollar a share. Now, think Cisco is almost double its true value, but I do think it's worth more than a dollar. |
