Cisco's options proposal endorsed
Qualcomm calls it 'a great idea'
By Bruce V. Bigelow
UNION-TRIBUNE STAFF WRITER
May 17, 2005
Qualcomm yesterday endorsed a concept that Cisco Systems has proposed for creating a market in employee stock options, saying it offers a more realistic method for determining the real cost to shareholders.
"It's a great idea that has the potential to bring some integrity to the valuation process," said William Keitel, Qualcomm's chief financial officer.
Last week, Cisco Systems asked for regulatory approval for a new type of financial instrument, a derivative security based on employee stock options.
The value of the security would be set by the market in which the security trades. Under Cisco's proposal, the company would base the value of its stock options on a market value, rather than using calculations required under the Financial Accounting Standards Board, or FASB.
"I like it because I'm concerned that the valuation methodologies that have been put forth by FASB are very theoretical," Keitel said. "The range of values that you can come up with while trying to apply that theory is very broad."
Dell, the Texas computer maker, and biotech giant Genentech also said they are watching the Cisco proposal.
Dell's chief financial officer, James Schneider, last week called it "an interesting idea." SEC Chairman William Donaldson also said last week that Cisco's request has "a lot of potential."
Many high-technology companies provide options to their employees as an incentive. The options give employees the right to buy the company's stock for as long as 10 years at a price set when the option is issued.
As a result, options can become very valuable if the company expands and the value of its stock rises substantially over time.
But shareholder advocates argued that financial statements issued by companies with stock options were misleading, because companies were not required to account for the value of stock options as an expense. After years of debate, FASB changed the rule in December.
The issue is important for Cisco because it grants options to all employees and because it will be one of the first companies to come under the new accounting rule.
The rule goes into effect June 15, for fiscal years beginning after that date. Cisco's fiscal year begins July 31.
Using the standard known as the Black-Scholes valuation model for expensing stock options could reduce Cisco's reported profits by roughly 20 percent, the company says.
Qualcomm said expensing employee options last quarter would have cut its profit by 13 percent.
"Black-Scholes is a well-established valuation technique that has been designed for short-term derivatives that are transferable and hedgeable," Keitel said.
In contrast, he added, "Employee stock options are long-term derivatives that are not transferable or hedgeable."
Cisco, the world's biggest maker of computer networking equipment, has discussed the new security with the SEC's accounting and economic analysis offices. While the regulator doesn't have to sign off on the plan, its approval would smooth the way for Cisco and other companies to use the derivative.
The proposed security, designed by investment bank Morgan Stanley, would have the same terms as Cisco's employee stock options, including the same exercise prices and five-year vesting schedule.
It would be sold once and couldn't be traded or hedged. Settlement of any gains would be with Cisco shares.
The plan could be easily modified for use by other companies.
Bloomberg News contributed to this report.
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